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Carillion: tip of the iceberg

We cast our eye over the UK outsourcers sector in the wake of the forced liquidation of Carillion early this week
January 17, 2018

Carillion (CLLN) has found itself at the top of a list of rotters in the outsourcing sector. Management had hoped to raise new capital and convert some of its debt to equity, but was forced to announce it would be entering compulsory liquidation with immediate effect.This is the worst possible outcome for investors. PwC, which has been appointed to manage the insolvency, warned “there is no prospect of any return to shareholders”.

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The troubles began in earnest for the group last July, when it announced an £845m provision against contracts, largely made up of three public-private partnership (PPP) contracts in the UK and the costs of exiting markets in the Middle East and Canada. In the same update, it had warned on profits, added more than £100m to the expected average net borrowings for the first half of 2016 and suspended the dividend. However, even before the warning the shares were heavily shorted, with many concerned about the levels of receivables and off-balance-sheet debt. 

Finger-pointing has inevitably followed the news of the support services group's collapse. Business Secretary Greg Clark has called on the Insolvency Service and the liquidator to fast-track a probe into the group’s directors, following the emergence of news that changes were made in 2016 to executive remuneration rules at the company, making it more difficult to claw back executive bonuses. Indeed, former chief executive Richard Howson and former finance director Zafar Khan are still due to be paid until October and July this year, respectively. The Financial Conduct Authority (FCA) earlier this month opened an investigation into the timeliness and content of the group’s announcements between 7 December 2016 and 10 July 2017. 

In the immediate aftermath, investors judged that Serco (SRP) and Interserve (IRV) would reap the greatest gain from Carillion’s collapse. This assumption makes some sense, since both are already major providers to the UK government. However, short positions in both companies have also been climbing. Interserve was the 15th most shorted UK stock at the time of writing, with roughly 8.7 per cent of its stock being shorted, according to data from the FCA. 

As the story has developed, public opinion has started to turn on Interserve in particular – with good reason. Like Carillion, the company recently announced it was at risk of breaching its financial covenants and has been struggling with ever-increasing impairments on its energy-from-waste business. The mis-calculation of cash flow to come from contracts, as well as the costs involved with servicing those deals, are arguably the most worrying parallels to be drawn between the two groups. 

Reports that the government had Interserve under watch sent the shares down 15 per cent on Wednesday 17 January, although they quickly recovered when the Cabinet Office said that, while it was monitoring "the financial health of all of our strategic suppliers, including Interserve", it did "not believe that any of our strategic suppliers are in a comparable position to Carillion”.

Another source of concern for us is Mitie (MTO), which has also released numerous profit warnings in recent years. Similarly to Carillion, the group is being investigated by the FCA over the timeliness of a 2016 profit warning. 

The shocks from the collapse were felt widely, with more than a dozen companies and funds issuing statements to calm investor nerves or quantify the impact on their balance sheets. Speedy Hire (SDY) said it remained on track to meet full-year expectations, despite 55 per cent of its core hire revenue in 2017 coming from Carillion entities. Balfour Beatty (BBY) announced it expected a cash outflow of £35m-£45m as a result of a number of projects on which it was a joint venture partner with Carillion. Galliford Try (GFRD) said its joint ventures with Balfour Beatty and Carillion would require £60m-£80m in outstanding cash contributions to complete, which may have to be funded by the remaining members.