Can Shaw Group Engineer a Comeback?

 | Oct 14, 2011 | 1:48 PM EDT
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Just as The Southern Company (SO) and SCANA Corp. (SCG) are about to begin building new nuclear power plants, their engineering procurement and construction (EPC) contractor, The Shaw Group (SHAW) is watching its stock sink. Shaw's shares peaked at $41.05 March 4 and closed at $20.99 Thursday; the Baton Rouge, La., company's market capitalization has fallen nearly 49% in just seven months.

What is going on with Shaw and what does it mean for Southern and SCANA's new nuclear units?

Financially, Shaw appeared to be under stress last quarter. While it has plenty of cash, its quick ratio was slightly under 1.0, debt-to-asset ratio was about 0.81, debt-to-equity ratio was 4.24, and stockholder equity was approximately $1 billion. Over half of stockholders' equity is tied up in goodwill and the remainder is locked into $850 million worth of plant property and equipment of unknown market value. Last quarter, Shaw booked a 16.7% year-over-year decline in revenues, earning less than 1% in gross margin, and incurred more than $129 million in losses for earnings before interest, taxes, depreciation and amortization. Who knows what happened last quarter, but the last four were dismal.

One thing that did happen last quarter was Shaw decided to sell its 20% ownership in Westinghouse Electric, the technology provider for the AP1000 nuclear steam supply system. Westinghouse is only weeks from receiving the Nuclear Regulatory Commission's coveted design certification for the AP1000 reactor. (A design certification from the NRC is considered the gold standard internationally.)

According to World Nuclear News, Shaw's option to trigger the sale was part of a deal struck when Toshiba and Shaw purchased Westinghouse from British Nuclear Fuels Ltd. in 2006. Shaw financed its 20% ownership of Westinghouse by issuing yen-denominated bonds. The agreement between Toshiba and Shaw included a put option through which Shaw could call on Toshiba to buy back the stake at any time before October 2012.

WNN reports that Shaw exercised that option in order to reduce exposure to the sliding dollar-yen exchange rate. The dollar value of the debt had grown by "over $600 million to a total of almost $1.7 billion." At the time the Westinghouse deal was consummated, $1 would buy about 116 yen, but the figure is only 77 yen today.

DealBook reports that by offloading Westinghouse, Shaw will be able to eliminate approximately $1.7 billion of debt. According to Shaw's  latest Form 10-Q, the "Japanese Yen-denominated bonds" were booked as a current liability and their carrying costs were approximately 30% less than the net income Westinghouse provided Shaw.

The 10-Q also shows that Shaw booked Westinghouse as a current asset worth slightly more than $1 billion. While there could be a one-time gain from the sale of Shaw's interest in Westinghouse, the strategic loss this sale represents to Shaw could be significant.

Separate statements from Shaw, Toshiba and Westinghouse emphasized a commitment to continue working together on the four Westinghouse reactors for Southern and SCANA. But future AP1000 projects may not include Shaw. Toshiba said they would consider other partners on a project-by-project basis.

This suggests Shaw will likely see new competition on the eight other AP1000s currently being licensed by the NRC for Progress Energy (PGN), NextEra Energy (NEE), and Duke Energy (DUK). Previously, Shaw had a lock on all these projects. Now, with its strategic relationship with Westinghouse gone, it seems Shaw also lost a strategic and competitive advantage for more than $60 billion worth of new construction.

More than these eight new AP1000 projects are in play. Westinghouse and Toshiba are marketing the AP1000 to the international community as one of the safest and most economic reactors in production that achieves the gold standard. In addition, Westinghouse and Toshiba have other reactor designs in the pipeline, including a small module reactor.

While Shaw is retreating, rival Fluor Corp. (FLR) is advancing. Fluor recently announced that it is investing in NuScale Power, a new reactor company focused on the small-modular-reactor business. NuScale's reactor design originated at Oregon State University in cooperation with the Idaho National Laboratory. The design is said to be inexpensive, inherently safe and proliferation resistant. It is currently in pre-application status with the NRC.

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