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10 warning signs that Forge was a poor investment

ANZ (ASX: ANZ) is set to extend Forge Group (ASX: FGE) a lifeline, allowing the debt-laden company to continue to honour its legal obligations to customers. If Forge does eventually collapse, there will be flow-on impacts on its clients and its creditors alike. After the company’s lengthy trading halt, and huge drop in share price, it seems likely that potential clients will now be reassessing whether Forge can be trusted to fulfil its obligations.

The problem with Forge Group is that the quality of its underlying business has deteriorated. This was occurring because the company was increasingly relying on projects for its power division to generate revenue. These projects achieve lower margins, as was becoming evident from the FY 2013 results.

One such project is the Diamantina Power Project for APA Group (ASX: APA) and AGL Energy (ASX: AGK). Forge’s subsidiary, CTEC, had already won the 302 MW gas generation project before Forge acquired it in 2012. Indeed, at the time of the acquisition, the then-Executive Chairman, Peter Hutchinson, boasted that CTEC brought an un-invoiced order book of $600 million to Forge.

Another part of that order book was the West Angelas Power Station for Rio Tinto (ASX: RIO) in the Pilbara. Forge has recently announced that it will write down $127 million against the value of these projects, sending the share price tumbling over 80%. Forge has announced a series of power plant projects in the last couple of years: for all we know, there could be further write-downs. An examination of the events leading up to the massive destruction of shareholder value is instructive for investors everywhere.

10 warning signs that Forge was a poor investment

In 2012:

  1. Lawyer David Simpson, previously corporate counsel at Leighton Holdings (ASX: LEI), is announced as the new CEO, receiving an extremely generous pay package. His performance bonus requires him to increase earnings per share by 10%.
  2. CTEC acquisition is announced, partly justified with the claim that CTEC will be able to write contracts for Forge’s other businesses.
  3. David Simpson takes over as CEO in June 2012 and does not buy any shares.
  4. Directors Gregory McRostie, Andrew Ellison, Peter Hutchinson dispose of all or part of their holdings in Forge Group, for prices well above $5.
  5. Andrew Ellison and Peter Hutchinson leave the board.

In 2013:

  1. Directors Gregory McRostie, Marcelo Cardaci, Keith Gallagher and Neil Siford all leave the board.
  2. Clough (ASX: CLO) sells its entire holding in Forge at an average price of over $6.
  3. Forge Group acquires Taggart Group, EPC contractor for coal miners, funded through a new debt facility.
  4. On 29 October, CEO David Simpson receives 170,000 bonus performance rights.
  5. November 4: Trading halt, prior to announcement of write-downs.

Foolish takeaway

Investors must always keep an eye on the margins a company is receiving: businesses with low margins are generally riskier. A high rate of director resignations and insider selling could indicate insiders have lost confidence in the business. Finally, don’t forget to view remuneration packages with a sceptical eye.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of the companies mentioned in this article.

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