The shorts are circling.

By Don Quijones, Spain & Mexico, editor at WOLF STREET.

Things are not looking good for Grupo Actividades de Construccion y Servicios SA (ACS), the world’s biggest international contractor. It started on December 4, when hedge fund manager Per Johansson told a conference in London that he was shorting the Madrid-based company because of its alleged accounting irregularities. And since then, ACS’ problems have snowballed.

According to Johanssen, the heavily leveraged construction company has drastically overstated its earnings, has “a lot of hidden liabilities,” and is suffering from “signs of problematic project execution.” He forecast a 40% decline in ACS’s share price. Shares have since plunged 25%.

ACS’ initial reaction was to do what any company would have done in its position: it issued a blanket denial. The comments are “groundless” and based on a labor case that was dismissed by a judge, ACS said in a statement. It also threatened to take legal action against Bodenholm. But things are just getting worse.

Headache Number One: A Rating Nightmare

Last May, Angel Garcia Altozano, director of corporate development at ACS, said that the company would ask Moody’s, Standard & Poor’s, and Fitch for a rating upgrade so that it could place bonds or other debt with institutional investors to fund its projects, an essential funding source for a developer that bids on large contracts. An upgrade would also allow it to issue bonds at lower rates.

But last week, Moody’s and Standard & Poor’s not only refused to upgrade the company, but added to ACS’s financial headaches when they explained their decision by citing two of the main problems originally identified by Johanssen:

First, ACS’s hefty off-balance sheet liabilities, estimated at €6.8 billion. This could be a very serious problem, given the front-line role that creative off-balance sheet accounting played in the recent bankruptcy of Abengoa, Spain’s biggest bankruptcy ever;

And second, the substantial cost overruns accumulating on some of ACS’s biggest projects, in particular in the U.S. and France. TP Ferro, a project aimed at building a high-speed train line linking up France and Spain, has been plagued with logistical problems and is now in receivership after ACS requested an additional €500 million to cover its costs.

When this kind of thing happens, what companies like ACS normally do is speak directly to their friends in the Spanish government whom they’ve been “allegedly” bribing for years, and ask them to make up the difference with taxpayer funds, which they invariably do. The problem right now is there is no government in Spain to speak of, or to.

Headache Number Two: A Blast from the Past

Last week the European Commission twisted the knife a little further, by demanding that Spain’s former government explain its decision, in July 2014, to bail out Escal UGS, a firm majority owned by ACS. The payment was made to cover the company’s original investment in a madcap scheme to convert an abandoned oil field off Spain’s Eastern coast into a natural gas storage facility, which — as experts had warned — ended up triggering hundreds of tremors across a 125-mile stretch of coastline from southern Catalonia to the northern Valencia region.

As WOLF STREET reported in December, once the problems emerged, the project was suspended and Escal exercised its right to relinquish the concession to the Spanish authorities. The Rajoy government was more than happy to take the worthless gas storage facility off the company’s hands. It even changed Spanish law to ease the process. Once the law was changed, it took just a week for Escal to get all its money back – all €1.35 billion of it.

But now the EU has launched a preliminary inquiry into the case. If the EU’s competition inspectors find sufficient evidence of illegal state assistance, they will open an in-depth investigation. If the Commission then rules that the payment is incompatible with the EU’s competition’s laws, Escal will have to return the full amount with interest!

Headache Number Three: Stopping an Investor Stampede

The volume of ACS shares held in-house, so to speak, is at its highest point since 2012, the worst year of the company’s 19-year history. Between December 11, 2015 and January 21, 2016 alone the company bought back 3.25 million shares. The activity in recent weeks has been “frenetic,” reports the Spanish financial daily Expansión. “In mid-December, the construction and services group announced that it had increased the percentage of its own shares that it owned from 1.33% to 2.57%.”

That ACS’s share price has plummeted 25% despite the company’s frantic efforts to prop itself up by buying back its own stock should be serious cause for concern. So too should the fact that the company’s largest shareholder of yore, Alba Financial Corporation, the investment arm of Banca March, an 84-year-old family-owned bank and equity investment group that once upon a time helped bankroll Francisco Franco’s reconquest of Spain, has been quietly selling its stake in the firm. Just under five years ago, the Mallorca-based private bank owned 23.3% of the construction firm; now it owns 11.7%.

Another long-standing investor in ACS, Alcor, has trimmed its stake from 13% in 2012 to under 7% today, leaving ACS Chairman Florentino Perez as the company’s biggest shareholder, with a 12.5% stake. The problem is that those shares serve as collateral, underpinning Perez’s personal debt, which is currently over €750 million, reports Voz Populi. Worse still, those shares are priced at €22 a piece on the balances of Inversiones Vesán, the equity fund Perez uses to control his stake in ACS. The current share price of ACS is €22.61, having bounced, dead cat-like, off annual lows last week of €21.24.

ACS’s creditors — which are mainly Spanish banks, many of whom are desperately striving to minimize the fallout from Abengoa’s collapse on their balance sheets — are turning the screw on ACS and Perez, demanding more and more guarantees to cover the increasingly risky loans they’ve made to the company.

All of this is happening against a global backdrop of increasing economic uncertainty, especially in Latin America, a region where ACS — and just about every other major Spanish multinational — is heavily exposed. As if that weren’t bad enough, there is also the specter of growing political uncertainty in Spain. The fact that ACS’ management can no longer rely on a friendly government to intervene on its behalf at the slightest sign of trouble is arguably the company’s biggest source of weakness right now, especially with so many risks converging on the horizon. By Don Quijones, Raging Bull-Shit.

Things are likely to get a whole lot uglier in Spain. Read…  “Everything Has Come to a Standstill”: Political Fallout Hits Business in Spain

Enjoy reading WOLF STREET and want to support it? You can donate. I appreciate it immensely. Click on the beer and iced-tea mug to find out how:

Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.