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ENA Investment Capital Calls on Bilfinger SE to Present Clear Targets and a Value Creation Plan

ENA Investment Capital (“ENA”) is a long-term, value orientated investment firm and the second largest investor in Bilfinger SE (“Bilfinger” or “the Company”). ENA has a disclosed stake of 10.33%.

Bilfinger will be hosting a Capital Markets Day on 13th February and is planning to outline a new mid-term guidance. ENA last week sent a letter (attached herewith) to Bilfinger’s Executive and Supervisory Boards outlining its expectations for this event and urging the Board and the management to provide shareholders with a transparent and accountable action plan to create shareholder value. ENA is publishing this letter today for the benefit of all shareholders.

Bilfinger is a listed German mid-cap company that has transformed from a construction company into an international industrial services pure-play, emerging from a multi-year restructuring phase under the current CEO, Tom Blades, who has been running the company since mid-2016.

There is no arguing the fact that Bilfinger’s share price has underperformed the market since the announcement of the Bilfinger 2017-2020 strategic plan by Mr. Blades (back in February 2017). There have been a series of mishaps and consistent execution failures resulting in recurring misses to margin and cash flow generation targets especially over the last 24 months, despite the management team’s hard work.

Moreover, while the Company reaffirmed its 2020 financial targets at the August 2019 investor presentation, only a few months later, on 13th November, Bilfinger’s management announced they were delaying their financial targets for 2020 by one year, thereby failing on their own 2017-2020 strategic plan.

It is evident that the market is under the impression that management is now treating any targets merely as a “general direction”.

As a result, Bilfinger shares have been trading at a large discount to peers (EV/EBITA 20e of 7.6x versus peers at >11-12x), and the share price is close to an all-time low. Unless management can restore investor trust, there will be no share re-rating, no reduction of the valuation discount to peers and the share price will continue to be undermined.

ENA has engaged constructively with Bilfinger for several months, before and after the decision to delay the 2020 targets, and has proposed ways to close this value gap.

Bilfinger’s management committed to provide a new mid-term guidance at the upcoming Capital Markets Day and ENA urges the Board to step-up and at last push the management team to realize the urgency and take the following actions towards a path for shareholder value creation:

  • Present clear organic revenue growth targets and be more aggressive in pursuing growth.
  • Communicate the key quantitative drivers for 2020 and 2021 margin improvement and outline its true underlying margin potential beyond 2021.
  • Introduce clear absolute cash flow targets that reflect the attractive underlying cash generation of the business.
  • Take measures to make better use of its currently inefficient balance sheet (~€400m gross debt despite gross cash of ~€450m or an estimated net cash position of >€50m in 2019).
  • Given the pending sale of Apleona by EQT – which could result in a net cash position of ~€500m by year-end 2020 – commit to return cash to shareholders either via a buyback or a special dividend.
  • Cancel the existing treasury shares as the current share price (~€32) does not support keeping them given they were bought at much higher levels (~€38 per share).
  • Engage external advisers to conduct a proper strategic review of its business portfolio and assess if it is the best owner for each individual unit as monetizing some of these assets can highlight Bilfinger’s more resilient and attractive maintenance services business.

Bilfinger has a strong and attractive core business with great turnaround potential and strategic value. A more ambitious approach by management to pursue the organic growth opportunity, target best-in-class margins and address structural issues (e.g. balance sheet, treasury shares, business portfolio) has the potential to drive the stock back to its previous levels of more than €50 per share (>50% upside) as discussed with the Company.

In addition, the reported plans of EQT to sell Apleona in H1 2020 (where Bilfinger maintains a 49% stake) could translate into proceeds of ~€350m. Hence, Bilfinger could have a ~EUR500m net financial cash position by year-end 2020, which would be equivalent to ~40% of its current market capitalization. This is largely overlooked.

ENA has engaged with the company but has been consistently disappointed with the lack of progress. The time is now for the Chairman and the Board to ensure that the management sets and achieves financial targets that deliver shareholder value.

It must not fail again.

ENA is making its expectations public so that all shareholders can support ENA’s plan for real value creation at Bilfinger.

The full detail of the letter is included in the release below.

-Ends-

To the Executive Board and the Supervisory Board of Bilfinger SE

Oskar-Meixner-Straße 1

68163 Mannheim, Germany

4 February 2020

Dear Mr. Blades, Dr. Cordes and Members of the Executive and Supervisory Boards,

We have enjoyed the constructive and open dialogue with you over the last several months. We have high expectations for Bilfinger’s Capital Markets Day (CMD) on 13th February, including the details of your 2020 guidance and the announcement of mid-term targets. The fact that the CEO’s contract expires next year and that discussions about his extension, we expect, should start imminently adds further significance to this event.

While we believe other Bilfinger shareholders share our view that next week’s CMD is an important value-determinative event, we understand that the company’s communications team has recently started to downplay its significance, which we worry is an attempt to lower expectations. Therefore, we want to make clear our expectations ahead of the event as we demand the company finally to provide its shareholders with a transparent action plan to create shareholder value .

You may recall that in November, before the announcement of Q3’19 results, we expressed our view that Bilfinger should commit to the 5% EBITA margin target for 2020, outline a clear plan of action and “do whatever it takes” to achieve its very own target for 2020 as part of the 2017-2020 strategic plan. As you know, we were extremely disappointed that you did not take our constructive opinions on board. Bilfinger’s -7% share price reaction on the day of that announcement suggests we were not the only ones that were disappointed. The board, and more importantly the management team, missed their own targets, once again, and spoke with complacency rather than urgency .

Speaking to investors and various market participants since, there remains a lot of skepticism about management’s targets and their accountability to them. But above all, there is a high level of skepticism about whether the board actually has a credible plan to create shareholder value . A lot of work needs to be done to restore credibility with the market and investors’ trust. This process should start with confident, assertive and clear targets at the 2020 CMD on 13th February with accountability and responsibility for those by both the Executive and Supervisory Boards . We therefore regard the CMD as a very important catalyst for Bilfinger’s equity story.

Dear Chairman and members of the Supervisory Board, we urge you to seize this opportunity to push management to finally present a clear action plan to create shareholder value and to address the topics below.

PRESENT CLEAR ORGANIC REVENUE GROWTH TARGETS

  • Bilfinger’s recent communication for a flat organic revenue development in 2020 has disappointed both us and the market.
  • We understand that you expect that growth might return in 2021 on the back of the much awaited Hinkley Point order. However, based on our due diligence, we have doubts about the timing of the Hinkley Point order as communicated by management. These doubts are compounded by the fact that management has been consistently wrong about the timing of this order for the past two years.

Most prominently and very recently, management indicated in August 2019 (and even included this on a slide in the Q2 results presentation) that the order was expected to come in H2 2019. To date there has been no announcement confirming this order. This has increasingly concerned shareholders as it is seen as an important element in the ability of the Group to achieve its targets. We fully acknowledge that Bilfinger is in prime position to execute work at Hinkley Point, but we also believe that management and the board should act prudently and prepare for a less favorable outcome.

In the meantime, management needs to be more aggressive and pursue growth in the rest of the business. It cannot just sit back in hope. At present, Bilfinger lacks a mid-term organic revenue growth guidance1 and the market doubts2 that Bilfinger can continue the positive growth trajectory it has shown during the past two years (2018 and 2019). Management needs to clearly outline its organic growth plans for the next years .

In light of concerns about revenue growth, we stress once again the importance of addressing the cost base, which leads us to the next point.

OUTLINE CLEAR STEPS TO ACHIEVE 5% EBITA MARGIN EXITING 2020 – MOREOVER, OUTLINE THE MARGIN POTENTIAL BEYOND

  • In your Q3’19 results, you missed once again your own targets and decided to delay your 5% EBITA margin target by a year and instead guided to 4% EBITA margin for 2020.
  • Moreover, you failed to outline clearly enough what exact steps the company will take to achieve this margin improvement by 2021. The comments made during the results release in November were unclear and didn’t provide comfort to investors.

As a result, the market has been unwilling to believe these targets. In a recent note, UBS, which estimates 2021 margins at 4%, described the 5% as “more aspirational” and “do not envisage the group achieving the 5% mid-term target in the foreseeable future”. It is therefore critical that you communicate the key quantitative drivers for the EBITA margin improvement in 2020 and 2021.

Considering the flat topline guidance for 2020 and the uncertainty around the Hinkley Point order, it is not just prudent – but imperative – that management steps up and takes appropriate action that will safeguard the delivery of the 5% margin. Based on the conversations we have had with the management team over the past few months, we understand there is additional scope for cost cutting over and above what was announced last November. We were disappointed that you decided not to try to fulfill your own targets. Management cannot fail on this again.

Finally, we believe you should give the market a clear indication that reaching the 5% margin level exiting 2020 and for the full year 2021, is not the end goal for Bilfinger but rather the basis for further margin expansion beyond. Management must communicate Bilfinger’s true underlying margin potential , now that we are past the restructuring phase and the US DOJ Monitorship. We see this EBITA margin potential significantly above 5%.

INTRODUCE CLEAR CASH FLOW TARGETS

  • Investors’ patience has worn out with the lack of cash flow generation.
  • However, we believe this was largely a function of significant one-offs during the restructuring phase that have masked the underlying cash generation of the business.

It is important that management re-assures the market on Bilfinger’s significant cash generation potential. Bilfinger should introduce clear absolute cash flow targets 3 that the market can relate to and the management can be held accountable for.

Finally, we reiterate once again the urgent need to introduce and communicate clear working capital targets, rigorously implement them into the organisation across all legal entities, and incorporate them into incentive plans.

REVIEW BALANCE SHEET, CAPITAL STRUCTURE AND CAPITAL ALLOCATION POLICY

  • Bilfinger lacks a clear capital allocation policy.
  • To align with your peers, the market needs a clear statement about the priorities for the use of cash.

Shareholders expect clarity about measures to create shareholder value with a potential balance of >€800m of cash which equates to two thirds of your market capitalization.

According to your own targets, Bilfinger will have a net financial cash position by year end 2019. In addition, you forecast that you will generate significant positive free cash flow in 2020. On top of this, we understand that EQT is preparing for the divestment of Apleona in 2020, and we estimate Bilfinger’s stake could fetch a valuation significantly in excess of the €240m carrying value4 . Added to the positive free cash flow generation you expect for 2020, this means Bilfinger could end 2020 with a very sizeable net cash position of up to €500m5 .

Further, given most of Bilfinger’s industrial engineering and maintenance peers operate with leverage ratios of around 2x Net Debt/ EBITDA, we see no reason why Bilfinger should target anything less than 1.5x Net Debt/ EBITDA6 .

Relevering to 1.5x FY20 EBITDA would release a further €360m7 of cash that can be more efficiently deployed.

In combination with the recently issued debt instruments, such a capital structure is clearly inefficient. You should announce plans to review your capital structure including the consideration to return cash to shareholders either via a buyback or a special dividend .

…AND CANCEL THE TREASURY SHARES

  • The current share price of ~€31 does not provide a rationale for keeping the treasury shares, given they were bought at much higher levels of ~€38 per share in 2018. One cannot even argue that shares bought at €38 on the understanding that the share price grossly undervalued the company should be kept for potential acquisitions while the share price is at its lows again.
  • The cancellation of the current treasury shares can be executed at short notice and could be immediately accretive.

We observe that parts of the analyst community (including media outlets such as Bloomberg) and the less sophisticated stock market participants fail to adequately adjust for the existence of treasury stock. This results in an incorrect calculation of the market capitalization and earnings per share which holds back Bilfinger’s share price. Given the prospects of a near-term cash windfall from the Apleona divestment, we fail to see any rationale of keeping the treasury shares as an acquisition currency or otherwise.

CONDUCT PORTFOLIO REVIEW & REASSESS M&A STRATEGY

  • The core business of Bilfinger is its European maintenance business.
  • Bilfinger is the clear market leader in maintenance services in the industrial cluster of Northern Europe (DACH, Benelux, UK, Scandinavia). While Bilfinger’s non-European businesses in the Middle East and US (E&M International) are valuable, the company is limited by lack of scale in those regions.

We think that as Bilfinger’s core business starts to turn the corner this year, Bilfinger needs to decide whether to divest some of these businesses or to double down.

…ESPECIALLY REGARDING THE TECHNOLOGIES DIVISON

  • A portfolio review is particularly relevant given the recent repeated execution issues in the Technologies division.
  • The Technologies division is heterogeneous to start with. It has been suffering from execution related project losses and capacity underutilization. Further, the division is also subscale from a global perspective, and attempts to turn around the division have been unsuccessful so far. There are no synergies with the core maintenance businesses.

In addition, its project-based nature means revenue is by nature lumpy, leading to low visibility and significant quarterly earnings volatility which can be disproportionately scrutinized by the market. While not right for Bilfinger, this division is exposed to positive end-market trends and contains very attractive assets for which a private company or a large strategic player might be a more appropriate owner.

In summary, as the cost cutting plan and EBITA margins are getting addressed, Bilfinger should run a strategic review of both the non-European businesses (E&M International) and the Technologies division and find the best owners for each individual unit. If these assets can be monetized at the appropriate prices, it will highlight Bilfinger’s more resilient and attractive maintenance services business.

Given the balance sheet structure as discussed above, Bilfinger has many options to unlock value and shareholders expect a clear set of criteria and priorities in order to do so. Given Bilfinger’s mixed track record when it comes to acquisitions, we believe it is important that Bilfinger runs a proper strategic review with the help of external advisors .

CONCLUSION

After failing to deliver the 2017-2020 strategic plan and going through a number of management and board changes, we cannot stress enough that we see the 13th February CMD as management’s last chance to present a path to create shareholder value and underwrite a specific value creation plan . Detailed mid-term targets to address the points above are a clear prerequisite. We see it as the board’s responsibility to ensure these targets are being set appropriately and met accordingly. The board cannot fail again.

As always, we look forward to continuing an open dialogue and discussing the company’s results and strategy with both the Executive Board and the Supervisory Board at any time. Moreover, we would be willing to support a proposal for an incentive plan at the next AGM that would be based on realizing the shareholder value creation plan that we expect to be announced next week.

Very Kind Regards,

ENA Investment Capital

1 The 2017-2020 growth CAGR has effectively been abandoned with the November 2019 downgrade.

2 UBS has recently downgraded not only the 2020 growth to 0% in line with guidance (versus +3% previously) but now also reduced 2021 growth estimates to 0%.

3 The present cash conversion target is rather vague.

4 UBS recently estimated the present value of the stake at €305m in the base case and €350m in an upside case; Mainfirst uses a valuation of €315m in the base case.

5 31 December 2019 estimated net financial cash position of c.€50m, proceeds from sale of Apleona of c.€350m and 2020e free cash flow of >€50m.

6 Core peer Wood Group, for example, has a target leverage ratio of 1.5x Net Debt/ EBITDA and clearly defines priorities for uses of cash.

7 Based on Bilfinger’s guidance for flat revenue growth in 2020 and 4% EBITA margin.

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