When shares in Saudi contractor Mohammad al-Mojil Group (MMG) were suspended in July, it sent shockwaves across the kingdom’s business community.

The news of financial issues at the well-regarded construction firm come at a time when the government is ploughing money into infrastructure projects and state entities are rolling out massive expansion programmes.

The worry is whether the firm’s problems may be symptomatic of wider issues in Saudi Arabia’s booming construction sector.

MMG, a specialist in oil and gas projects with major organisations such as Saudi Aramco and Italy’s Saipem among its clients, had been experiencing financial difficulties for a couple of years. Cost overruns and delays in collection of payments contributed to massive losses that reached more than 120 per cent of its share capital by mid-2012.

MMG losses

Its second-quarter 2012 results revealed a net loss of SR643m ($171m), implying accumulated losses of SR1.5bn, a sizeable sum for a mid-sized contractor such as MMG.

With directors discussing plans to dissolve the company, the crisis echoed the larger corporate debt problem that embroiled the AH Algosaibi and Saad Group conglomerates, which revealed combined debts of $20bn in 2009.

As with these large debt-ridden corporates, Saudi banks were exposed to MMG to the tune of more than SR1bn. Although on a far more manageable scale than the exposures to AH Algosaibi and Saad Group, the potential fallout is nonetheless a cause for concern, especially for Saudi banks who spent much of the post-2009 period shoring up their balance sheets and making greater efforts to limit exposure to such troubled entitles.

The fact that MMG racked up such losses during a relative boom in the Saudi construction sector raises pointed questions about the financial health of other contractors. The situation with MMG is somewhat surprising, given that it has successfully won construction contracts. It ranked eight in MEED’s list of top 10 contractors for 2011, with $1.8bn-worth of contracts. This was largely thanks to its ties with Italy’s Saipem, which subcontracted work on Aramco’s Manifa heavy oil field development to MMG. This is one of the contracts that MMG says contributed to losses of SR375.5m in the third quarter of 2012.

Problems first arose in 2009, when delays in key projects affected the cash flow of its portfolio and the resultant increase in costs and provisions were depleting the company’s profit margins.

By September 2012, MMG issued a statement to the Saudi Stock Exchange (Tadawul) that the company’s liabilities exceeded its assets, having run into problems on some large contracts. Losses for the nine months to 30 September 2012 reached $180.5m and reportedly included a $94.7m loss recorded against the Manifa oil project. According to the company, its liabilities stood at $744m at the end of June 2012.

Having been barred from accessing bank facilities in August, the outlook for MMG looked bleak. On the announcement that MMG’s accumulated losses for September exceeded its capacity by 75 per cent, an emergency general meeting was triggered. 

The company’s future was in the balance, just a couple of years after it caught the Saudi initial public offering wave and floated 30 per cent of its shares on the Tadawul. In November 2012, shareholders rejected proposals to liquidate the company, agreeing instead a recovery plan that would include asset sales, cutting bank debt and absorbing accumulated losses to keep the company afloat.

Legal action

The company’s management is taking the offensive to bolster its frayed financial position. On 20 January, MMG announced plans to take legal action to collect dues. It said claims worth more than $107m will be pursued against the local unit of the UK’s Petrofac, local contractor Saudi Binladin Group (SBG) and South Korea’s SK Engineering and Construction, an affiliate of SK Holdings.

In a statement submitted to the Tadawul, MMG said that the legal action was being pursued “after all available solutions and options were exhausted”. The company had already made its intention clear by floating several restructuring solutions that would include enhanced efforts to collect cost overruns from existing clients and speeding up the process of payment collection.

The story of MMG’s decline over the past three years is a result of its over-exposure to large projects that experienced significant overruns, in particular, to large contracts including Aramco’s Manifa development. It provides a salutary lesson of the risks facing contractors in a rapidly expanding market.

MMG said the construction of the Manifa development had generated a loss of SR355.2m in the first nine months of 2012, as a contract for Saipem had been terminated.

Analysts view the company’s predicament as an inevitable consequence of the piling up of receivables on the company’s books.

“Effectively, MMG is a contractor that works with other contractors and with major oil and gas groups,” says Taher Safieddine, an equity analyst at UAE investment bank Shuaa Capital.

“In this case, there were delays in collection of receivables, which resulted in write-downs and recognition of provisions on some others. Profitability inevitably got hammered and reached a point where accumulated losses crossed the red line in terms of capital. This is why they had to look into dissolving the company.”

As yet, there are no indications that the problems encountered by MMG are being experienced at other contracting companies in Saudi Arabia. Yet the firm was clearly a victim of the cost overruns that have plagued a number of Saudi projects in recent years. Forced to take on excessive leverage to mitigate against delays in completions, it has faced significant cost increases.

“Costs ran out of control and that’s why they went back to their clients to renegotiate and seek to convert the lump-sum contracts into cost-plus variants, which preserves for them a profit on the project,” says Safieddine.

Under the cost-plus model, the contractor’s expenses are covered, as well as an agreed profit, whereas lump-sum deals deliver a fixed sum to the contractor. 

Rising competition

Growing competition also exacerbated the pressure on MMG. “There is competition from companies such as [the local] Abdullah AM al-Khodari & Sons (Al-Khodari), [the UAE’s] Arabtec and Drake & Scull International, which now operates in Saudi Arabia. Competition is escalating and the pie is getting smaller,” says Safieddine. “But while you might see pressure on margins, the market remains lucrative and attractive, projects are being awarded and 2013 is expected to be another strong year for project awards. MMG is not a barometer of the health of Saudi construction market.”

Nonetheless, high costs have eroded margins at other Saudi contractors, as evidenced by the sharp contraction in profits at Al-Khodari, which is building the second phase of the Border Guard Airport in Umm Almelh in the kingdom’s Empty Quarter region. 

Al-Khodari saw its net income for 2012 decline 14.3 per cent to $36.1m, despite seeing contracting revenues for the year grow by 34.6 per cent to $104.1m. New contract awards during the year totalled $253.3m, 17 per cent lower than the $305.6m in 2011.

Al-Khodari has identified the costs associated with implementing the Nitaqat programme, designed to increase the number of Saudi nationals in the workforce, as a contributing factor to its weak financial performance. In a statement issued to the Tadawul on 19 January, Al-Khodari said “due to projected local hire of manpower, as well as the projected cost impact related to the expected continuous delays by clients in appointing consultants in order for construction of recently awarded projects to commence, the management continues to revise the estimated cost-to-complete of all projects on a case by case basis resorting to a more conservative stance”.

There have also been rumours and speculation of cashflow challenges at other major contracting companies, but these have been denied. “There has been speculation that Saudi Oger has lost a couple of contracts in the kingdom. But even if any of the large contracting companies did experience losses, it would definitely be contained by the government,” says one Beirut-based analyst.

The kingdom’s banks are now having to deal with the aftermath of MMG’s financial problems. According to Shuaa Capital, Saudi banks’ total exposure to MMG stood at SR1.16bn at the end of 2011, the largest borne by Sabb (SR310m) and Riyad Bank (SR250m). Of all Saudi banks, only Alinma Bank had no exposure to MMG.

Loan regulation

The Saudi banking sector’s robust non-performing loan (NPL) coverage provides assurance that asset quality will not be affected. Under central bank regulations, Saudi banks’  exposure to a single name cannot exceed 25 per cent of its equity, which limits problems.

Most banks have taken a hit and moved on. However, there has been concern in the kingdom that some contractors have reached the limit on credit lines, forcing them to approach other GCC banks to raise funding.  “These companies have expanded aggressively in recent years and this hasn’t necessarily been very well planned or implemented,” says a senior Gulf economist. “Paradoxically, there has been a bit of a push from the other side with Gulf banks trying to gain exposure to the Saudi construction sector, which is seen as a real growth story.”

MMG’s financial travails are not of sufficient size to upset the country’s construction boom, nor will they drag down the country’s banks.

“What happened to MMG is not necessarily a reflection of the whole Saudi construction market. It is the largest in the Middle East and North Africa region, and still one of most attractive with significant infrastructure and development expenditure plans,” says Safieddine.

But the fate of a mid-sized contractor carries lessons that other firms operating in the region’s most dynamic market need to learn if they too are not to be laid low by unexpected losses.