Stockholders will receive $46/share, a 72% premium

Chicago bridgeChicago Bridge & Iron (NYSE:CBI) agreed to acquire The Shaw Group (NYSE:SHAW) for $3.04 billion in cash and stock on July 30. The surprise move extends CB&I’s growth into the U.S. power generation market particularly nuclear energy.

CB&I CEO Phillip Asherman told financial wire services the acquisition is designed to diversify the firm’s offerings in global energy infrastructure with a strong presence in U.S. energy markets.

CB&I said it would finance the deal with cash and debt. It will pay a premium at $46/share for Shaw stock which closed at $26.61 on July 27. The new firm will operate under the name CB&I Shaw. It will have a $28-30 billion backlog of projects and employ over 50,000 people.

Shaw had revenue of $6 billion in 2011, but reported a $175 million loss. CB&I had revenue of $4.6 billion in 2011 with net income of $255 million. About 90% of CB&I’s revenue comes from the oil and gas industry and a total of 80% of all revenue is from projects outside the U.S. Acquiring Shaw substantially increases its domestic footprint.

The transaction is expected to close in the first quarter of 2013. Asherman will remain as CEO and Shaw CEO J.M. Bernhard, Jr., will leave the firm.

Wall Street surprised

The acquisition came as a surprise to financial analysts who follow the construction industry. CB&I had been buying up other firms, but none as large as Shaw. Some analysts questioned why CB&I bought the whole company when it could have just acquired a controlling interest, and a position in the U.S. power sector, through buying some of the shares of the firm.

According to data compiled by Bloomberg, it is the largest deal of its kind in these industries so far in 2012 and has the highest premium paid for stock of the firm being acquired in such a deal. The average premium for firms in these industries in 2012 is 10%. In this deal, if it closes at the numbers as announced, the premium will be 72%.

Bloomberg also reported that CB&I’s offer to Shaw is about 26 times earnings before the usual deductions. A survey by Bloomberg of similar deals in the past decade in these industries shows an average of 8.3 times earnings.

CB&I CEO Asherman defended the deal in a conference call with investment analysts. He said the combination of the two companies makes it one of the largest firms of its kind targeting energy industries. Also, he said that CB&I feels that cost challenges at U.S. nuclear projects will be resolved over time.

According to Engineering News Record, CB&I had $6.8 billion in new contracts in 2011 and The Shaw Group had $3.7 billion in new work the same year. Taken together, their combined total of $10.5 billion would rank them at the number three position behind Flour ($26.9B) and Bechtel ($47.2B)

Stock swings

stretched thin financiallyUntil the deal was announced, there had not been much movement in the stock price of either firm.

After the deal was public, investors expressed doubts about the wisdom of the deal and its price by dropping CB&I’s stock in one day from $41/share to $35/share.

At market close Aug 2 CB&I was trading at $35.37 against a 52-week range of $23.88-$47.74.

By comparison, Shaw’s stock surged from $26.61 to $41.49 on July 30 against a 52-week range of $18.98-$43.70.

Shaw losses in 2011 related to energy projects

Energy analysts said that the fixed price nature of large capital infrastructure projects creates risks of losses from cost overruns. This is what happened to Shaw in 2011.

Shaw recorded financial results in 2011 of a loss of $175 million, compared to profits in 2010 of $82 million, and it came about from several factors.

A lawsuit in the power sector over a project dispute cost the company $38.7 million after tax. The dispute with Xcel Energy, centers on a coal-fired power plant in Pueblo, Colo.

The firm lost $29.4 million on loans made to the developer of two new ABWR nuclear reactors at the South Texas Project.

Cost increases and schedule delays on an Asian ethylene project cost $118.1 million after tax. Labor cost increases on a U.S. coal project cost the firm $44.2 million after tax.

Shaw’s U.S. nuclear business

Nuc_Logo-01_1_-255x198Shaw’s activity as a U.S. nuclear EPC contractor is complimented by environmental remediation work and military construction contracts.

CB&I has been building liquefied natural gas ports, but has no experience as the lead EPC firm for building new nuclear reactors. It is a supplier of nuclear containment vessels.

Shaw is the EPC contractor for Southern’s twin 1,100 MW Westinghouse nuclear reactors being built in Georgia and two similar reactors for Scana in South Carolina. In China Shaw is supporting the construction of four AP1000s. In the U.S. Shaw is already contending with schedule delays and cost issues at both sites.

Securities analysts point out that both U.S. projects are in very early stages and that cost control and schedule performance have a long way to go before it will be known if Shaw will make a profit on them.

Shaw has a lot of predictable and steady revenue from technical services provided to about 40 U.S. operating nuclear reactors and to coal and natural gas power plants.

Shaw had previously announced sale of its 20% stake in Westinghouse back to Toshiba. When that transaction closes it will wipe the firm’s slate clean of debt. The transaction was announced in September 2011, but has been delayed until early 2013. The reason is bondholders from the original deal rejected a request for early redemption.