Troubled construction giant Carillion hit the headlines again yesterday after it announced its interim chief executive Keith Cochrane will be replaced almost three months earlier than planned.
When Andrew Davies, who was set to take over on 2 April 2018, starts on 22 January, he will become the company’s third chief executive in six months. It was the latest in a series of chaotic events which have come to characterise the company in the second half of 2017.
Cochrane was parachuted into the Wolverhampton-headquartered firm in July after it delivered an unscheduled trading statement, sending shockwaves through markets. Investors fought to flog shares, sending Carillion stock into freefall. Across town, West End hedge funds booked mammoth profits from carefully manicured bets against the contractor.
The surprise announcement set in motion a herculean effort to rake in enough cash to convince Carillion’s lenders they should throw the firm a lifeline: Carillion, a company with annual revenues of £5.2bn, has seen its valuation collapse from more than £1bn at the start of the year to less than £70m. But the fall-out for the contractor’s 50,000 global staff has been particularly devastating.
One of the firm’s senior managers has now broken the silence, giving City A.M. an exclusive inside view into bungled redundancy programmes and disillusionment with a stream of increasingly draconian new execs. Meanwhile, staff in cash-strapped offices feel isolated, being left to work in buildings that in some cases cannot even afford toilet paper.
The big short
Hedge funds cottoned onto the fact something was not quite right at Carillion back in November 2016. With London-based Marshall Wace leading the charge, funds borrowed more and more of Carillion’s stock to take out bets against its fortunes.
The Carillion manager, who has requested anonymity, claims the hedge fund interest was a product of leaks from senior meetings.
We knew from November  time, from the leadership conference in Birmingham, that there was a high-level of focus on cash collection. But at no time was it explained why that focus had come forward. At no time did [then chief exec] Richard Howson indicate in any way, shape or form the state of play with the business’ finances.
Howson and the board managed to safely navigate an annual general meeting in May. But on 10 July the charade was over, after a partial review by auditors KPMG identified £845m of contract write-downs.
Analysts worried further hits could be on the cards once the review was completed. They estimated shareholders would be asked for £500m. Howson was shown the door and hopes were pinned on the experienced Cochrane to steady the ship.
“The balance sheet is a mess,” wrote Liberum analyst Joe Brent. Peel Hunt’s Andrew Nussey advised Carillion’s “shares are best avoided until management provides further insight”.
The Carillion insider says the reaction from within the firm was one of shock. “There was disbelief from the staff generally. Nobody on my management team could believe the scale of the issues at hand.”
“We all knew the accounts were questionable; it was the most shorted stock in Europe,” a leading City analyst told City A.M. “But the extent of the problems were gobsmacking.”
With accountancy firm EY called in to help management pull together an operational and financial restructuring plan, Carillion continued to win contracts. The most high profile of these was a £1.4bn joint venture to build Britain’s controversial HS2 rail network. From 10 July to date, Carillion and its JVs have been awarded a slug of major contracts worth more than £2bn. Details of KPMG’s completed review, half-year figures and Carillion’s plan were slated to be unveiled on 29 September.
Long investors were hoping Carillion had “kitchen-sinked” matters in July. They prayed September’s announcement would simply rubber stamp the losses, drawing a line under the chapter and providing valuable insight on next steps. But in the event, KPMG revealed it had found another £200m of contract write-downs, and half year losses before taxation climbed to £1.2bn. The firm’s basic loss per share was a whopping 261.2p.
Analysts were disappointed. “Challenges [are] deepening despite decisive action,” wrote Investec analyst Chris Moore. Gregor Kuglitsch of UBS said: “No light at the end of the tunnel.” Peel Hunt’s Nussey added: “Risks [are] still too great.”
Average net debt in the second half was forecast to be over £1bn. Hopes of an equity raise had evaporated and it was becoming clear the banks would likely suffer losses by swapping loans for newly issued shares. But despite the level of financial distress, Carillion insisted it was, and still expected to be, in compliance with its financial banking covenants.
Meanwhile, the likes of Marshall Wace started to reduce their short positions and take profits. But the number of investors betting against Carillion remained high. There were plenty of other funds still queueing up to borrow stock. “We don’t know whether to go long or short on Carillion,” one hedge fund manager, with $5bn (£3.7bn) under management, told City A.M. at the time.
Rewind to July and the initial fear among Carillion staff was for their jobs: since the summer announcement, there have been two rounds of voluntary redundancies followed by a round of compulsory redundancies.
“But in typical Carillion style they had not completed the consultation process properly,” says the insider.
[Staff in my team] given compulsory redundancy ended up signing a compromise agreement and being paid off because the redundancy process was not followed through correctly.
And while the 10 July headlines included the chief exec’s sacking, Carillion said Howson will “stay with the group for a period of up to one year to support the transition”.
Industry insiders explain Howson was kept on for one reason: to persuade some of Carillion’s Middle East clients, who owed the firm hundreds of millions of pounds, to pay up.
One of the biggest problem projects was a $650m development preparing Qatar for the 2022 FIFA World Cup.
The Qataris, concerned at the prospect of Carillion not being able to complete the works, thought they were owed money – and withheld payment.
Attendees of cash conference calls, which were now happening three times a week instead of the normal two times a month, heard first-hand of the trouble involved in extracting cash from Middle East clients, saying simply that it appeared “impossible”.
By 11 September it was clear Howson, who had been given the role of chief operating officer, was getting nowhere. Andy Jones, the head of Carillion’s sizeable Canadian arm, replaced him. On the same day, head of construction Adam Green, support services chief Nigel Taylor and group strategy director Shaun Carter were culled.
50 miles to save £3
On the ground, things were going from bad to worse. A crackdown on expenses made life even harder for workers desperately struggling to meet clients, boost profits and bring in cash.
“We cannot travel anywhere in the country without two levels of authorisation,” the insider says. “The company was putting guys in hotels 50 miles away from where they were supposed to be working because it was £3 cheaper. It was incurring more cost and time commuting to the centres than if they had been in hotels next door.”
Extreme cost controls meant office kitchens ran out of teabags, and photocopiers out of paper. Even the loos were out of toilet roll. In the meantime, cash conference calls became increasingly tense, with satellite offices feeling cut off from group management.
“We have had an influx of accountants from EY, chasing invoices and cash,” says the source.
“The minute I issue an invoice for a body of work, [head office] chases, looking to do deals to get early cash in.”
The insider gives an example of extreme cash collection measures: checking his ledgers one day, he was shocked to find more than £1m allocated to a project as though the work had already been completed, meaning the client could be billed. “[The] project hadn’t started,” the person says.
“When I queried it, I was told to mind my own business.” This kicked off a “vicious circle”, where managers refrained from billing clients for fear of relationships being damaged by being chased for early payment.
In the meantime, suppliers were not paid to terms.
Third-party suppliers on 30-day terms have been put on 90 and 120 days without their knowledge. Because of the way the payment processes are set up, we cannot influence any of the processes directly.
As is normal in the construction sector, Carillion operates many of its contracts through joint venture (JV) partnerships, often with rival firms.
“If Carillion goes bust it’s not just the company [at risk], it’s all the arrangements with the likes of Amey, Balfour Beatty and Galliford Try,” said a leading construction sector analyst, who asked not to be named.
If Carillion cannot pay and the others are affected it also impacts on the supply chains on projects. The industry is riddled with JVs and cross guarantees for bonds and loans. [The fall-out is] totally unquantifiable, as outsiders have no appreciation of the extent of any liabilities.
There is no suggestion at the moment that Carillion will go bust, but that people talk about it in such apocalyptic terms shows just how serious the group's problems are perceived to be.
Among the key infrastructure projects are HS2 and a £1.5bn project to upgrade Britain’s broadband internet for BT’s Openreach division, for which Carillion has partnered with smaller telecoms installation firm Telent.
Telent was formed out of the UK and German operations of collapsed operator Marconi. The Openreach joint venture represents a huge chunk of its £400m of annual revenues – yet experts say it does not have the capacity to deliver the contract on its own.
“We know there have been issues in terms of overtime and operational targets being missed,” says the insider of the joint venture with Telent.
“We have had issues where staff haven’t even been able to put diesel in a van to go and service a contract. It becomes a bit of a joke. And this is happening not just on the Openreach contract but everywhere else.
“[Joint venture partners] are internally furious because they feel they are being let down. Carillion is not carrying its proportion of the weight of the contract.”
The situation became even worse on 17 November.
Carillion admitted it was on track to breach its banking covenants, a series of financial ratios and pledges the firm must operate within. As a result, the firm had convinced lenders, from which it had already borrowed £140m of short-term cash, to waive their testing. The market’s already dismal expectations would not be met either, Carillion said. The company’s share price halved within minutes of the announcement.
On a conference call with senior management on 21 November, Cochrane was fuming. “The theme was simply ‘it’s not my fault we breached the banking covenants, it’s yours for not doing enough’,” staff said.
Cash targets had been changed without staff knowledge, it emerged. Call participants said Cochrane “simply shut down questions” when asked why.
In the mid-November announcement, Carillion unveiled plans to embark on a strengthening of its balance sheet. “This will require some form of recapitalisation, which could involve a restructuring of the balance sheet,” it said.
But the future looks increasingly bleak. Shares continue to hit fresh lows – the firm now has a market capitalisation of less than £70m.
Many hedge funds think shares can fall further and continue to bet against Carillion’s fortunes.
“Hedge funds aside, no one wants to see Carillion fail,” says a leading City analyst.
“But that does not mean it won’t happen, depending on how you define failure. I expect there will be a huge debt for equity swap and the banks will take the business off-market. Current shareholders will only receive a nominal amount, if that.”
While insiders were critical of Cochrane before yesterday’s announcement, many insist Howson and previous management should shoulder their share of the blame.
“They have all had their hand on the tiller… In reality, if Carillion wrote off £250m in a year, nobody would blink. It would be three lines of newsprint and that would be it. But they have been saving this up for quite some time.”
What does the City think is at the core of Carillion’s problems?
“The full shebang. Contracts bid at the wrong price, with the wrong risk transfer that were poorly executed and poorly accounted,” says the analyst. Carillion’s involvement with many critical government contracts has led to several public shows of support from the Cabinet Office. Market watchers see this as critical to keeping the firm afloat.
“If Carillion flops, the whole bloody thing [sector] flops,” says the market analyst. “So do you think any of the banks or the government want to sort a situation like that out?
"They are going to have to keep the damn thing going because they know they can’t let it fail,” he adds.
The future at the coal face looks grim. Demoralised staff, many of them experts in their sector, are fearful of losing their jobs.
The insider concludes:
We don’t believe we are safe. We don’t believe we are secure. We are probably going to leave. Our business is broken.
One thing is clear: when Davies picks up the baton from Cochrane on 22 January, Carillion will still have a mountain to climb before it can convince staff and shareholders it has left its problems behind.