Carillion puts outsourcers’ accounting practices into spotlight
Watchdogs probe the way industry books revenues as contracts become more complex
If Carillion was a bricks n’mortar building rather than a bricks n’mortar business employing 43,000 workers it would be rubble by now.
It is a miracle of engineering that Carillion still stands. Its debt — close to £900m — plus a £590m pension deficit tower over equity. The shares have fallen from above 200p a year ago to 17p, valuing the group at £75m, and it has only just averted breaching its banking covenants.
Carillion — created by cementing together the construction and support services divisions of Tarmac, Wimpey, Mowlem and Alfred McAlpine — was once capitalised at more than £2bn. It is a beyond-textbook illustration of what happens to businesses built on asset-light balance sheet and debt-fuelled acquisitions in challenging conditions. Yet until half way through last year, investors seemed confident the group was big enough to overcome the structural weaknesses facing outsourcers — long-running contracts won on poor terms, rising costs and unyielding customers.
A year ago Richard Howson, Carillion’s then chief executive, talked of good growth in revenues and operating profits and declared Carillion to be “well positioned” to reduce its £586m borrowings. In May he said trading conditions “remained largely unchanged”.
Then in July the group warned that cash was gushing from key contracts, debt was rising, it would have to write off £800m and scrap its dividend and Mr Howson was leaving. Suddenly the FTSE 250 stalwart was a stock market titch.
Now the Financial Conduct Authority is checking for damp. It is probing the timeliness and content of announcements underpinning Carillion’s shares between December 7 2016 and July 10 2017.
The FCA is taking its newish powers to police and punish market abuse seriously. It has castigated several companies over information disclosure and has been going over statements made by Mitie in the run-up to its profit warning in 2016 that knocked a quarter of its stock market value.
But the City overseer is not alone in its interest in hod-carrying companies.
Accounting watchdogs have also been sliding their rulers over the way companies book revenues. Unsurprisingly their attention has been caught by outsourcers and their bundled, multi-faceted contracts with embedded costs for acquiring customers and supply-chain financing.
These contracts have become more complex. In the early days of the early 2000s, when returns on capital were high and executives could offset low operating margins through economies of scale, terms were relatively straightforward. But outsourcers overstretched themselves, taking on too much and signing up to projects they couldn’t control or predict.
Carillion expanded everywhere from Canada to the Middle East and into everything from maintaining army barracks to energy-from-waste projects. The group has continued to win big projects, such as helping to build the HS2 rail link to Birmingham. But contracts have been drying up as fast as labour costs have risen. Cash has become harder to collect and the bills have piled up.
As one analyst puts it: “The issue was pretty basic. Growth and revenues slowed. The answer was more acquisitions or use aggressive accounting techniques.” Many companies did both. That includes Mitie, which under new management, admitted last year to aggressive accounting practices in May when it wrote off £40m or so of its assets and restated its 2016 accounts.
As UBS says, outsourcing “contains the greatest degree of accounting judgments today”. That will change. Rule setters have introduced measures to align reported income to cash. It will create short-term confusion over underlying earnings, but “greater clarity in the long term”, says UBS.
Trouble is, Carillion’s shareholders can’t wait. Some may hope that Andrew Davies, who replaces Mr Howson as chief steeplejack this month, can repair the group’s stock market rating from his boatswain’s chair. They will be lucky. The group has staved off its lenders for a bit. But a debt-for-equity swap is on the cards.
The banks now in charge of Carillion will be slow to call in the demolition team. The group is, after all, one of the UK government’s biggest contractors, employs thousands of sub-contractors and is entwined with rivals in joint ventures. Unravelling the cross-guarantees and insurance bonds would take time and skill. But when necessary, lenders are as adept as any demolition expert at causing unstable skyscrapers to implode and minimising the damage to surrounding buildings. Note to investors, it takes months to prepare sites, but a building can fall in on itself in less than 10 seconds.