Forging more than a Roy Hill fortune?

About a month ago Forge Group shares suffered an extraordinary implosion after the engineering group had a near-death experience. This morning its shares spiked nearly 66 per cent in volatile trading on heavy turnover, suggesting either the worst is behind it or there’s something more strategic occurring.

There is an obvious explanation for why the shares leaped 67 cents to $1.69 in this morning’s trading before falling back to about $1.42 at lunchtime.

Before the start of trade Forge announced it had received a formal notification from Samsung C&T to proceed with phase three works for the $1.5 billion engineering, procurement and construction contract for the processing facility at Gina Rinehart’s Roy Hill iron ore project in the Pilbara.

Forge’s share of the contract, which it has joint ventured with Spain’s Duro Felguera, is about $830 million and its chief executive, David Simpson, said the go-ahead would underpin the group’s order book for the rest of this financial year and into 2015. He said it was encouraging to note that the Roy Hill project was progressing to schedule.

Over the past week or so the $10 billion Roy Hill project has secured debt funding approaching $3.5 billion from South Korean and US trade finance agencies.

In some respects the market’s reaction to the Roy Hill announcement isn’t unexpected, given that an announcement of a mere $40 million asset management contract two weeks ago caused an equally sharp spike in its share price, albeit from markedly lower levels.

Since that earlier pick-up, however, Forge’s price has risen as much as 168 per cent, suggesting there might be something other than a reaction to some good news occurring.

Towards the end of last week there were some suggestions in the market that Forge could become a takeover target.

The Australian Securities Exchange last week queried the group about a surge in its share price but Forge said it knew of no reason for the rise, other than the asset management contract it won earlier in the month.

About 17 per cent of Forge’s shares were traded this morning, reflecting either a massive change of institutional opinion in relation to the group, or something more strategic.

About a month ago Forge Group lost 84 per cent of its value when it came out of a three-week trading halt and disclosed a $127 million profit writedown associated with loss on two power station projects in Western Australia and Queensland. Forge had picked up those contracts with its 2012 acquisition of the privately owned engineering services company, CTEC.

Not only did Forge announced the writedown but it said it faced a $45 million net cash outlay to complete the projects at a point where it had only $44 million of net cash – creating a “challenging” liquidity position as early as this month.

Had it not been for the support of ANZ Bank the former sharemarket darling would have been in a desperate position.

ANZ agreed to waive a number of covenants, expanded Forge’s working capital facility and deferred quarterly principal repayments on an existing facility. In return Forge agreed to issue warrants equivalent to about 13 per cent of its capital base (if the warrants were exercised) at one cent apiece.

ANZ Bank’s support indicated that it, at least, believed Forge’s problems were confined to the two power station projects, which Forge has quarantined from the rest of its business. The market activity over the past few days of trading would tend to vindicate the ANZ decision, as well as pointing to a potentially tidy little profit on the warrants.

Given that Forge’s market capitalisation had collapsed from nearly $600 million earlier this year to less than $60 million, if the issues confronting the company were only those two troubled contracts then the market’s reaction to them could be regarded as a massive over-reaction.

Considering the volume of Forge shares traded over the past few days, it should become clearer before too long whether the massive rebound in the group’s share price reflects a reappraisal of its prospects, or something – from Forge’s point of view – more sinister and opportunistic.