Carillion has gone into receivership, despite frantic talks with creditors and the government over the last week. The UK’s second biggest construction company biggest revealed a succession of nasty surprises about its balance sheet over the second half of last year, destroying confidence in its ability to pay back its substantial debts.
PwC is now expected to step in as administrator, arranging to liquidate assets and pay off its £1.5bn debts. Carillion chairman Philip Green has said that he understands the government will step in with funds to maintain the public service contracts carried out by the firm, which include operations in prisons and schools.
‘This is a very sad day for Carillion, for our colleagues, suppliers and customers that we have been proud to serve over many years. Over recent months huge efforts have been made to restructure Carillion to deliver its sustainable future and the Board is very grateful for the huge efforts made by [CEO] Keith Cochrane, our executive team and many others who have worked tirelessly over this period,’ said Green.
Here’s MT’s piece on what went wrong with Carillion, originally published January 10.
We don’t like to get too hung up on share prices here at MT, but when you come across a chart like this, it demands explaining.
*Winces. Source: Google Finance
Carillion’s demise on the stock markets has been nothing short of spectacular. It all started with a shock announcement in July, when the construction and services company helpfully informed investors that it had overestimated the value of its contracts by £845m, that its efforts to reduce leverage were being forced into reverse by disappointing cash flows and that it was cancelled the dividend.
Since then, it’s just been a disastrous drip feed of embarrassment, as the problem everyone thought was bad just kept getting worse. Carillion replaced its CEO twice, discovered a few hundred million more in over-valued contracts, announced a £1.1bn half year loss and then said it wouldn’t be able to abide by its banking covenants (usually somewhat problematic, when you have £1.5bn of debt).
It’s for this reason that the firm is meeting with its banks this week to discuss refinancing options, which are likely to include a debt-equity swap, but which some people fear might actually end the company.
What makes this particularly interesting is that Carillion is still operationally profitable, just about. It’s winning new business too, most notably contracts for HS2 and in the Middle East. Carillion’s share price has fallen 90% but its revenues (expected this year to be £4.6-£4.8bn) haven’t suffered anything like as much, though they are still forecast to fall. At first glance, this may seem to explain why MT doesn’t like talking too much about share prices – they’re distracting, because they aren’t fundamental to what the business is actually doing.
But when it’s this extreme and banking covenants are involved, the share price absolutely does matter. Above all, the disintegration of Carillion’s fortunes despite its continued profitability illustrates the importance of keeping a healthy – and accurate – balance sheet, and keeping an eye on debt.
Businesses like Carillion rely on long-term contracts. In an ideal world, new contracts would start just as old ones ended. In the real world, they're more like buses. Debt is sometimes required to cover the gaps. The assumption is that there will be peaks as well as troughs, allowing the money to be paid back. But if the peaks don’t turn out quite as towering as expected, the debt mounts.
Revenue may be vanity, profit sanity and cash reality, but if you’re not careful debt can be insanity. It’s helpful in so many ways, but there comes a point when it can choke a business. Hence the banking covenants, which in this case require the net debt to EBITDA ratio to be between 1 and 1.5.
Carillion will hope to convince its lenders that the surprise asset write-downs are firmly in the past, and that its new contracts and cost-cutting exercises mean it will be able to turn net borrowing around before the debt becomes insurmountable.
In the process, it will also hope to convince investors (pesky hedge funds included). Even a small flutter of confidence would, in the circumstances, go a long way to restoring the firm’s value, and give its leaders a little breathing space.
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