China Civil Engineering Construction Corporation (CCECC) is said to be interested in making a bid for infrastructure group Balfour Beatty (LSE: BBY), the Sunday Times reported. Balfour Beatty, which recently scrapped its dividend, has been suffering from low margins and cost overruns relating to its UK construction projects.
CCECC, a subsidiary of the state-backed China Railway Construction Corporation, is said to be particularly interested in Balfour Beatty because of its involvement in building Crossrail and other major infrastructure projects. Balfour Beatty also has attractive growth opportunities in Asia through its joint venture in Hong Kong and Singapore, which has secured contracts to build affordable homes and transport infrastructure.
Carillion and John Laing Infrastructure Fund are also interested
The Chinese construction company is not the only suitor for Balfour Beatty, as local rival Carillion (LSE: CLLN) had already made three offers for the company, all of which had been rejected. Carillion, which has a smaller market capitalisation than Balfour Beatty, has so far only made opportunistic bids. It could come again with a more serious offer, now that another potential bidder is interested.
In addition, John Laing Infrastructure Fund (LSE: JLIF) had proposed to acquire Balfour’s PPP (public-private partnership) infrastructure portfolio for approximately £1bn. But, this offer was too rejected as it did not fully reflect the value of its assets, and management sees synergies from owning investments and the group’s other businesses in construction and support services.
“Build to Last” restructuring programme
The growing bid interest reflects increasing confidence in the company’s expected turnaround. Its restructuring programme, “Build to Last”, plans to reduce costs, simplify its organisational structure and improve management’s oversight. The expected cost savings over the coming two years is expected to total £100m, with an improvement to operating cash flow of £200m.
Aggressive project bidding before the recession and lax cost control is the cause of its legacy issues with the UK construction business, which is largely to blame for its recent underperformance. In little more than two years, the company gave six profit warnings and hired KPMG to conduct a review of its UK construction business. The review found further funding shortfalls and led to an additional write-down of £118 million to the value of its construction business.
Although low margins from construction has forced Balfour Beatty to scrap its dividend and cancel its share buyback programme, the company has a sizeable investment portfolio of post-construction infrastructure assets. Including £55 million of construction assets, its investment portfolio is worth £1.3 billion at the end of 2014. These assets generate fairly stable cash flows, which should give the company enough financial flexibility to turnaround its construction business.
A turnaround play?
Balfour Beatty currently has a forward P/E ratio of 28.0, as analysts expect legacy issues will continue to crimp earnings in the short run. The restructuring programme is expected to take two more years, and the firm’s much needed cultural change will probably take even longer.
Analysts expect earnings per share will recover to 14.5 pence by 2016, which means its shares trade at 17.2 times its expected 2016 earnings. Although that still looks pricey, much of the company’s underlying value comes from its infrastructure investment assets, which generate high levels of cash flow. With plenty of bid interest effectively putting a floor on Balfour Beatty’s share price, the company is an attractive turnaround play.