Over two years ago, on 15th January 2018, the private contractor Carillion took steps to enter into compulsory liquidation with immediate effect after suffering significant financial troubles, but what led to their demise and were the warning signs there?
Carillion was the UK’s second-largest construction firm and a major strategic supplier to the UK public sector, with work ranging from hospitals to building roads. At the time of going bust, Carillion was working on around 420 public sector contracts.
Carillion was known to squeeze its suppliers by making them wait over 120 days for payment. The company then abused the “Supply Chain Finance Scheme”, which was launched by the Government in 2012. Through this scheme suppliers could take their invoices to a number of partner banks and be paid in advance in return for a fee, while the debt would be transferred so that Carillion then owed the money to the banks. It used this system as a line of credit yet did not account for it as borrowing on its financial statements. This led to a huge increase in trade creditors. While most companies are leveraged to some degree, Carillion’s loans exploded from relatively sustainable, but still high, levels of £277m in 2010 to £1.3bn at the time of its eventual liquidation in 2018. This was one of many terminal issues within the company.
Carillion also acquired many competitors despite not allowing or planning for synergies, mainly funded through rising debt while the contractor ignored growing pension deficits. It persevered with an unstainable business model, becoming increasingly reckless in the pursuit of growth.
Carillion had managed to paint the picture of a healthy company mainly due to an increasing dividend year on year and aggressive accounting policies. This all being in the face of volatile financial performance and growing debts. Carillion’s directors chose short-term gains over long-term sustainability. The May 2018 report of a Parliamentary inquiry by the Business and the Work and Pensions Select Committees said Carillion's collapse was "a story of recklessness, hubris and greed, its business model was a relentless dash for cash".
However, many investors had spotted the problems with Carillion well in advance of its collapse.
In early 2015, UBS claimed total debt was higher than Carillion were publicly stating, first triggering a large increase in short selling Carillion’s shares. In 2017 over a quarter of Carillion’s stock was owned by short sellers and Standard Life Investments, a major shareholder, began selling its shares from December 2015 onwards and had completely sold their 10.8% equity stake in the company by 2017, stating “concerns on a number of issues including strategy, financial management and corporate governance”. Unfortunately, Carillion’s growing net debt was ignored until the company was in significant trouble.
Carillion's collapse had significant consequences. Debts of almost £2bn were owed to its 30,000 suppliers, many of whom received little back from the liquidation. The government also had to commit around £150m in taxpayers’ money in keeping essential services running. The demise of Carillion was seismic however it is not a one-off. There are cases of many other outsourced contractors not being able to complete the work they were paid to undertake in the face of severe financial difficulties.
Carrying out thorough due diligence is a cornerstone of the decision-making process and can help to ensure scarce funds are not poorly allocated. Councils should be performing due diligence when outsourcing work to a firm. It is also important to undertake ongoing financial analysis on contractors to assess whether their financial situation has deteriorated to levels where they may struggle to complete work and to make necessary contingency plans. The financial strength should be reviewed on a regular basis.
Arlingclose has a successful track record of performing due diligence on a variety of commercial enterprises. Projects can be carried out efficiently and in as much detail as required, whether a broad-brush desktop review of the financial statements to more in-depth look at many factors. These reports are completely bespoke and therefore allow us to adapt to your wants and needs.
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