MacMahon loses Christmas Creek

MacMahon was supposed to generate $1.2bn in revenue over a five-year period from work on Fortescue Metals' Christmas Creek iron ore mine. It was the contractor's single largest project and a key lynchpin in our investment case when we included MacMahon in our mining services mini portfolio (see Is it time to buy mining services? Part 3).

In a flash, the company announced this morning that it had lost the contract, triggering a 40% collapse in its share price. This is not a case of the market overreacting to mildly bad news with a devastating sell-off: this is seriously bad news for the business.

The premature contract loss will mean the loss of $780m worth of revenue over the next three years, enough to force an immediate restructure. Management has already slashed revenue forecasts (for a second time) to $600–700m and is in discussions with banks about the company's debt.

MacMahon currently carries $169m of debt and has $124m in cash on the balance sheet. Although net debt is relatively low at just $45m, the sudden loss of so much revenue means banks can demand repayment.

The business now has 90 days to complete negotiations with banks and, if that goes badly, another 60 days to repay them. Quite suddenly, MacMahon, which has been in business for half a century, could fall over. With enough work on hand, banks should allow a sensible restructure of debt but sense is often lost in the scramble for dollars.

The loss of Christmas Creek is a shock. Fortescue has decided to aggregate contracts to a single supplier, a move it says will save it as much as $19m a month on the project. MacMahon has just become the latest – and most surprising – victim of the iron ore price slump. It will have to dramatically shrink its cost base and successfully renegotiate with banks to survive.

For all the downside, the business remains cheap with significant contracts still on the books, including work at the Tropicana gold mine which MacMahon will lead until 2022 although, as we have seen, contracts aren't worth much in this industry. The downside has increased but low portfolio limits offer some protection.

There are a few lessons to draw from this. Firstly, this is an absurdly lousy industry. Order books and contracts aren't guarantees and producers are always better placed – in booms and in busts – than contractors. Our foray into the sector might end OK but, to date, it has been disastrous with MacMahon down 60% since our first recommendation. Bottom feeding has been costly so far.

Some investors may wish to crystalise a tax loss but we are willing to wait through the discussion with banks. In the meantime, we're downgrading to HOLD.