Royal Imtech: A 'Squeezed Lemon' That Is Unlikely To Recover

| About: Royal Imtech (IMTEF)


Imtech is involved in several accounting fraud scandals, which have crushed its stock price.

Banking covenants were broken and Imtech is looking to raise money for repayments.

Dilution of shares is inevitable, even with the divestment of Imtech's ICT division.

Despite potential short-term gains, I do not recommend investing in this stock.

Trading this stock is very risky due to very high volatility and volume.

At first sight, it does not make sense to compare stocks with lemons. Nonetheless, George Akerlof inspired many researchers to compare the stock market with the market for used cars, also referred to as lemons. His study "The Market For Lemons" was published in 1970. Akerlof's thesis was proof that consumers are willing to pay less money if uncertainty about the product's quality is high.

At the beginning of this century, financial markets were negatively surprised by several large cases of fraud, for example Enron and Ahold (OTCQX:AHONY). Since than, more researchers started to link Akerlof's study with the valuation of stocks. Not the quality of used cars, but the quality of earnings was the indicators for buying a potential 'lemon'.

Akerlof's thesis builds on risks and uncertainty that investors cannot identify at first sight. Now, what happens if it is clear that the quality of earnings of one specific company is bad and their financial statements are not to be trusted? This is for example the case when a company commits any form of accounting fraud. It makes sense that investors lose confidence in the quality of the firms financial reporting. As a result, the price of this particularly stock will fall.

One of the latest 'lemons' to commit a form of accounting fraud is Royal Imtech N.V. (OTC:IMTEF), a small-cap technical service provider, based in the Netherlands. In February 2013, Imtech reported that it had to take a €100 million ($134 million) impairment charge on its work-in-progress related to a theme park in Poland and that the company's financial position was in bad shape.


In fact, Imtech was no longer able to meet the requirements of its banking covenants. To deal with this imminent situation, Imtech strengthened its balance sheet by issuing €500 million ($670 million) in additional equity rights.

Imtech's stock price tumbled after the announcement of accounting fraud in February 2013 and has not stopped falling since. To put this into perspective, the stock closed at €7.83 ($10.49) per share on February 1, 2013, the trading day before Imtech's pre-market announcement. Today, Imtech closed at €0.39 ($0.52) per share, a loss of 95%.

There are several reasons for the stock to lose 95% of its value. First of all, an additional fraud report in Switzerland shocked the market again in February 2014. It seemed that Imtech's problems with accounting fraud in Poland and Germany were not isolated events; the problem was much more fundamental.

As more reports about accounting fraud were coming in, so were the impairment charges and write-offs on Imtech's work-in-progress. The company had to take additional charges of €370 million ($496 million) in the fourth quarter of 2013, much larger than the initial charge of €100 million ($134 million) in 2013.

So, by the end of 2013, the company found itself back in the same situation as its was in February. Due to the large write-off in the fourth quarter, the company did not meet the requirements following its banking covenants again. However, Imtech managed to ease tensions about the company's future as the banks agreed to a temporary exemption for Imtech to come up with a solution.


Trading at just a fraction of what the stock price ever was, Imtech has few cards left up its sleeve. On August 26, 2014, the company will publish its second quarter earnings report and more important, an update of its attempt to reduce the company's net debt in accordance with banking covenants.

The market expects Imtech's net debt to be around €1,040 million ($1,390 million) of which almost the entire amount qualifies as interest bearing debt. Imtech agreed with the banks to reduce net debt to €600 million ($804 million) to €400 million ($536 million), but time is running out. The temporary exemption expires on September 30, 2014. Before this date, Imtech needs to come up with enough money to repay €600 million of their debt.

Here are some of Imtech's options to free up the necessary cash:

1. Divestment of Imtech's ICT division.

The most likely option for Imtech is to divest its ICT division, as the company already announced as an important part of its debt reduction and restructuring program.

However, I have to point out several downsides of this transaction. First, the divestment will not be enough to repay Imtech's debt with the required €600 million ($804 million). The ICT division is valued around €300 million ($402 million). Further, it remains questionable that Imtech will receive the ICT division's true value, because buyers are aware of Imtech's urgent need to sell this asset.

So, even with the divestment of Imtech's ICT division, the company needs additional funds to have enough money to repay their debt and meet the banking covenants. Therefore, other actions are required.

2. Additional rights issue

Another plausible option is that Imtech issues additional equity rights, as the company already did in February of last year. On the other hand, this solution equals a massive dilution for current shareholders.

The degree of dilution all depends on the company's share price, which currently is very unfavorable to choose for issuing additional equity rights. Shareholders could see their position diluted up to 300%!

3. Conversion of debt into equity

A third option is that banks agree to the conversion of its debt into equity. The banks, including ING Bank (NYSE:ING), Commerzbank AG (OTCPK:CRZBF), Royal Bank of Scotland (NYSE:RBS) and Rabobank, will immediately become Imtech's major shareholders. Again, this option will dilute the position of current shareholders.

This option requires the banks to be very cooperative. I am not sure whether ING Bank, Commerzbank, Royal Bank of Scotland and Rabobank are willing to take the majority of Imtech's shares, rather than the repayment of most of Imtech's debt.


It seems that none of the single options are sufficient to reduce net debt and, on the other hand, will not dilute the position of current shareholders. As a result, I believe it is inevitable that shareholders will experience a massive dilution, no matter the outcome of the divestment of Imtech's ICT division.

Still, the divestment of the ICT division could unlock some value for Imtech and its shareholders. The division should be worth more than Imtech's current market capitalization. On the other hand, investors should ask themselves the question: what is left of Imtech after divesting the ICT division?

Imtech is a difficult stock to trade. It is called a 'casino stock' for a reason (and that reason is not because the company exploits casino resorts). If Imtech nails the divestment of the ICT division and keeps dilution of shares limited to a reasonable level, the stock has a lot of upside potential.

However, I would like to point out that investing in this stock is very risky. Clearly, this is confirmed by the activity among short sellers. According to the short selling register (published by the AFM, the Dutch equivalent of the SEC), about 10% of Imtech's shares are covering short positions.


If you were to initiate a position, this week seems to be a good opportunity to do so. Imtech will report its second quarter earnings next week and any positive news shall send this stock higher. Given the short positions, such a movement could trigger a short squeeze. On the other hand, negative news is likely to crush the stock.

Based on my findings, I believe it is highly unlikely that the stock price of this 'Squeezed Lemon' will ever recover. The divestment of the ICT division, Imtech's best performing division, is necessary to reduce a part of Imtech net debt. However, the divestment makes it harder for Imtech to improve its financial results and become profitable again.

Further, Imtech's accounting fraud was not a one-time event, it was fundamental and supported by more than one division. Investors are losing faith in the company and there is very little time and money to run a full scale restructuring to recover both investors' faith the company's financial performance. For example, the temporary exemption to meet banking covenants expires on September 30, 2014.

Overall, I would not recommend to initiate a long position in this stock. Potential short term gains may look appealing, but in the long run I foresee only more troubles ahead.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please note that trading this stock is extremely risky due to high volume and volatility.

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