The vast Carillion construction and public services group was fighting for survival this weekend as management, the government and lenders to the stricken construction services firm were locked in rescue talks.
The company is bleeding cash from several contracts that have turned sour and it is struggling under the weight of £1.5bn of debt, including a huge £590m pension deficit.
Professor Karel Williams at Manchester University noted that Carillion had turned from a construction company into an outsourcing conglomerate, which was, he said, “a bad idea”.
Williams added: “With outsourcing, you have to continually bid for new contracts, and the stock market expects to see continuous growth. But sooner or later you take on a contract that makes huge losses and the operation can’t sustain those losses.
“There are problems when you move past being a specialist outsourcer. Many conglomerates just churn through contracts and move into areas they don’t understand, until their luck runs out. This was an accident waiting to happen.”
Carillion employs 43,000 workers, including nearly 20,000 in the UK, and is one of the UK government’s biggest contractors. It works on the high-profile HS2 project, it builds, maintains and operates hospitals for the NHS, and manages nearly 900 schools.
The crisis gained momentum in recent days. On Wednesday, the company presented a potential rescue plan to its lenders. On Thursday, there was a meeting of key government ministers to decide on contingency plans if collapse could not be avoided. On Friday, there were more meetings with the pensions regulator, to assess the threat to the company’s pensioners and pension scheme members.
A collapse would be disastrous for the government and, potentially, costly to the public purse.
The threat to Carillion is so acute that audit heavyweight EY was placed on standby on Friday to step in as administrator if banks and the government could not thrash out a deal to save the firm.
EY was said to be favoured by the company’s directors, possibly because Lee Watson, a partner at the audit giant, is on secondment to Carillion, acting as a director and as the contractor’s chief transformation officer.
The rescue plan shown to lenders last week included handing back some loss-making contracts, revamping others and accepting financial support from the government.
But it is understood that Carillion’s main lenders – Barclays, HSBC and Santander UK – have indicated they are reluctant to provide additional funding because they are already exposed to huge potential losses.
A solution could be a debt-for-equity swap and the government guaranteeing its loans, which would shield lenders from losses in the event of a collapse.
The company’s parlous financial state was revealed last year, when it said borrowings were piling up and that it was making losses on key contracts. That meant it would have to write off £800m and suspend its dividend. A plan to raise £300m through sell-offs by the end of 2018 has so far only delivered £50m.
The group’s market value has shrunk from £2bn after it was formed from the construction divisions of Tarmac, Wimpey, Mowlem and Alfred McAlpine, to just £61m at Friday’s close. The shares, which just two years ago were changing hands at around 300p, closed on Friday at just 14.2p – down nearly 30% on the day, as fears of total collapse heightened.
A construction industry expert said part of Carillion’s problem had been that it had lacked focus. He said: “One minute it’s pulling out of construction altogether in order to focus on services. Then it changes its mind when it thinks it can make some money in construction again. It’s been a bit of a mess.”
The group’s chief executive, Richard Howson, quit last July, after the first of three profit warnings in four months.
Three public finance initiative schemes, which are late and over budget, are partly responsible for the blow-up at Carillion – the £350m Midland Metropolitan hospital in Birmingham, the £335m Royal Liverpool University hospital and the £745m Aberdeen bypass.
In the case of the Royal Liverpool hospital, it is at least a year behind schedule. It was due to be completed in March 2017 but, according to industry website Construction Enquirer, the discovery last year of cracks in two concrete beams, which required significant remedial work, pushed the handover date back.
Last week, it emerged the project had been hit by a further setback that means the new 28 February completion date will again be missed by the contractor. At a time when the NHS is at breaking point, the potential collapse of a key private partner is a shocking prospect.
According to Carillion’s website, it is “one of the largest providers of facilities management to the NHS”. It employs about 8,000 people in the healthcare division; its engineering teams carry out about 200,000 maintenance tasks on about 1m square metres of NHS space; the buildings that Carillion is responsible for include 200 operating theatres, with 300 critical-care beds and just under 11,500 in-patient beds; it prepares more than 18,500 patient meals per day; and the firm’s NHS helpdesks manage more than 1.5m calls each year.
The scale of its work for the NHS – without even considering work it does for the Ministry of Defence or Prison Service – is enough to focus the minds of ministers on a rescue deal. Williams noted: “The whole rationale for PPP (public private partnership) – where Carillion has been a big player in the UK – is that, notionally, you transfer risk to the company that takes the contract. But, fundamentally, the limit of that risk is the balance sheet of the outsourcing company. If you move beyond that, it becomes a crisis for the government.”
Carillion, like many other outsourcing and service companies, relies on long-term contracts. In the case of building and operating a school or a hospital, there is a lot of expense and a lot of risk involved at the construction stage. But contractors reap the rewards on the 20- or 30-year management and maintenance deals that follow, which provide some comfort and clarity over future earnings. Ideally, firms would spread the work so that new deals replace contracts that are just about to end.
However, this is rarely the case and debt is often required to plug the gaps in the lumpy cashflow cycle. The danger is that if something goes wrong with a contract, and it doesn’t make as much money, or even loses money, it suddenly becomes more difficult to finance those large borrowings.
Williams urged ministers to cast a more critical eye over future outsourcing deals between the government and private firms. “We should have offered them a management contract, because the government can borrow more cheaply,” he said. “But the Treasury doesn’t want the debt on the government’s books. So it passes the problem to somebody else – until it goes wrong.”
This weekend, it seemed to be going wrong in spectacular style – and thousands of jobs, pensions and key public services now look to be at risk.
History The business was built from the construction division of Tarmac. It was spun out of the Tarmac corporation in 1999 and then acquired several rivals, including Mowlem and Alfred McAlpine. It also acquired a number of Canadian businesses.
Employs 43,000 staff (20,000 in the UK)
How the problems emerged A profit warning on 10 July revealed an £845m impairment charge in the construction division. By the end of the summer the shares were down more than 70%. There were further profits warnings in September and November.
Major projects Carillion has been involved in the construction of numerous high-profile and prestigious projects, including the GCHQ government communications centre; the Beetham Tower in Manchester; the London Olympics Media Centre; the Rolls Building courts complex in London; London Heathrow Terminal 5; the Library of Birmingham; Liverpool FC’s Anfield stadium expansion; the Battersea Power Station redevelopment; and work on HS2.
Government contracts Include school meals and cleaning at nearly 900 schools, maintenance contracts at half of the UK’s prisons, managing 200 operating theatres and traffic monitoring systems for the Highways Agency.