Out of the Wood

Chief among these issues is the involvement of the Serious Fraud Office (SFO). The anti-corruption body’s sprawling criminal investigation into Monaco-based fixer Unaoil has dragged in both Wood and Amec, the latter of which is under investigation over its historic use of third-parties “and possible bribery and corruption and related offences”. That probe was formally disclosed in July, two months after Wood told shareholders it had opened an internal investigation into its own past links to Unaoil. This week, Wood said it was unable to conclude whether payments made to Unaoil were used “in ways that would amount to bribery, corruption or money laundering offences”, or whether the oil services company had been complicit in any untoward activity. It is hard to see how this will be positive for the shares.

It is equally hard to quantify the various probes’ significance or likely cost. As analysts at Morgan Stanley suggested this week, the spectre of historic fraud has already deleted $500m-$600m (£390m-£470m) of market capitalisation value, which the bank argued is “more than adequately priced in”. Unlike peer Petrofac (PFC) – itself the subject of an SFO investigation – both Amec and Wood appear to have co-operated with prosecutors from the start. Encouragingly, the fallout does not seem to have prevented either group from winning new work this year – most recently Wood’s five-year service maintenance contract from Houston-based Phillips 66 (US:PSX).

But fraud investigations have a habit of dragging on, which is particularly unwelcome given the state of Wood’s end markets. In the first half of 2017, pre-tax profit declined 77 per cent year on year to $13.5m, as clients cut back spending, and weak trading in the North Sea persisted. As energy consultancy Wood Mackenzie recently pointed out, new conventional oil and gas projects – the source of much of Wood Group’s historic revenues – are “in crisis”, and are being approved on a more selective basis by a dwindling number of large players. That presents an enduring challenge to service company margins.

Interim profit would have been higher were it not for the Amec deal, which soaked up $25.2m of exceptional costs. The kickback to the combined group, we were reminded, will be “at least $170m” of annual cost synergies, down from an original estimate of $200m due to the need to dispose of Amec’s UK upstream oil and gas assets to satisfy competition authorities. As both companies' trading suggests, this is not an obvious sellers' market.

Wood's management will counter that Amec’s hodgepodge business lines bring a breadth of engineering expertise in other areas, although the recent performance in Amec’s solar division suggests otherwise. And as Macquarie analysts remarked at the time of the deal, new positions in environmental, infrastructure and mining work seem to be “more an outcome of the deal rather than a primary driver".

Amec brings something else to the table: large borrowings. As of June, its net debt stood at £989m, or 3.7 times cash profits (earnings before interest, tax, depreciation and amortisation, Ebitda). Wood’s own trailing ratio is 1.2, but with profits under pressure we think the combined group will struggle to meet its stated aim of bringing net debt to between 0.5 and 1.5 times Ebitda within 18 months of the merger.