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| 13 June, 2018

CORRECTED: Orascom Construction looks to build bridges into Africa

Chief executive looks to put together deals with joint venture partners and export credit bodies to fund infrastructure projects

The 4,800 megawatt gas-fired Burullus Power Plant in Egypt, one of the biggest combined cycle power plants in the world.

The 4,800 megawatt gas-fired Burullus Power Plant in Egypt, one of the biggest combined cycle power plants in the world.

Orascom Construction/Handout via Thomson Reuters Zawya

(Correction: An incorrect reference in the 5th paragraph relating to the company’s Natgasoline project in Texas being lossmaking has been removed. The project remains profitable.)

Orascom Construction's chief executive, Osama Bishai, was in confident mood as he spoke to Zawya just ahead of the company’s annual general meeting in Dubai last month.

The business, which was formed following a demerger March 2015 from the OCI NV fertiliser business via separate listings on Nasdaq Dubai and the Egyptian Exchange, has incurred fairly substantial losses within its United States arm since the listing, which has dragged down its overall profitability.

Last year, for instance, it managed an overall net profit of $78.5 million on revenue of just below $3.7 billion, but its Middle East and North Africa division made almost twice that amount ($152.1 million), and its 50 percent share of Belgian contractor Besix netted a further $54.4 million, but its US operations lost $128 million. This was a substantial improvement on the $246.5 million lost in the US in 2016, and more than $523 million in the year of its demerger in 2015.

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Yet Bishai argued that the company's travails in the United States were coming to an end. The losses incurred have related to one project - a huge, $2 billion fertiliser plant in Wever, Iowa, for former parent company OCI NV. Work began on the plant via an EPC contract in 2012 and was initially due to complete in 2015, but time and budget overruns meant it only completed last year.

The company is also building a major methanol plant for Natgasoline in Beaumont, Texas. This reached mechanical completion in April.

Bishai expects its US division to generate positive earnings this year, and its recent experiences in the US have not dimmed Orascom Construction's appetite for taking on new work in the country. By the end of the first quarter of this year, contracts in the United States still formed more than 20 percent of its consolidated backlog, which (excluding its 50 percent Besix share) stood at $4.3 billion at the end of March. During the quarter, it declared a net profit for its owners of $36.3 million, a 9 percent year-on-year increase. First quarter revenue was $756.8 million, 29 percent lower year-on-year.

The company has two US subsidiaries ­­- Iowa-based general contractors Weitz and Watts Contractors (now Contrack Watts), which were acquired in July 2012.

Bishai argues that partnerships the firm has developed in the Middle East - it has worked with Siemens on power plants, for instance, and with FCC Aqualia on desalination plants - could offer further value in the United States.

And although a new investment holding company was set up at the end of 2017, according to its filed accounts, Bishai said that new deals were more likely to be joint ventures than any further acquisitions.

Not buying

"I would say, never say never, but we haven't seen something that would interest us at the moment, whether here or in the States."

Orascom Construction is actively looking to diversify its revenue sources, though. Currently, 68.6 percent of its backlog is in Egypt, and almost 40 percent of this is in Egyptian pounds – a currency that has faced pressure as a result of inflation.

Egypt's core inflation fell back to 11.1 percent in May, having peaked at over 35 percent in July last year, according to Central Bank of Egypt data.

Bishai argues that the company is fairly well insulated against the impact of inflation, stating that “the majority of our contracts” have provisions that allow it to bill for increased materials, labour or energy costs.

"We were expecting the devaluation and the inflation to happen, so we were kind-of preparing ourselves for that day. And if you have been monitoring our results, we had a relatively soft landing as far as those issues were concerned," he argues.

He said that in terms of exposure to potential currency losses or gains, “our policy is to remain a neutral position”.

"We try to sign contracts where our needs and requirements on foreign currency equal our revenue on foreign currency so that we don't play the game of exchange rates," Bishai said. "We are trying to act as a contractor and not as a financial institution."

The company is also looking to hedge against overexposure to individual markets. Although Bishai said that “Egypt has been the star of the group for the last couple of years”, and he expects 2-3 years of further growth in infrastructure in the country, citing major projects such as the New Administrative Capital being built east of Cairo and the new Al Alamein city, the company is looking to expand to other markets across the Middle East and Africa.

Orascom Construction chief executive Osama Bishai

People power

“Our driver is really the populous areas in the Middle East, which are basically Egypt, Saudi, Iraq and Algeria. This represents almost 60 percent of the Arab population,” Bishai said.

He said the firm remains "extremely cautious about Saudi" given the payment problems that contractors have faced in the kingdom over the past three years, but also acknowledges that the economic reforms planned for the country offer potential.

“We haven't seen yet the robust pipeline of opportunities, but… we are still present. We are monitoring the market carefully and we believe that there is a niche that we can serve.”

This gap exists between firms such as Saudi Binladin Group capable of delivering mega-projects, and the hundreds of smaller players in the market that lack technical expertise, he said.

“The niche of the $200-$300 million (contractor) is not there - high end, high quality, sophisticated projects. There's maybe one or two contractors in Saudi other than us.”

On top of this, he said, “there's a hope that a place like Syria, at one point, will come back and that will require major resources”.

For Africa, Bishai said the company is “seriously” looking at a number of markets, but on a case-by-case basis, with its interest being based more around its own specialist areas - power, water and rail - than specific countries.

“I personally believe that Africa is a great opportunity. It has one of the highest growth rates in the world. It's way, way underdeveloped from an infrastructure standpoint,” Bishai said.

The company will also look to put together consortiums with the ability to bring in funding for schemes. He said the company has previously partnered with Japanese and Korean contractors, who can secure loans backed by export credit guarantees.

Finding funds

"There is also African Exim (Afrexim) bank that we can even tap directly as Orascom Construction through the Egyptian operation. We have succeeded to arrange some financing for some of the projects in Egypt and we believe that we can do the same for some of the projects in Africa."

Bishai also sees opportunities in the PPP space, especially in its home market where it has been part of consortia delivering desalination plants and even ports in the past. He expects that with such a young and fast-growing population – over one-third (34.2 percent) of its population of 96.3 million by the end of 2017 were under the age of 15, and 85.7 percent were under 50, according to the government’s Central Agency for Public Mobilisation and Statistics – more new social infrastructure such as hospitals will be required.

Christine Kalindjian, an analyst with Arqaam Capital, said that although its main legacy projects in the United States were drawing to a close, “it doesn't clear their exposure” as there remains a $50 million claim that has been filed against it by a subcontractor on the Iowa fertiliser plant contract named MEI.

“Orascom denies any obligation to pay the subcontractor due to defective or incomplete work,” Kalindjian said. “The first hearing will take place in September 2018, so we don't see any impact of that in the next two quarters. It's either going to show up in Q4 or next year.”

Even if the subcontractor’s claim is dismissed, Kalindjian is less bullish about the company’s United States operations generating positive earnings this year.

Arqaam is forecasting a -1 to -2 percent net profit margin for Orascom’s US business this year, “and even with that loss we have 70 percent growth over 2017 numbers,” Kalindjian said.

“Almost half of their projects with other subcontractors in the U.S. are fixed-price projects. And the risks on these fixed-price projects are obviously higher, because if you incur variation costs or it just takes you longer to achieve a project, you would have to incur additional costs of keeping the employees and the workers on site.”

Kalindjian said that although it is operating in a very competitive market in the MENA region, Orascom Construction has been able to generate gross profit margins of between 9-11 percent for infrastructure work in Egypt.

“You would think that with these projects, there would be some politics involved, but it hasn't been the case - especially in Egypt. It's purely based on competency and cost-effectiveness.”

(Reporting by Michael Fahy; Editing by Anoop Menon)

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