20/11/2013 - 05:50

Growth does not equal success

20/11/2013 - 05:50

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Forge Group’s current troubles cast its rapid expansion in a new light.

Three months ago, Forge Group managing director David Simpson spoke at a business breakfast about the company’s profitable expansion.

Forge had achieved strong growth in sales and profits, picked up a swag of new contracts, and acquired an engineering business in North America.

I asked Mr Simpson how he was going to keep tabs on the rapidly expanding business.

He acknowledged the challenge but, as always, expressed full confidence in the ability of his management team to handle the task.

It is now apparent that all is not well at Forge, which put its shares into a trading halt on November 4 and is yet to resume trading.

For a company that aspired to be like market leader Monadelphous, Forge has found itself in a terrible state.

The repeated extension of its shares’ suspension adds to the gravity of market concerns.

With the likelihood of a large and deeply discounted capital raising, prospects are getting worse for Forge shareholders.

While clearly premature to pinpoint what went wrong, it’s interesting to look back at some notable moments in the company’s recent history.

Forge has announced that its problems stem from two power station contracts – the $420 million Diamantina project in Queensland, and the $150 million West Angelas project in the Pilbara.

It acquired both contracts when it purchased local company CTEC in January 2012.

The purchase followed the usual due diligence review, and also included earn-out clauses that tied payments to vendors to profits in the 2012 and 2013 financial years.

Earn-out clauses are designed to reduce risk for the buyer, and provide an added incentive for vendors to keep things on track – but in this case the problems only came to light after the earn-out period had expired.

It will be interesting to see whether Forge is able to retrieve any of the profit-based payments made to the vendors.

The company was still run at the time by Peter Hutchinson, who led Forge with great success for five years.

He talked up CTEC’s business model, saying it lowered risk where possible via sub-contracting and procuring items guaranteed by “renowned international suppliers such as Siemens and GE”.

As events have transpired, Siemens is one of the suppliers that Forge is currently locked in negotiations with, to try and sort out its problems

One day earlier, when Mr Simpson’s appointment was announced, the company said one of his key priorities was to deliver on the “growth and stretch targets set by the board”.

At that time, Forge had about $500 million of committed work.

In its most recent accounts, at June 2013, Forge had a $1.3 billion order book; that has been followed by several other big contract wins, including a $1.47 billion joint venture on the Roy Hill iron ore mine.

In other words, it has achieved extraordinarily rapid growth in a market where many of its peers have been battling to achieve any growth.

The rapid expansion allowed Forge to include a glossy graphic in its annual report, showing its “global footprint”.

The company described itself as a “global industrial, with over 2,000 employees working across eight countries on four continents”.

But bigger, clearly, is not better. 

Despite the growth, the market has had misgivings about Forge.

Its share price peaked at about $6.70 in early 2011 and reached the same levels in early 2012 and early 2013. But it has slumped sharply every year, trading at $4.18 before entering its trading halt.

Forge told the market this week that all contracts, excepting the two power stations, are going fine. Unfortunately it only takes one or two bad contracts to bring the good work undone.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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