31 January, 2020


Skeletons in the closet

Nigel Stevenson

Shareholders in CIMIC have had a tough time recently with its shares falling 45% from their peak, following the delivery of two pieces of bad news, both of which we flagged in our April newsletter: the factoring of receivables to hide weak underlying cash flow, and losses at its Middle East joint venture. Unfortunately, there may be more skeletons in the closet: CIMIC has still not come clean on the level of reverse factoring which may (once again) be hiding weak underlying cash flow. Additionally, the company seems to have exploited a change in accounting standards to recognise the same profits twice-over. CIMIC’s upcoming results provide an opportunity to come clean on these issues. Hopefully its auditors, Deloitte, will ensure this happens.

Unanswered questions remain

Our first newsletter on CIMIC from 30 April last year included a list of questions regarding the company’s financials. Previously, we had put these to the company’s management but they failed to answer. Since then, CIMIC has been forced to provide partial answers to two of our concerns: the level of receivables factored, which had hidden weak underlying cash flow, and losses at its Middle East joint venture. On both occasions, CIMIC’s shares fell around 20%, as Figure 1 shows. However, several important questions remain unanswered, including the level of reverse factoring and the re-recognition of revenue and profits. Minority investors deserve full answers to these outstanding issues.

Factoring receivables hides weak cash flow

One unanswered question raised in our first newsletter concerned the level of receivables factored, which CIMIC had previously refused to divulge. However, in its FY19 interim results released in July 2019, the company revealed that it had factored A$1,995m at 30 June 2019, up slightly from A$1,953m at the end of FY18. This latter figure was far higher than our estimate of A$1.2bn.

It seems CIMIC had been pressured into disclosing this information. Rating agency, S&P revealed in a report, published less than a week before CIMIC’s interim results, that the level of receivables factored had risen from A$0.6bn at YE17 to A$1.9bn at YE18, an increase of roughly A$1.3bn. Proceeds from factoring receivables are treated as an operating cash inflow, the same as if they were collected from the payer. Therefore, it suggests most of CIMIC’s A$1.7bn of operating cash flow in FY18 was from increased factoring, painting a very different picture from the “strong cash generation” and “sustainable cash-backed profits” presented by the company. The increased factoring in FY18 was clearly important information in forming a view on the company’s financial performance which we think should have been produced earlier. Indeed, its disclosure prompted a near 20% share price fall. Without a significant boost from increasing factoring in 1H19, operating cash flow weakened considerably as unbilled revenue continued to grow (discussed below).

Most of CIMIC’s A$1.7bn of operating cash flow in FY18 was from increased factoring

While CIMIC now discloses the level of factoring, several questions remain unanswered, including the specific nature of the instruments sold. The company’s annual report refers to the sale of receivables and “contract milestone receipts”. It is possible the latter are not recognised as assets on the balance sheet, which may mean their sale results in an increase in liabilities. The company should give a full explanation of the impact on its financial statements of its factoring activities.

Withdrawal from Middle East joint venture

On 23 January this year, CIMIC announced plans to exit its Middle East joint venture, BIC Contracting, at a cost of A$1.8bn, primarily from writing off loans and honouring financial guarantees. Only the latter will result in further cash outflows, which the company estimates at A$0.7bn in FY20. The announcement referred to “an accelerated deterioration of local market conditions”, although no information was provided on BICC’s current financial performance. CIMIC’s share price fell a further 20% following the news.

Another question CIMIC had previously failed to answer which we raised in our first newsletter was whether, from FY18, it had stopped recognising losses from BICC, after its value had been written down to zero following the introduction of new rules on revenue recognition. We assumed CIMIC had stopped recognising any further losses, although the disclosure in its annual report was ambiguous. The company inexplicably refused to confirm whether this was the case. Nonetheless, CIMIC continued to book interest income on loans it made to BICC, even though the interest was not being paid but was added to amounts owed.

...whether, from FY18, it had stopped recognising losses from BICC, after its value had been written down to zero following the introduction of new rules on revenue recognition

Having previously reported BICC as a separate segment, from FY18, CIMIC folded it into the Corporate segment, claiming it was no longer material. This was true only in a technical sense: BICC still owed CIMIC around A$1.2bn in loans and accumulated interest at 30 June 2019 (A$674m after loss allowances). Furthermore, CIMIC had also guaranteed BICC’s bank debts. These have spiralled over the last 18 months to A$1,249m at 30 June 2019, as Figure 2 shows, a jump of A$831m from the end of FY17. Since CIMIC stopped disclosing BICC’s results, this has provided the only indication of its financial performance. It suggests the joint venture has been haemorrhaging cash, and should have alarmed any investors in CIMIC.

While some analysts appear happy to draw a line under CIMIC’s Middle Eastern adventure, the announcement provides few details and raises several important issues. We are concerned that CIMIC may have stopped recognising losses at BICC just as its performance deteriorated significantly, keeping minority shareholders in the dark. The severity of the share price reaction suggests investors were surprised by the news, even if they were aware of problems in the business. We think CIMIC should clarify BICC’s financial performance and what, if any, contribution it has made to CIMIC’s recent results.

While the bad news surrounding factoring and the Middle East joint venture is now out in the open, we think there are still several other important skeletons in the closet that we previously mentioned…

How much is outstanding under reverse factoring facilities?

The first skeleton is supply-chain financing, also known as reverse factoring. This has received considerable media attention in Australia recently. The precise arrangements vary but typically involve a company arranging a facility with a bank whereby suppliers can present approved invoices for early payment in return for a small discount. The company repays the bank on the invoices’ original due date. The introduction of the facility is usually accompanied by a significant lengthening in payment terms.

CIMIC like most companies treats the amounts outstanding under reverse factoring facilities as payables rather than debt. Doing so not only lowers reported debt, but also boosts operating cash flow if the amounts outstanding increase, as inflows from higher payables are treated as an operating rather than a financing activity.

...lowers reported debt, but also boosts operating cash flow...

The accounting treatment is clearly an issue where judgement plays a critical role. Indeed, CIMIC’s approach, which has been approved by its auditors, Deloitte, may technically be correct. However, our main concern is the lack of any disclosure which would enable investors to make their own adjustments. CIMIC acknowledges its use of supply-chain financing, but provides no information on how much is outstanding under the facilities. In contrast, telecoms company, Telstra (TLS AU), for example, discloses the amounts outstanding under its facilities at each year-end.

In our first newsletter, we estimated CIMIC had up to A$1.1bn outstanding under reverse factoring facilities. This was based on the increase in payable days over the last few years and was inevitably subject to considerable uncertainty. Since then, CIMIC’s payables have increased further, rising to A$6bn at 30 June 2019. We estimate payables have increased from 165 days at the end of FY18 to 180 days at 30 June 2019. It suggests the amount outstanding under such facilities may have increased further in the first half of the year, perhaps by A$300m or more. The level of reverse factoring is clearly important information for investors, and something we think CIMIC should disclose. There seems no good reason for it not to, particularly as its parent, ACS (ACS SM), provides it for the combined group.

How much revenue and profits have been recognised twice?

The second skeleton relates to the recognition of the same profits twice over. Accounting rules give CIMIC considerable discretion over when and how much revenue and profits to recognise. Revenue (and profits) can be booked before the client has been billed, even if the amount due has not been agreed. CIMIC records this unbilled revenue as contract assets within trade and other receivables. It discloses net contract debtors (i.e. after deducting advance payments) each quarter.

In our first newsletter, we pointed out that the introduction of new accounting rules on revenue recognition has in effect enabled CIMIC to recognise a substantial amount of revenue and profits twice over. When the new rules came into effect at the beginning of FY18, CIMIC restated its opening balance sheet, reversing around A$0.7bn of previously booked revenue and profits that were not deemed “highly probable”, the required threshold under the new rules. Its retained earnings, and equity, fell by a similar amount. The revenue and profits can be recognised a second time when they become highly probable.

...the introduction of new accounting rules on revenue recognition has in effect enabled CIMIC to recognise a substantial amount of revenue and profits twice over...

The reversal was reflected in a reduction in net contract debtors, which roughly halved on the restatement, as Figure 3 shows. Since then, net contract debtors have quickly bounced back above their prior level, growing to A$1.5bn by 30 September 2019, an increase of A$0.8bn from the restated level. It is unclear how much of the rapid recovery in unbilled revenue is due to aggressive recognition of new revenue, or the re-recognition of previously recognised revenue. Unfortunately, CIMIC refused to say, but it could partly explain why the company’s underlying operating cash flow has been so weak in the last couple of years: cash is only received once, even if profits are booked twice. We think CIMIC may have been aggressive in its recognition (and de-recognition) of revenue in recent years, resulting in significant double counting and pulling forward of revenue and profits.


CIMIC has shown itself reluctant to disclose information that might expose the underlying weakness in its financial performance. When it eventually has come clean, the market reaction has been severe. We think there may be more skeletons in the closet which could result in further nasty surprises for investors.