Carillion: From sunny outlook to bust in just five months


By Russell Bruce

One of the things you should do at the start of a new year is have a good look at your finances. It is more than incompetent that Carillion did not carry out a total review of their financial position in January 2016 and January 2017.

In March 2017 Carillion issued their Annual Report for 2016. It was sunny and upbeat with few clues to the underlying issues – like the change to director remuneration hidden in 8pt type in a dense section of the report.

They paid a final dividend in June 2017 for the 2016 financial year. Issued a profit warning and cancellation of future dividends in July. The company was short of cash yet paid out that last dividend when prudence would have suggested they needed to retain cash rather than consume what was left of their free cash and borrowing limits.

Keith Cochrane, who had led Weir through a difficult period, became CEO on 10th July 2017. Presented to the City as a new face, things were somewhat different. A qualified chartered accountant, Cochrane knew his way around the boardroom with a long history as a Finance Director and CEO; migrating from Stagecoach to Scottish Power to Weir to Carillion with overlapping directorships.

Cochrane actually became lead non-executive director of Carillion on 2nd July 2015. Even more damming he was on the audit and remuneration committee at Carillion, according to the Sunday Herald, for two years before his elevation as CEO. This was a man with the skills and experience to unravel the core problems at Carillion. Did he speak up? Did he advise against paying that last dividend in 2017 to preserve cash? Did he not see Carillion were going through a period of extreme difficulties that other outsourcing companies had encountered? It is the function of directors to keep an eye on competitors. Did Cochrane think Carillion was immune?

From 2015 through 2016 Cochrane was becoming firmly embedded in the establishment. An opponent of Independence, David Mundell appointed Cochrane  as the lead “non-executive director” for the Scotland Office and Office of the Advocate General. He was made a Commander of the Order of the British Empire (CBE) in the 2016 Birthday Honours list.

In late September, 3 months from Armageddon, the 2017 interim report indicated reduced operational profits but showed a massive write off against tax on underperforming contracts.

Reality could no longer be shrugged off but the company was still winning new government contracts and presenting an upbeat face to concerned shareholders.

Cochrane believed Tory friends would bail out Carillion

Cochrane and Carillion had become an embarrassment. The FT reported, “Lack of political support dooms Carillion”. The Carillion team, led by Cochrane, sitting down with 160 bankers faced their combined determination not to shovel any more money Carillion’s way unless the government was prepared to cough up.

160 banks said no more unless the government steps up with a package. They didn’t. The government had decided they were going to cut Carillion loose before they attended the meeting. Cochrane and Carillion were dead meat.

Although there might have been an argument for a bailout, given the other companies dependent on government PFI contracts, the message had to be – ‘get sorted you won’t be bailed out.’ More than that ‘one of their own’ had put the government in an impossible position. No forgiveness.

Carillion’s collapse will reverberate for months

The fallout from the Carillion crash will reverberate for many months to come, not least for the 30,000 sub contractors facing losses from unpaid bills. Carillion took at least 120 days to pay and reportedly were not any better at getting in money owed to the company. Bad cash flow management with the consequent lack of free cash meant they were increasingly reliant on short term borrowing on top of their longer term rising debt pile and pension fund deficit.

Everybody and the dogs knew that PFI contracts were a spectacularly bad idea. The cost to the public purse is a heavy burden for the public sector. Public services are being squeezed in a violent pincer movement – budget cuts from Westminster on new department settlements and PFI payments growing as a percentage of base costs.

PFI costs a lot extra

Instead of funding infrastructure construction costs from the capital budget or straightforward government bonds, PPI and PFI contracts leave the cost of borrowing with the contractor, often in a consortia. Companies borrow at a higher rate than the government is able to. Fees, insurance, contractor margin, writing of complex contracts all pile up to calculate the cost of repaying the debt over 25 years.

The National Audit Office has calculated the cost to be as much as an extra 40%. There are currently 716 live PFI contracts that will cost the country £199 billion extra. If the government had borrowed in a conventional manner to bolster allocations to the Capital Account our public services would not be buckling under such a strain.

Conservatives are supposed to be the ones best at managing money, budgets and the economy. It is a myth. Their obsession with private sector involvement has cost us dear, damaged key public services, created an endless property bubble and failed to deliver affordable homes.

PPI/PFI was introduced by John Major’s government in 1992 and enthusiastically increased by Gordon Brown to magic away an increase in national debt by hiding the borrowing in the private sector. The practice has continued unabated under Tory governments for the last 7 years. PFI payments are public debt and the structure needs to be overhauled.

Keeping a safe distance from private sector involvement

May insisted at PMQs the government was just a client of Carillion. In some cases the government takes a stake in the consortia behind PFI projects putting the government on both sides of the contract in a complex and long running relationship that is far too close. Carillion started as a construction company and ended up gathering in contracts to build hospitals, manage the facilities it built and even deliver 32,000 school dinners.

The company was over complex, debt ridden with badly performing (loss making) contracts hidden in a web of subsidiaries with the result the company managers were hiding reality from themselves as well as shareholders and the government. Paying a contractor to build a facility for the public sector is a more straightforward relationship and one that enables both parties to keep a safe and due diligence relationship.

Heaping new contracts on a failing company meant the government did not have a grasp on a situation they were in a position to demand clarity on in the public interest.

Profit warnings and outsourcing

Balfour Beatty, another former construction company now heavily involved in outsourcing ran into problems a couple of years ago and issued a series of 7 profit warnings. It has, reportedly, returned to health. Carillion mounted an unsuccessful bid to take over Balfour Beatty in 2014. Takeovers were a core part of Carillion’s growth strategy and a source of much of its accumulated debt pile.

Interserve shares dropped 14% when the Carillion bust plopped last Monday. Interserve shares were trading at 359p last January and reached a low of just 59p in early Dec. They had a turnover of 3.2 billion, but made a loss of 94m in 2016. They employ 80,000 people, 20,000 in the UK, so their survival is a real cause for concern.

There is a numbers pattern echoing the Carillion debacle. Low or missing profit margins on large turnover, paying an unaffordable dividend, collapsing share price and vulnerable to shorting activity.

Using Contract for Difference (CFD) investors can bet that a share price will go up (long) or that it will fall (short). It is high risk. Banks, hedge funds and fund managers use it as a type of Insurance against loss. Blackrock, the world’s largest fund manager, held 8% of Carillion shares. It made a reported £200 million pound profit betting against the company.

Interserve has seen the number of its shares shorted on CFDs rise from 1% to 14% in recent days in a sign the company has flashing red lights all over it.

Outsourcer Mitie manages and maintains buildings for the public sector. It reopened its 2015/16 results to take a hit of £50 million. The CEO, Baroness Ruby McGregor-Smith, was forced out along with the finance director and a new team took charge of a more cautious approach to contract risk. The company blamed the failure of new contracts coming through because government was so tied up with Brexit plans to leave the EU.

Mitie, like being investigated by the Financial Conduct Authority (FCA)

Serco In May 2014 Rupert Soames, perhaps best known as a grandson of Winston Churchill, moved from Scottish based power provider Aggreco to become CEO of Serco. It was in a mess. Plunging share price, issued profit warning, at risk of breaking banking covenants, high levels of distrust between senior managers and staff and urgent requirement for a £170m cash injection.

Their share price in 2014 was just over 400p and has sunk steadily since, closing last Friday at 97p. To be fair to Soames he has probably stabilised Serco but his hopes for a rise in the share price this year look optimistic. Their 2016 result showed profit before tax of just 1%. The interim 2017 results are better at 2.33% but still nothing to get exited about. Nothing suggests the 97p share price is other than a significant overvaluation for the sector. The current share price is equivalent to over 15 years earnings.

The history of the outsourcing sector shows a pattern that they follow like sheep, learning nothing from the experience of those who stumbled before them. The conclusion must be that this section of the private sector is not just inefficient but uniquely incompetent.

Could something good come from Carillion’s demise?

Outsourcing covers a range of contracts from complex infrastructure construction to who serves up the school dinner for the weans. When capital cost is converted to higher purchase payments on steroids then real concern mounts. There is an opportunity to end all PFI funded construction schemes and use conventional government capital budgets and debt issuance.

PPI and PFI were constructed to keep this additional public debt off the books. That is no longer the case anyway, under new rules for defining a country’s indebtedness.

What we now know, in the wake of Carillion and with other outsourcing companies on life support, is that the myth the private sector is perpetually efficient is nonsense. Bundles of contracts handed out to these companies have produced a far too cosy arrangement between Westminster ministers, civil servants and the outsourcers.

The Scottish Government makes much use of the Scottish Futures Trust model instead of PFI. The Aberdeen Western Periphery Route is a public project and the Scottish government examined implications of Carillion’s involvement back last July.

Under devolution Scotland’s capital budget is set by Westminster, as is the limit to borrowing powers. It is a complication that makes budget planning more difficult than proper strategic allocation that is only possible with independence.

A complete review is urgently required with all major construction projects financed directly by the government. The chance of change is probably slight for two reasons – firstly Conservative governments are in thrall to pushing everything out to the private sector, regardless of real efficiency measures or proper cost control; and secondly the government is tied in knots over Brexit, working day and night on hopeless plans for a deal in areas May’s red lines rule out.

If Brexit was supposed to bring back control all it has produced so far is a government out of control with no prospect of finding Global Wonderland.

But hey! England is to get a loan of a 950 year-old tapestry from France celebrating how the French thumped the English in 1066. I don’t think the English do irony.

Keith Cochrane slips away

Cochrane must have known it was time to move on. Perhaps get out of the country. Private Equity company Blackstone has taken over Darmstadt based  Schenck Process, a global market leader in measuring and process technology equipment. Cochrane is their new chairman.

The Schenck press department in Darmstadt issued a press release on the appointment on 4th January, just 10 days before Carillion was flushed down the plughole.

Keith Cochrane said: “Schenck is a great company, and I am delighted to be taking on this role. I look forward to being closely involved in the next stage of the company’s development, working alongside the executive team and continuing its growth strategy to deliver significant value.”

Commenting on the appointment, Andreas Evertz, CEO of Schenck, said: “On behalf of the Board, I am very pleased to welcome Keith as our new Chairman, marking another important step in the evolution of the company. Keith is an experienced leader with a proven record, and we will greatly benefit from his vision and deep understanding.”

Lionel Assant, Head of European Private Equity at Blackstone, said: “Keith’s intellect, operational expertise and relevant sector experience will be invaluable as we build on the growth already achieved and the on-going transformation of the business.”

Blackstone and Schenck have given Cochrane a piece of German pasture to graze on and slip from the limelight. That is not likely to happen. Blackstone’s timing, judgment, and prudence are splattered with question marks.

With Cochrane now away in Darmstadt so often David Mundell has the perfect excuse to cut Cochrane’s links with the Scottish Office.

Postscript: Keith Cochrane resigned as a Business Advisor to David Mundell three days after this article was published