Collapse of Carillion

Institutional investors, auditors, government officials and Carillion executives all have big questions to answer following the construction giants collapse on Monday 15 January.

Carillion was the second largest construction and outsourcing company in the UK where nearly half its 43,000 worldwide employees were based. At its formation Carillion was valued at £2bn, now it faces compulsory liquidation with debts of £1.5bn including pension liabilities of £600m.

On Wednesday 10 January Carillion’s management team met with over 150 advisors from major UK banks confident that they could secure a deal which would keep them solvent. They had proposals for several possible deals which would have kept Carillion afloat. However, without assurances that the loans would be guaranteed by the government in the event of collapse, no major banks were willing to loan the millions that Carillion required to maintain its operations.

Within the industry company finances can be precarious. Many firms borrow lots of money upfront to challenge and set-up contracts which only return revenue over time, often over more than a twenty year period. Bids for contracts have increasingly slim profit margins and even slimmer margins for error.

As a result, if (as many do) companies accrue high levels of debt and if several contracts go sour simultaneously then they can get into difficulty very quickly.

This was the case for Carillion whose luck began to run out in July as the souring of three public sector contracts in Aberdeen, Birmingham, Liverpool and a further £5.5bn private sector contract in Doha caused a £845m black hole in the company’s finances. This triggered the first of three profit warnings within five months and ultimately was the turning point in Carillion’s demise.

Profit warnings are far more common for companies than liquidation is, therefore it was not unusual that the government decided to continue to award Carillion contracts initially. Indeed, seven days after the government awarded the £1.4bn HS2 contract to Carillion.

Although, such large government contracts take many months to award therefore it was too late to factor in Carillion’s new profit warning without risking legal action.

Credit can be given to the government who granted the HS2 contract across multiple companies to ensure risk minimisation.

However, it is unclear why the government continued to award Carillion contracts following the second and third profit warnings in September and November when the risk of Carillion being unable to fulfil their contractual obligations grew significantly.

However, the government was in a difficult situation. It also couldn’t have pulled out of awarding future contracts to Carillion without increasing and accelerating the likelihood of collapse given the signal that it would send to investors. Shareholders took the most risk (and as a result lost all their money) when they invested into a company which recklessly pursued growth through questionable acquisitions, systematic underbidding for contracts. However, many will feel aggrieved that growing debts within Carillion were masked by deceptive (but entirely legal) accounting methods which opens larger questions for the generally accepted accounting practices.

However, now the biggest challenge lies with the government who has never seen an outsourcing failure on this scale before and now will attempt to renegotiate hundreds of contracts with different companies to ensure essential public services are provided. This Whitehall must now decide whether Carillion was to blame, or the entire system of public-private partnerships is unsustainable as many of its critics would claim.


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