Quebec engineering firm WSP Global Inc. WSP-T saw its shares fall Wednesday after an attack by a prominent U.S. short-seller.
Spruce Point Capital Management LLC, which has targeted a number of Canadian companies over the past half-decade, criticized WSP’s accounting and leadership in a 68-page report called “Poorly Engineered Financials.” Spruce Point argued that investors are wrong to believe WSP is a savvy acquirer with industry-leading profit margins and it sees 25-per-cent to 50-per-cent downside risk to the company’s stock.
WSP shares traded down as much as 7.4 per cent in Wednesday’s trading.
“WSP is aware of the short-seller report,” the company said in an unsigned statement sent to The Globe and Mail via e-mail. “While the report is being reviewed by our team, WSP upholds the highest levels of governance standards, and we take our obligations in this regard seriously.”
Short-selling shares is a bet that a company’s stock price will drop. An investor borrows shares, sells them and repays the loan by returning new shares, hopefully bought at a lower price. Spruce Point chief executive officer Ben Axler would not say how large the firm’s WSP short position is, saying securities laws do not require that disclosure.
Spruce Point had big winners in 2018 with a bet against Maxar Technologies Ltd., the former MacDonald Dettwiler & Associates Ltd. and in 2021 with Lightspeed Commerce Inc. and Nuvei Corp. Short campaigns against Dollarama Inc., Canadian Tire Ltd. and GFL Environmental Inc. from 2018 to 2020 had less impact. Its most recent Canadian short idea, in November, 2022, was Saputo Inc. The dairy-seller’s shares fully recovered from the Spruce Point news but now trade 20 per cent below their prereport close.
Spruce Point says WSP shouldn’t exclude merger-and-acquisition costs or the expense of a new enterprise resource planning software system when it presents EBITDA, or earnings before interest, taxes, depreciation and amortization. “WSP’s business strategy is to be an industry roll-up acquiror in the engineering services industry,” Spruce Point writes. “Yet, the company wants investors to ignore ordinary and necessary costs to implement its strategy.”
While WSP has presented adjusted EBITDA margins ranging from 16.8 to 17.6 in each of the past three years, Spruce Point argues adding back those items would bring the margins down to a range of 14.5 per cent to 15.9 per cent – more in line with competitors like Edmonton-based Stantec Inc.
Spruce Point also flagged WSP’s 2022 acquisition of the Environment & Infrastructure business of John Wood Group PLC. As part of merger accounting, WSP estimated the E&I business’s provisions for future uncollectible revenue.
Spruce Point alleges the provisions were more than four times industry standards. That, Spruce Point argues, creates a “cookie jar” that can be dipped into to improve earnings. (When a company reduces a provision amount, it takes a credit to earnings.)
And Spruce Point alleges that’s what WSP did to meet expectations for its fourth-quarter 2023 earnings. Spruce Point observes a $9.6-million decrease in the provision in the quarter, the first period after it announced the “final” provision balance from the acquisition. That would add $9.6-million to profits if run through the income statement.
WSP reported fourth-quarter adjusted EBITDA of $525-million, just above the FactSet analyst consensus expectation of $522-million. The results, Spruce Point says, “would be less spectacular” if the provision had not been reduced. ”The ‘strong’ results gave cause for analysts to proclaim spectacular results and raise WSP’s price target.”
Spruce Point also says WSP is not nearly as good as it claims at converting its reported profits to cash flow. It says that while WSP is allowed under International Financial Reporting Standards to remove interest expense from its operating cash flow numbers, thereby boosting them, many other publicly traded engineering firms do not. Spruce Point also says WSP consistently spends less on capital expenditures than it annually forecasts, another means of boosting its cash-flow numbers.
“WSP trades at the highest valuation among its global peer group despite clear evidence of business and financial challenges,” Spruce Point says. “The premium may exist because investors believe WSP is a superior acquiror and operator within the industry.”
In a report issued Wednesday, analyst Maxim Sytchev of National Bank Financial attempted to rebut Spruce Point. “In a nutshell, we believe the disclosure is in line to the industry peers. ... We are buyers of the shares on the sell-off.”
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David Milstead