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With World Bank audit, Bombardier shows the risk of frontier markets

Originally quoted in The Globe and Mail

By: David Berman

Here’s one takeaway from the recent travails of Bombardier Inc. and SNC-Lavalin Group Inc.: Investors cannot ignore the risks run by companies that do business in faraway lands where the rule of law takes a back seat.

Both companies have encountered big headaches from their pursuit of growth and profits in frontier markets. For SNC, that market was Libya: The company now faces the prospect of a trial for bribery and fraud for its actions in securing contracts from the Gadhafi dictatorship.

For Bombardier, there’s new trouble in what has already been a woeful year. A World Bank audit obtained by The Globe and Mail alleged the Montreal-based transportation company used corruption and collusion to win a US$339-million contract to install rail-signalling equipment in Azerbaijan in 2013. The World Bank, which helped finance the deal, could blacklist Bombardier from future projects it finances.

In a statement on Friday, the company said the audit’s findings are preliminary and that it disputes the conclusions, which have not been proven. “As the World Bank’s audit process is governed by strict confidentiality requirements, we can only reiterate that we strongly disagree with the allegations and preliminary conclusions contained in the letter.”

For investors, reality bites. SNC and Bombardier are facing these headlines about allegations of overseas shenanigans from years ago at the same time as they’re suffering from serious operational problems in foreign markets. It’s enough to raise concerns over any company that has planted a Canadian flag in faraway places.

“The global marketplace is becoming increasingly competitive, and not all companies are operating off of the same regulatory playbook," said Steve Bonnyman, co-head of North American research and portfolio manager at AGF Investments. "And that makes it far more challenging for companies that want to be competitive, and yet operate within the regulatory environment of their home countries.”

Bombardier’s share price did not move much on Friday, falling less than 1 per cent. But other problems have already hammered its share price. Earlier this month, the company suspended its financial targets for 2020 amid a multiyear turnaround plan that now involves selling its aircraft component factories in Morocco and Northern Ireland. The shares are down 60.9 per cent from recent highs in July.

SNC-Lavalin, also based in Montreal, has fared even worse. Once Canada’s largest engineering firm, it faces a potential ban from bidding on federal contracts for 10 years if convicted on the Libya charges, and already the bad publicity has caused tremendous damage to its reputation.

The shares closed on Friday at $27.17, down 40.8 per cent for the year. Benoit Poirier, an analyst at Desjardins Securities, estimated that SNC’s stake in the Highway 407 toll road in Ontario is worth $26.94 per share. This implies that the company’s core engineering and construction business is now being valued by the market at just pennies a share.

Yet SNC-Lavalin and Bombardier represent a tiny slice of Canadian companies that are turning to far-flung locales for growth opportunities.

After its merger with Randgold Resources Ltd., Barrick Gold Corp. has gained new exposure to African-based mines. Apparel-maker Gildan Activewear Inc. has manufacturing facilities in places such as Nicaragua and Bangladesh. And even Bank of Nova Scotia – Canada’s third-largest bank – prides itself on its exposure to countries like Peru and Colombia. The list is long.

Indeed, observers point out that investors have long needed to weigh the risks associated with international expansion, and the risks aren’t confined to the sort of problems facing Bombardier and SNC-Lavalin.

“Their scrutiny is not limited to corruption and bribery – it includes disclosure relating to a host of issues, some of which are newer in terms of the disclosure that is being made and requested (such as climate change and diversity on boards),” Anita Anand, the J.R. Kimber chair in investor protection and corporate governance at the University of Toronto, said in an e-mail.

She added: “An increased focus on corruption and bribery in terms of the international actions of corporations does not change the risk calculation for issuers in my view because these issuers must operate in compliance with all laws.”

Mr. Bonnyman noted that investors have always needed to recognize that global expansion brings risks, given not only regulatory issues but also the threat of nationalization and shifting rules.

“You have to take a very structured and disciplined approach to look at all the things you know and don’t know, and assess whether those risks are worth taking on in light of the potential investment reward,” he said.

For some investors, that will mean sticking with companies that operate closer to home. For others, it means knowing the facts behind companies’ international operations – and understanding that the kind of risks now facing Bombardier and SNC-Lavalin could appear elsewhere.

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First published in The Globe and Mail - Since 1995, Ontario’s Securities Act has contained

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