by David Buchler
MONTY Python’s corpulent diner Mr Creosote exploded after a ‘wafer-thin’ mint tipped him over the edge. Carillion’s messy demise, however, was in no small part down to its long term diet of contracts with margins barely as fat as a squashed After Eight.
As the recriminations gather momentum, the collapse of the UK’s second largest contractor will shine a light on the industry’s precarious business model of gigantic projects yielding meagre profits. Juggling complex contracts spanning a range of sectors and markets is testing even for the world’s most talented management. Add in projects going wrong, then subtract a degree of talent and the outlook quickly becomes bleak.
Carillion’s debt profile and pension deficit were for a long time wholly inconsistent with its business model. Delivering a net margin of 3% on 2016 sales of more than £4bn left hardly any wriggle room once interest payments and an unrealistic dividend policy were serviced.
That is why predictable cash flow from operations is always so critical. It’s also why former Carillion CEO Richard Howson’s apparent strategy of chasing risky low-margin contracts, while keeping subcontractors unpaid for up to 120 days, was unsustainable.
The whiff of desperation about the company’s cash management clearly did not elude the hedge funds which have made fortunes shorting Carillion stock from as far back as 2013. The inexplicably low tenders for large contracts, now obviously to keep the cash circulating, seems to have prompted fewer questions.
The revenue profile is, ultimately, why the company has - at first, bafflingly – gone into liquidation, rather than administration. It is now obvious that there are no viable parts of the business to sell. The contracts are certainly not meaningful assets to borrow against, even if a diligent administrator might have found a creative way to sell them on.
What remains baffling for the corporate recovery community is why the six to seven months between Carillion’s major profit warning in mid-2017 and the company’s eventual collapse did not feature a significant day-to-day involvement of professional, external turnaround specialists. It beggars belief that the full picture of woe was not known to the executive board some time before this.
No cheers for the non-executive directors here, either. Howson was replaced as CEO on an interim basis by an NED of two years’ service, Keith Cochrane. He would have stepped aside this month anyway when a permanent boss joined, although his basic salary of £750,000 was to remain until July. NEDs had already approved, in 2016, a relaxation of rules to claw back bonuses.
A business in such dire straits probably needed a full suite of interim executive directors with turnaround experience – at the latest, early in 2017. Some existing directors might have moved to NED roles, for continuity and assistance. The move would no doubt have hastened the slide in Carillion shares, but something might have been salvaged for investors at the end.
Instead, directors persisted with a dereliction of duty on a scale rarely seen before in a major UK public company. The egregious abandonment of decency in matters of boardroom pay, given the circumstances, is symptomatic of the lack of grip on reality at the top. It’s a kick in the teeth for all stakeholders, but certainly not the first or last time spectacular failure has been rewarded.
Much worse and longer lasting is the effect on Carillion’s ten of thousands of employees, its suppliers, many of them SMEs, subcontractors, contract partners and clients. Those who survive this sorry episode, including banks, will incur significant costs and write downs. Others will lose livelihoods, businesses and homes. The total fallout, including debt and shareholder value, could run into billions.
Over more than a decade, Carillion had been a consolidator in the construction industry. It acquired Alfred McAlpine, Mowlem and part of John Laing. In 2014 it failed to win Balfour Beatty for £2bn. Now Balfour faces estimated costs of £45m from its suitor’s collapse.
None of these deals insulated Carillion from the flawed workings of its sector. They added diversity which only made the enlarged group even harder to manage, while possibly encouraging an unrealistic view of growing the top line. None of it helped margin growth, cash flow or risk management longer term.
The hedge funds were right, four years earlier. Last year, Carillion shares were consistently among the most shorted. The writing was on the wall: like Mr Creosote, the company was truly stuffed long before its last meal.
David Buchler is Chairman of turnaround and restructuring specialist Buchler Phillips
www.buchlerphillips.com