Spruce Point Capital Management Announces Investment Opinion: Releases Report and Strong Sell Research Opinion on WSP Global Inc. (TSX: WSP)
NOTE TO EDITORS: The Following is an Investment Opinion Issued by
Believes WSP is Experiencing Growing Financial and Business Strains Masked by Aggressive and Non-Standard Financial Reporting, Accounting and Reduced Transparency
Estimates That WSP’s Free Cash Flow Conversion is Approximately 38%, Materially Below Management’s 110% Claim Which Does Not Account for Recent Whistleblower Allegations of Tax Evasion
Questions Revisions to the Accounting for Provisions to the Wood E&I Acquisition That Were Made Beyond One Year as Allowed Under IFRS and Appear to Improve Adjusted EPS and EBITDA
Expresses Concern with WSP’s Board and Audit Committee Which is Stacked with Local Montreal Business Executives, with WSP’s Chairman of the Board’s Association with an Accounting Fraud and with its Vice Chairman Who Was Sanctioned For Violating Professional Code
Sees 25% to 50% Long-Term Downside Risk to WSP’s Share Price
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Spruce Point Report Overview
Headquartered in
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.
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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.
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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 fromCanada . 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. ChairmanChristopher Cole omits on his biography that he was Non-Executive Chairman ofRedcentric plc Pierre Shoiry was President and CEO from 1995 to 2016 where he groomed the current CEOAlexandre 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 theDisciplinary 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 OnMarch 29, 2024 , WSP announced thatMr. 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 withMontreal 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.
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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 atC$182.26 ) inNovember 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
About Spruce Point
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