Investors smell a bigger rat, beneath the bad numbers.

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

Spain’s shrunken construction giant OHL began this week in spectacular fashion, as its shares plunged over 11% in the first two hours of trading on Monday, to plumb depths that hadn’t been seen in decades. By the end of the day, shares settled at €3.00, down 9.9% for the day, and down over 40% year-to-date.

The market was reacting to the company’s worst half-year results ever. The headline-grabber was that OHL’s profits had shrunk 94% during the six-month period. According to analysts at Spanish lender Bank Inter, one of the biggest causes for concern is the company’s steady loss of international contracts.

Since the collapse of Spain’s real estate sector in 2008-09, opportunities for large construction firms in the once-abundant home market have run dry. The ability to survive the new reality hinged on firms’ ability to carve out new opportunities abroad. OHL was particularly adept at that, winning prestigious construction and infrastructure projects all over the world, from Montreal to Mecca, from Mexico to Manila.

But things have soured, particularly in its Middle Eastern markets. In May, Qatar terminated a contract worth €1.1 billion for the construction of two metro stations in Doha, citing an apparent “failure to fulfill certain contractual obligations.”

In Saudi Arabia, meanwhile, OHL is part of a Spanish consortium hired to build a high-speed rail line from Medina to Mecca. The project is as far behind schedule as it is over budget. Its biggest problem is the unforeseeable challenge of keeping the Arabian Desert sand off the train tracks. None of the consortium partners want to take responsibility — or the attendant financial hit — for resolving the problem. And the House of Saud, already hemorrhaging money due to the oil bust, is in no position to pay Spanish companies extra funds to deal with it [read: Saudi Arabia’s Oil-Bust Cash-Flow Debacle Begins to Bite].

Normally in Spain, a problem like this would be easily resolved. As has happened on numerous occasions with Spain’s world-beating construction industry, Spanish taxpayers would be forced by the government to make up the difference. But right now there’s no elected government in Spain to sign along the dotted line, which means no financial lifeline for firms like OHL. It also means fewer white elephant projects being handed on a platter in return for under-the-table political donations, which invariably end up in some Spanish politician’s overseas bank account.

In the absence of such proactive government support, OHL’s fortunes have declined so much in recent months that it was just removed from Spain’s benchmark index, the IBEX 35, due to insufficient capitalization. Once worth over €3 billion, OHL is now down to just €890 million. To make ends meet, the company has already sold off its most valuable assets, including its 7% stake in the Catalan energy, construction and telecommunications conglomerate Abertis.

Yet the bleeding continues.

OHL’s biggest problems are in Mexico, where the company is the country’s largest toll-road operator. For years Mexico has been one of the firm’s biggest profit centers, thanks largely to the close relations it has forged with the country’s current president, Enrique Peña Nieto. But in the last quarter revenues from all of OHL Mexico’s operations (construction, toll road concession, airport management) grew by a mere 1.4%, while its profits slumped 41%.

The company’s management blamed its poor performance on a host of factors, from Mexico City’s new anti-congestion laws to the exorbitant fees the company had to pay lawyers and auditors from all of the “Big Four” firms — Deloitte (its long-time auditor), KPMG, PwC and Ernst & Young — to try to convince investors, regulators and the Mexican public that it hadn’t:

1. Repeatedly bribed Mexican authorities, as a series of recorded phone calls seem to strongly suggest; and
2. Exaggerated its spending reports for a State of Mexico toll-road project, defrauding investors and the state government of billions of pesos.

While the jury is still out on the first count, at least on technical grounds, it made up its mind on the second a long time ago . As WOLF STREET reported in March, despite the millions OHL Mexico funneled into the bottomless pockets of corporate lawyers and auditors, Mexico’s securities authority found the company guilty of a series of violations of stock market laws, most notably in its use of “guaranteed revenues” in its accounting record, for which it had “no contractual right.”

The company was given a $4 million slap on the wrist and was not found guilty of securities fraud. The markets in Mexico were jubilant. As we half-joked at the time, the company will probably be able to continue operating “on the basis of five years’ worth of financial accounts that Mexico’s market regulators and investors know have been substantially inflated.”

Unfortunately, it turns out we were right. According to an exposé by the Spanish daily OK Diario, OHL has failed to rectify. In the official results for the first half of 2016 it continues to use the inflated earnings — inflated by €2.98 billion — derived from the guaranteed revenues that Mexican regulators have identified as an accounting violation and for which the firm and its auditor (Deloitte, who else?) have already paid an insubstantial fine. Without the creative accounting, the company would have declared a loss of €220 million, according to OK Diario.

To make matters worse, on page 18 of its latest financial results OHL openly concedes that it used “guaranteed revenues,” but it claims that this has “no impact whatsoever” on the company’s results, consolidated funds or assets.

As for Deloitte, it said the following (in one of the longest, most complex sentences I have ever had to read, never mind translate and paraphrase):

On the basis of a “limited review,” which “in no way can be considered a full audit,” of the OHL Group’s accounts, especially considering we did not have access to “all the information that complete consolidated financial records are required to have by International Financial Reporting Standards,” we have no reason “not to believe that the financial records… do not comply with the requirements established in the International Accounting Standards.”

Confidence inspiring, no?

So, it appears that OHL, which just presented its worst half-year results ever, and whose shares have lost 40% this year and 84% since their recent peak in 2014, continues to knowingly mislead investors about the true state of its accounts. If it had offered a genuine reflection of the state of its accounts in Mexico, OHL Group would have had to declare losses in its financial report. But given how shares have been mauled, investors seem to be smelling a bigger rat beneath the accounting shenanigans.

As for Deloitte, once it had covered its own tracks, it was more than happy to half-heartedly sign off on OHL’s accounts. No surprise, there. And finally, both Spain and Mexico’s market regulators seem to know all about it. Just don’t expect them to do anything about it.

On Tuesday, trying to stem the collapse of its shares, and of confidence in the company, OHL announced another scheme: it will buy back a ton of its own increasingly worthless shares, up to 3% of the total float if necessary, and borrow whatever it takes to do so. But investors still aren’t getting it: by afternoon, shares have plunged another 6.2% to €2.81. By Don Quijones, Raging Bull-Shit.

So who’s going to bail out the European banks? Read…  Did Germany Just Blink?

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