Is a rights issue next for Cobham?

Defence engineer Cobham has issued another profit warning and admitted that its balance sheet is “clearly” not strong enough. A fundraising is the next likely step.

By Garry White in Companies and Markets, 16th Feb 2017 14:55pm

Garry White

 

Five weeks ago, I asked whether we could expect another profit warning from Cobham, implying it was likely. Today, that profit warning duly came. Its fifth warning over the course of the last 18 months sent its shares down by more than 20%. Not only that, the group said that delivery of a similar performance to 2016 in 2017 may be challenging – and also hinted that it may need to raise more money to shore up its finances. 

“The balance sheet is clearly not strong enough to properly support the operations of the group,” Cobham said. “A strong balance sheet will be an important part of delivering medium-term growth.” However, with its new chief executive only starting in December and the finance director in January, there has not been sufficient time to complete the review of the business and Cobham was therefore unable to say exactly what it would do to improve its financial position. However, it seems highly possible there will be a fundraising through a share issue – either a placing or rights issue. More information on this will be provided in its preliminary results announcement on March 2.

“2016 was an incredibly turbulent and disappointing year for Cobham,” chief executive David Lockwood said. “Execution failure in many businesses led us to miss expectations badly and provides a poor entry point into 2017.”

This is Cobham’s fifth warning in 18 months. In April last year, the company fired some of its top executives following “accounting irregularities” at its wireless division. The group was also hit by problems with contracts in its US defence business Advanced Electronics Solutions. Contracts for components such as the guidance systems of air-to-air missiles were agreed at a fixed price, but there were significant cost over runs, which hit profit margins.

There has also been significant uncertainty surrounding the outcome of its KC-46 tanker programme. Cobham’s engineers pioneered air-to-air refuelling and the programme related to such equipment for a new US military aircraft being developed by Boeing. Today, management announced a write down of £150m relating to this project plus a whopping £680m of other write downs. 

This includes a £574m write down against its wireless, semiconductor and integrated electronics activities. This includes the Aeroflex business which was bought in 2014. There were also £29m of charges against other contracts within its mission systems, advanced electronics and communications divisions, plus a £20m adjustment to underlying trading profit for 2016.  

Mr Lockwood said that the impairments did not reflect a lack of confidence from the board that these businesses can create value in the future. There are also hopes that most of the negative news is now out, although the balance sheet issue remains to be resolved.  Any equity fundraising would dilute the stake of current shareholders unless they participate in a rights issue.

The problems faced by Cobham are company specific. The outlook for the wider defence sector remains reasonably positive, particularly given the new Trump administration’s pressure on Nato members to increase defence spending to meet their commitment to spend 2% of GDP on defence.

At Cobham, Mr Lockwood appears to understand what’s now required. “The route to realising this potential is strong operational performance and financial control, which will be the relentless focus through 2017,” he said. Now he has to fix the group’s balance sheet and implement these controls. The shares are likely to remain subdued until he can demonstrate he is delivering on these promises. 

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