Nils Pratley 

Blame the deluded board members for Carillion’s collapse

Lessons must be learned from this corporate calamity; Carillion took too many risks with too much debt
  
  

The new Liverpool Royal hospital under construction
Cost over-runs at the new Liverpool Royal University hospital cost Carillion dear. Photograph: Pak Hung Chan / Alamy Stock Phot/Alamy Stock Photo

Responsibility for Carillion’s collapse lies in the boardroom. It is the job of the directors to manage risk and the eight pages of Carillion’s last annual report devoted to the subject clearly only scratched the surface.

Chairman Philip Green should have spent less time wondering about the long-terms risks from Brexit and more time addressing the upfront and present dangers from cost over-runs on three big jobs: new hospitals in Liverpool and Smethwick plus the Aberdeen bypass.

The walk-on role played the auditors, KPMG, will go under the Financial Reporting Council’s microscope in due course. But the hard fact is that Carillion directors were boasting in March last year of having “substantial liquidity with some £1.5bn of available funding” yet the company ran out of money 10 months later.

That suggests delusion in the boardroom on a grand scale. Hedge funds, looking from outside and betting on the shares going south, seem to have had a better grasp of Carillion’s financial distress than the insiders.

The Carillion CV

History – The business was built from the construction division of Tarmac. It was spun out of the Tarmac corporation in 1999 and then acquired rivals, including Mowlem and Alfred McAlpine. It also acquired a number of Canadian businesses.

Base – Wolverhampton

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. Months later shares were down more than 70%. There were further profits warnings in September and November.

Major projects – Involved in the construction of numerous high-profile projects, including the GCHQ ; the Beetham Tower in Manchester; London Olympics Media Centre; Rolls Building courts complex in London; Heathrow Terminal 5; Library of Birmingham; Liverpool FC’s Anfield stadium expansion; the Battersea Power Station redevelopment; and work on HS2.

Government contracts – 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.

As usual with the construction sector, the immediate cause of failure is a mix of badly priced contracts, badly managed risks plus too much debt. On a good day, contracting firms run on tight operating margins of 3%. If debt is too high, there is little room to absorb calamitous contracts. When three contracts go sour in quick succession, the numbers can spiral out of control.

Balfour Beatty was in a similar, but smaller, hole four years ago and managed to claw its way out. By the time Carillion revealed its crisis – via a monumental profit warning last July that felled chief executive Richard Howson – events had run too far.

In the end, it comes down to judgments made in the boardroom. Carillion, outrageously, was declaring a fatter dividend for shareholders only last spring. Given what we know now, the correct action would have been to go to those investors and ask for a big injection of capital via a rights issue. Half the board would have had to resign, but an over-stretched balance sheet might have been repaired. Instead Carillion seems to have chosen to chase more low-margin contracts in a desperate attempt to keep its revenue line moving.

NHS
• Managed facilities including 200 operating theatres and 11,800 beds
• Made more than 18,500 patient meals per day
• Helpdesks dealt with 1.5m calls per year
• Engineering teams carrying out maintenance work

Transport
• Built 'smart motorways' – which ease congestion by monitoring traffic and adjusting lanes or speed limits – for the Highways Agency
• Major contractor on £56bn HS2 high-speed rail project
• Upgraded track and power lines for Network Rail
• Major contractor on London’s Crossrail project
• Roadbuilding and bridges

Defence
• Managed infrastructure and 50,000 homes for Ministry of Defence

Education
• Designed and built 150 schools
• Catering and cleaning contracts at 875 schools

Prisons
• Maintenance and repairs at about half of UK prisons

Libraries
• Managed several public libraries in England

Energy
• Built substations, overhead cables and other works for National Grid

In the circumstances, the government had no choice but to let the company go bust. Carillion had six months to organise its own rescue and failed, despite being thrown a few contracts such as work on HS2 to buy breathing space. Besides, a bailout of Carillion would also have been a bailout of the company’s banks and bondholders, who definitely don’t deserve it since they were asleep to the risks as much as the directors.

The government has still inherited a fine old mess – and, however much ministers talk up their “contingency” plans, it seems highly likely that costs from Carillion’s failure will rebound on the public purse.

It is a relatively simple matter to take facility-management contracts (covering prisons and schools so forth) in-house or award them to other operators. A similar shuffle can be performed on building contracts where Carillion was part of a consortium: fellow members can be pushed to fill the empty shoes, just as Balfour and Gailford Try have on the Aberdeen bypass.

But the thicket is deeper when it comes to Carillion’s hospital work, conducted via public-private partnerships and special purpose vehicles with a different set of lenders from the parent. Untangling that mess could prove hellish. Do joint venture equity partners have to be bought out before a new contractor can be appointed? How much will a new builder demand to complete another company’s half-finished job? How much longer will new hospitals in Liverpool and Smethwick be delayed?

Whatever the answers, a review of these public-private deals is long overdue. A bare-minimum reform might be a balance-sheet test to lessen the likelihood of a big contractor falling over in a heap, threatening chaos for local subcontractors.

A second moral is that the Pensions Regulator needs more power to order companies to close deficits. The same annual report boasts of 16 years of unbroken dividend growth yet pensioners are now being thrown into the pensions lifeboat. How could a company with Carillion’s pension deficit – £580m – be allowed to pay £83m in dividends last year? It’s a nonsense.

The last conclusion is the official receiver should immediately demand the repayment of executive bonuses for 2016. Clawback conditions were relaxed that year, but the moral case is overwhelming for Howson to hand back his £245,000 bonus plus whatever he cashed from his £346,000 share-based award. The seeds of this corporate calamity were sown on his watch.

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