Merger woes: People attend the launch of an Alstom train in Paris. The company’s acquisition of Bombardier has been troubled. — Reuters
AROUND once a decade, Alstom SA suffers an oh-so-very French existential crisis. A train manufacturer prone to such frequent calamities requires a stronger balance sheet.
Shares in the French rail giant have cratered by more than one-third since it warned last week of a shocking ¤1.15bil cash outflow which investors fear puts its investment-grade credit rating at risk. Management said an equity raise is “not on the table,” but I think Alstom’s capital structure is no longer fit for purpose.
A disastrous Canadian acquisition explains why.
To recap: In 2003, Alstom had to be rescued from the brink of bankruptcy following massive losses stemming from technical problems with gas turbines. In 2014, with debt rising again and US corruption investigators breathing down its neck, Alstom agreed sell its sprawling energy activities to General Electric Co (GE).
Though a proposed merger with Siemens’s train business was blocked by the European Commission in 2019 on competition grounds, Alstom succeeded in acquiring rival Bombardier Inc’s train unit in 2021. Investors hoped its problems were over and the world’s largest train manufacturer outside China would profit from global decarbonisation and urbanisation trends.
The two companies’ product and geographic exposures are complementary, and it now has more bargaining power with customers – essential when rail clients tend to demand margin-sapping bespoke kit and manufacturers bear too much risk when something goes wrong.
But these positives have been overshadowed by Bombardier’s woeful finances and project management. In the two years after closing the ¤5.5bil deal, the French group burned through ¤1.7bil of cash. (In hindsight, I was also much too optimistic.)
Analysts now reckon Bombardier’s rail business was starved of capital, it bid on too many contracts to generate cash and supplier payment terms became stretched. Alstom was left in the invidious position of having to rectify several billion euros worth of delayed or technically deficient Bombardier rail deals while repairing supplier and customer relationships.
Last year, Alstom brought arbitration proceedings against Bombardier at the International Chamber of Commerce over alleged breaches of the takeover agreement. Bombardier intends to defend itself “vigorously” and is challenging certain adjustments Alstom made to lower the purchase price.
Those familiar with the massive impairments GE took after buying Alstom’s fossil power activities can be excused for feeling some schadenfreude at the French company’s predicament.
Although it has made progress fixing those legacy Bombardier contracts, the group’s working capital remains alarmingly volatile. Around one-third of the cash shortfall reported last week stems from not being paid yet on British rail contract that Bombardier won.
Amid worries there may be other nasties lurking in Alstom’s ¤87bil order book, its market capitalisation has shrunk to just ¤5.3bil – around 70% below the 2021 peak. Short interest in Alstom as a percentage of the Alstom free float climbed to almost 20% in July and is still elevated at around 9.5%, according to IHS Markit data.
Hedge funds who spotted Alstom’s problems early, such as Marshall Wace LLP and Ako Capital LLP, have done well.
Though Alstom hasn’t yet published updated financial statements, I estimate its net indebtedness (including lease obligations) has increased to almost ¤4bil – a figure that doesn’t include other liabilities such as pensions, provisions and customer advances.
That’s a shocking deterioration from the ¤600mil of net cash Alstom had in March 2020 after paying out GE sale-related dividends, according to data compiled by Bloomberg, especially given that the Bombardier transaction was funded mostly with equity.
When asked to describe an appropriate balance sheet for Alstom in 2017, its chief executive officer Henri Poupart-Lafarge said he preferred a net debt position of close to zero “because we know that we have volatile working capital. We know that we are partially financed by our customer”.
He was referring to how train manufacturers collect prepayments from clients ahead of delivering rail equipment.
Alstom also relies on around ¤26bil of customer bonding arrangements – guarantees provided by a bank or insurer that it will deliver what it promises.
“Alstom should ideally be run with negligible net debt,” Redburn Atlantic analyst James Moore told clients last week.
“This was the plan, but it was torpedoed by acquiring Bombardier Transportation, a company with extremely poorly funded working capital.”
Moody’s downgraded Alstom in May, leaving it just one notch above junk. Investors worry a cash-flow warning of this magnitude may force the rating company’s hand again.
Were Alstom to lose its investment-grade status, the cost of new bonding guarantees and the commercial paper it uses for short-term liquidity would increase, and some clients may be deterred from placing orders.
This would represent a stark change from 2021 when Alstom was able to sell bonds with a 0% coupon, and its commercial paper borrowings had a negative interest rate.
Fortunately, Alstom doesn’t have bonds maturing before 2026, it has ample access to liquidity and some of its cash burn should soon reverse as excess inventories are reduced. — Bloomberg
Chris Bryant writes for Bloomberg. The views expressed here are the writer’s own.
