Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on WSP Global Inc. (TSX: WSP)
Spruce Point Capital Management, LLC ("Spruce Point" or "we" or "us"), a New York-based investment management firm that focuses on forensic research and short-selling, today issued a detailed report entitled "Poorly Engineered Financials" that outlines why we believe shares of WSP Global Inc. (TSX: WSP) ("WSP" or the "Company") face up to 25% to 50% long-term downside risk, or approximately C$110.00 ? C$165.00 per share. All figures are in Canadian Dollars unless otherwise noted. Download or view the report by visiting www.SprucePointCap.com for additional information and exclusive updates.
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Spruce Point Report Overview
Headquartered in Montreal, Quebec, Canada, WSP Global Inc. is an engineering and professional services firm focused on transportation and infrastructure, earth and environmental, property and buildings, and power and energy end markets. The Company was formed when Canada's Genivar Inc. (TSX: GNV) acquired WSP Group plc in the U.K. in 2012. In April 2013, Genivar changed its name to WSP Global Inc. to distance itself from a corruption scandal where it was eventually ordered to pay a $4 million fine for bid-rigging. Ever since, WSP has been built largely as a roll-up acquiror and has acquired 22 companies totaling $4.3 billion since 2020. WSP has 66,500 employees globally with an equal balance of private and public sector clients, and over 90% focus on OECD countries. For the year ended 2023, WSP reported $14.4 and $1.9 billion of gross revenue and Adj. EBITDA, respectively.
The concerns we outline in our report include:
- WSP appears to be under greater financial and business stress than is evident by its increasingly opaque financial reporting. Spruce Point believes WSP's financial transparency is weakening and could be improved. Nonetheless, we uncover clues that WSP is experiencing increased growth challenges and financial stress. Industry consolidation is driving up demand for human capital, and headcount growth is accelerating among the smaller players, while we estimate WSP's headcount declined organically in 2023. WSP's two largest acquisitions of Golder (2021) and the Environmental & Infrastructure (E&I) business of John Wood Group plc (2022) appear to have added financial strains to the Company, while tuck-in acquisitions are exhibiting shrinking margin contribution, and appear to have a significantly lower Adj. EBITDA margin profile than WSP consolidated, despite the CEO claiming recent deals have similar margins. After a period of strong days sales outstanding ("DSO") improvements in 2020-2021, the metric increased in 2022 and came in above target in 2023. However, we believe WSP's DSOs are higher than reported since it excludes other receivables. Our measure of working capital to LTM revenues also indicates rising financial stress. WSP's backlog to LTM revenues is declining and our analysis of acquisitions in 2022 and 2023 indicates that acquired net order intake to estimated acquired revenue is plummeting. WSP recently made changes to its backlog definition which we believe has made it even more confusing and limited relative to definitions used by global peers. Furthermore, WSP only reports backlog by geography, and not by market segment, which would provide investors with a better understanding of its business. WSP also ceased quantitative disclosure about the percentage of revenue generated from cost-plus contracts with ceilings and fixed-price contracts from cost-plus contracts without stated ceilings. These types of revenue contracts have historically been a Key Audit Matter noted by PwC. In addition, PwC removed the statement that it tested the effectiveness of controls over costs.
- Cash flow and earnings quality appear to be embellished by aggressive and problematic accounting revisions. Spruce Point believes that WSP's Adj. EBITDA margin increase is purely an accounting mirage. WSP's business strategy is to be an industry roll-up acquiror in the engineering services industry. Yet, the Company wants investors to ignore ordinary and necessary costs to implement its strategy. In reality, we believe that WSP's margins are not increasing, but rather declining. WSP also recently changed the language in its revenue recognition policy, stating that it reviews costs on a "periodic" vs. "monthly" basis which could enable management to defer cost updates to projects that would lower reported margins. Despite frequently meeting revenue and Adj. EBITDA targets, WSP has consistently missed its net capex forecast by a large margin over the past four years, which is a lever that management can use to temporarily improve free cash flow. However, we often find consistent capex misforecasting to be an indicator of future underperformance. WSP claimed that free cash flow conversion was 110% in 2023, excluding a tax issue. Even despite the tax issue, we believe WSP generated free cash flow by materially pulling back on capital spending relative to its initial guidance. In addition, WSP reports approximately $197 million of net interest expense (excluding interest on lease liabilities) through the financing section of its cash flow statement. By reclassifying this as an operating expense and cash flow reduction, consistent with industry peer reporting practices, we estimate WSP's free cash flow conversion to be 36% to 41%. We also uncovered errors in cash flow classification in a foreign filing. Even more alarming, a former WSP India employee acting as a whistleblower has alleged that the Company evaded tens of millions in taxes, which if found to be true, could be another lever used by management to embellish free cash flow. We also find evidence that WSP has revised its provision balance for the Wood E&I business beyond 12 months as allowed by International Financial Reporting Standards ("IFRS"). By reducing the provision, we estimate that WSP recorded approximately $10 million and $0.06 per share of Adj. EBITDA and Adj. EPS benefit in Q4 2023, respectively.
- We are troubled by WSP's Board leaders and Audit Committee which we believe needs fresh oversight with new members independent of management and the clubby Montreal business community. WSP promotes itself as a global company and now derives less than 20% of net revenues from Canada. However, we do not believe the Board reflects the nature or character of its business. For example, the two most senior Board members have professional stains on their records. Chairman Christopher Cole omits on his biography that he was Non-Executive Chairman of Redcentric plc (LSE/AIM: RCN) from 2014 to 2019 during a period in which it had a major accounting scandal involving missing cash and profit overstatement. Furthermore, Vice Chairman Pierre Shoiry was President and CEO from 1995 to 2016 where he groomed the current CEO Alexandre L'Heureux. Mr. Shoiry was blasted by the Order of Quebec Engineers and was fined for acts derogatory to the honor of the engineering profession. As stated by the Disciplinary Council, "Mr. Shoiry violated the Professional Code by failing to put in place the measures required to monitor the application of internal guidelines on competitive bidding processes, in order to prevent, stop, or eliminate the dishonest and doubtful practices occurring in the firm."1 On March 29, 2024, WSP announced that Mr. Shoiry would retire from the Board. We believe investors should be highly suspicious of the timing of his retirement considering our report's findings. In addition, WSP's audit committee is stacked with Montreal business executives who have worked at other public companies that have come under criticism from activist short sellers including Spruce Point. Finally, we take issue with WSP's Compensation Committee and its decision to reward management based on short-term incentive metrics that are fundamentally different from results provided to investors.
- We believe WSP's shares present a poor risk/reward while trading at an unwarranted premium to peers. WSP's shares are trading near an all-time high price and within 8% of the sell-side consensus price target on the belief that it is a high quality ESG business firing on all cylinders and management is executing well. Based on our forensic research, we have a fundamentally different opinion and believe WSP will struggle to grow because attracting and retaining qualified human talent and sourcing quality and margin accretive acquisitions appears to be growing more difficult. We believe WSP is exhibiting many classic signs of a struggling company including changing definitions of key performance indicators (KPIs) such as backlog, modifying revenue recognition language, delaying capital expenditures, allegedly evading taxes, and attempting to pass off necessary expenses to implement its strategy as adjustments to boost financial results. WSP trades at a premium multiple of 2.8x and 16x ?24E revenue and Adj. EBITDA and is leveraged at 2.3x Net Debt / Adj. EBITDA vs. 1.5x as depicted by WSP. Over 30% of shares are owned by retail investors who may be unaware of the problems we identified. However, the Canadian Pension Plan Investment Board (CPPIB), one of its largest institutional holders, recently liquidated $452 million of stock (~2.5 million shares at C$182.26) in November 2023 during the market rally. Valuing WSP's shares in-line with industry peers to reflect its rising fundamental challenges and financial strains suggests 25% to 50% downside risk (C$110 ? C$165 per share).
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Please note that the items summarized in this press release are expanded upon and supported with data, public filings and records, and images in Spruce Point's full report. As a reminder, our full report, along with its investment disclaimers, can be downloaded and viewed at www.SprucePointCap.com.
As disclosed, Spruce Point and/or its clients have a short position in WSP Global Inc. (TSX: WSP) and own derivative securities that stand to net benefit if its share price falls.
About Spruce Point
Spruce Point Capital Management, LLC is a forensic fundamentally-oriented investment manager that focuses on short-selling, value and special situation investment opportunities.
1 "The Disciplinary Council of the Ordre des ingénieurs du Québec fines Pierre Shoiry a total of $75,000", Ordre des ingénieurs du Québec , Feb 24, 2020
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