Two large British outsourcers are also on the verge of collapse, and the vultures are circling.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
Two large British outsourcers are at risk of following in the doomed footsteps of Carillion, the infrastructure and services giant that collapsed in free-fall fashion in January. Between them the two firms, Capita and Interserve, employ roughly 150,000 workers worldwide and are responsible for delivering a dizzying array of vital public services in the UK.
Both are in deep financial trouble. Fears are growing that Carillion was not a one-off episode but rather the swan song of a dying business model. Until two months ago Carillion was the UK’s second largest construction firm. Now, what remains of its corporate corpse is being picked apart by employees of PricewaterhouseCoopers (PwC), which was hired to liquidate the company.
There’s unlikely to be much to liquidate. Big outsourcers like Carillion generally have relatively few tangible assets and borrow against intangibles — such as contracts or the value attached to an acquired brand name — which may have little value if a business fails, Adam Leaver, a professor at Sheffield University Management School, told the Financial Times.
For years Carillion was able to mask the true state of its financial health by delaying payments to subcontractors. The maximum payment term was increased from 30 days to 65 and then from 65 to 120 days, and suppliers would incur a charge from the banks if they requested to be paid earlier.
By the time it collapsed, approximately a third of the company’s £1.5 billion debt to banking partners was made up of “reverse factoring” — a popular financing arrangement whereby banks pay a company’s invoices to suppliers as a form of temporary lending. Part of the attraction of reverse factoring is that companies are not required to disclose the money owed in their financial reports, and can thus conceal the full extent of their debt liabilities.
In its later stages, Carillion needed to win new contracts just to be able to pay subcontractors “who they treated as a short-term creditor, making it something like a legal Ponzi scheme”, says Prof Leaver. “Once you’re borrowing from one place to pay your debts from another, that’s pretty much the definition of Ponzi-like financing.”
Carillion’s demise has already shaken the foundations of a high-growth, thinning-margin, poor cash-flow, high-debt business model used across Britain’s outsourcing industry. Attention is now shifting warily to Capita and Interserve.
Capita’s shares crashed in February, after it had sparked a new panic. The shares, now at £1.52, are down 56% from the end of January and 88% from July 2015 (€13.20). Market cap plunged to just over £1 billion. The new CEO, Jon Lewis, slashed profit forecasts, announced plans to tap the capital market for £700 million, and suspended a dividend that had paid out over £200 million to shareholders last year.
At the height of the rout, the government released a statement insisting that Capita was “not another Carillion.” But whatever the government might say, there is still a striking resemblance between the two companies, including their huge dependence on government projects and their penchant for running up absurdly high levels of debt.
On the positive side, unlike Carlillion, Capita has over £1 billion of cash on its balance sheet. And Capita doesn’t have high-risk high-cost construction projects bleeding it dry. But nonetheless it is still hemorrhaging funds at a startling rate. Its reported revenues keep shrinking and it has been losing important business contracts, partly as a result of the political uncertainty over Brexit.
Whether Capita gets through the immediate storm it faces will depend largely on its ability to raise £700 million from shareholders, for which it claims it already has full “standby underwriting.” But this undertaking has gotten immensely more difficult after the crash of its shares.
Capita’s rival, Interserve, is in even graver condition. At last count, its total debt was over £500 million, and its current market cap has plunged to £112 million. In January the government became so worried about the company that it assigned a team of officials to monitor its financial situation.
Interserve has been plagued for years by compounding losses in its waste management division. But recently the problems have spread to its core UK businesses, almost all of which are under-performing, as the company itself alerted in a profit warning in October 2017:
In U.K. support services, [losses were] driven by the continued employment cost pressures in the business, the cost of contract mobilizations, margin deterioration driven by a cost base which has not been flexible enough and contract performance in the justice business. Our U.K. construction business has seen further deterioration in operating profit as challenging market conditions and cost pressures as well as operational delivery issues have continued to impact performance.
Interserve warned that it probably would breach its banking covenants. The company’s lenders want to cut their losses but the firm is not completely out of options just yet. The Telegraph reported earlier this month that since in recent months private equity firm Emerald Investment Partners has been quietly buying up Interserve’s debt from the likes of Lloyds and Barclays “for as little as 50 pence on the pound” and “may now own as much as a third of [the]loans.” The vultures are circling.
This may be a play for the best pieces of the cadaver in a debt restructuring that could include wiping out or sharply diluting current shareholders. Even if it is a play for an eventual recovery of the business, the core problem — the poor performance of its underlying businesses — is unlikely to change, even with new financing.
If either Capita or Interserve do succumb in the coming months, the UK could begin to have a genuine crisis on its hands. Not only will investor confidence in an already fragile sector be shattered at a time that fears of Brexit are already taking their toll on market sentiment, but the government will pick up the pieces, once again, at substantial cost to taxpayers. Meanwhile, many of the fortunes amassed and extracted during the outsourcing boom continue to sit comfortably in private bank accounts dotted across many of the world’s tax havens. By Don Quijones.
Carillion collapsed even as KPMG signed off on its financial statements; now KPMG denies any responsibility. Read… “It’s Not only Carillion that’s Built on Sand, it’s our Whole System of Corporate Accountability”
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So let’s me figure out what happened.
People in the UK pays their taxes to the government all right? Then the government pays this private company to do services.
Only said private company outsources the doing of said service to different companies. That also raises costs.
Oh and they get in debt of course, hoping the government will bail them out.
Only Brexit happened.
That was it, right?
Basically they acted as an intermediary or something?
It only gets better. Some of this may have been tweaked in the time I left the business, but the rules (we’ll laughingly cal them “rules”) of the IT outsourcing game were somewhat as follows:
1. It was only possible to outsource functions; existing employees could not be forced to go to work for the outsourcer – the employee whose job was outsourced had the option of staying with the original employer.
2. If an employee went to work for the outsourcer, the terms of the original pension followed the employee (the older an employee, the bigger the cost),
3. Outsourced employees had the option of staying at their original work location; outsourced employees could not be forced to relocate.
4. We won’t even discuss employee layoffs. Suffice to say layoffs are very expensive, but they’re cheaper in Britain than anywhere else in Europe (generally more expensive the closer you are to the Mediterranean, if you get my drift).
Not sure about “4”. Denmark is the cheapest by a good margin.
In Denmark one customarily* gets maybe 3-6 month severance (unless one knows enough to sign an NDA agreement and can trade). The employer can also relocate the job and if one doesn’t want to relocate, it is counted as a voluntarily resignation! This is process is in fact happening right now with all the government entities which are bothering the government.
*) There is not much in the way of law, it is negotiated as part of a collective agreement with unions, the unions are “friendly”, so ….
Nah – the UK has it Easy:
I have a British friend who was about to be fired from Exxon because they were closing “his” datacenter. Except, because he had worked for more than 10 years at this place, his severance payment was 2 or 3 years current salary and they didn’t want to pay and he didn’t want to move from the empty site until “ordered” (Likewise they couldn’t force him to relocate to Leatherhead, where aviation fuel from Gatwick flights is rained upon corporate sinners installed in porta-cabins until they resign – but I digress).
In the end they promoted him to a much bigger job in Germany with relocation, private school for the kids and whatnot – Only – for someone to get out from paying the 2-3 years severance grant!
Your friend had a special deal with Exxon.
Pay out is age, wage and length of service dependent.
UK example below is for about 54 yr old, 17 yr service as statutory, a company can decide to pay more, not less..
“0.5 week’s pay for each full year worked when you’re under 22
1 week’s pay for each full year worked when you’re between 22 and 41
1.5 week’s pay for each full year worked when you’re 41 or older”
First £30K pay off is tax free.
Brexit has to be the laziest excuse to have come around since “The dog ate my homework”. And what the May Cabinet is doing to sabotage the process smells of treason.
Regardless let’s get back to Carillion and its sisters.
Unless local laws limit its use, outsourcing is an extremely widespread model for large contracts in several European countries, as is the kind of financial tricks Carillion engaged in.
In countries like Italy or the UK sub-sub-contracting (or even more) is also pretty widespread, not merely because it’s another form of rent seeking, but also because it allows to throw liability around like a ball. When water pipes burst in the six-months old school it’s obvious somebody screwed up, but again unless the law is clear and the government ready to use it, there will be a whole lot of fingerpointing and in the end it will be discovered the contractor that did that specific section of plumbing has already been liquidated or has taken the books to court. I’ve seen this too many times.
actually the employer pays the employee’s tax to the government. the employee never sees it unless they are self employed then they do it themselves.
If you’re a finance dude from from Capita, with a market cap of “just over 1B pounds” and “just over 1B pounds of cash on the balance sheet”, you have to understand the value of your business is almost exactly zip, nada, zilch.
Only an EU banker would look at that steaming hot mess and say “yep; here’s another 700m pounds”.
Another form of asset stripping enabled by off balance sheet financial engineering . Excellent journalism
– But, but, but I thought that private companies never had any evil intents. Their intentions are Always good and pure, right ?
– Yep. Socialize the losses and privatize the profits.
– There’s a difference between a private company and the government: A government doesn’t have to make a profit.
You see this model all the time in both private and public institutions. Some idealogue gets in power by making promises to either shareholders or citizens. Then, the stripping or adding-on begins for the benefit of________. After awhile it collapses.
A private example is the BC story of US based Weyerhauser buying Macmillan Bloedel, a very large forestry company. Divisions were closed and centralized. Workers were forced to drive for hours to new marshalling points in the effort to get them to quit. Contracting out became more and more common. Even the office furniture and computers were leased. Profits flowed away from the company’s place of business and into the hands of ‘investors’.
It was also attempted with BC Hydro, partailly achieved with BC ferries and BC Systems. BC highways was broken up and privatized.
All over the World we have seen an assault on companies and Govt departments who have been forces of progress for decades. These assaults are made on promises of false economies and savings. In many cases the average voter has absolutely no say or influence in the process. Maybe they don’t even know about it as the story unfolds.
I think it started with Reagan and Thatcher, but that’s just my opinion.
And who wil get hurt as this unfolds? Make a guess. The irony is who will get the blame, those unfortunates currently in power and most likely had nothing to do with the situation.
The BC Rail privatization was the biggest farce with the taxpayers raped as usual and many private and government individuals cashing in on the scheme.
– 50 pennies on the pound ? And that with this kind of little “real” assets ?
– And how large were the bribes that e.g. Carillion & Interserve paid to the government officials to get these (sweatheart) deals ? To make this outsourcing (ponzi) scheme possible ?
The REAL loser’s of Carillion’s failure?
Some 28,500 pensioners.
Almost 30,000 subcontractors and suppliers who are owed millions.
Over 20,000 employees spread over not only the UK, but Ireland and Canada also. eg: Carillion was responsible for the maintenance of 40,000 kilometers of roadways in Ontario and Alberta.
Plus five big banks in the UK on the hook for over a billion pounds worth of debt owed by Carillion to RBS, HSBC, SANTANDER, LLOYDS and BARCLAYS.
The damage to the residential mortgage markets will be extensive as these high paying positions within Carillion are made redundant and the individual mortgage holders come under the threat of insolvency.
The saddest of all – the pensioners who worked their whole lives, only to lose it when governments divested by “privatization”. Only to be hollowed out and pillaged by predatory corporations. The treasure has long disappeared offshore into tax havens.
According to Reuters, here is where the money went. “Collapsed British firm Carillion, which has come under political fire for paying dividends while racking up big debts and a pension deficit, has handed more than $1 billion to shareholders since it was created 19 years ago, a Reuters analysis shows.” This is how our society works now. And all this was enabled by our elected politicians. For the greater good, so to speak!
I worked for capita for a very short time 5 years ago. You could see then the business model wasn’t right. To stop competition they would buy competitors out in certain sectors for big premiums, then find out they bought a pup. Also charge local councils huge amounts for projects they couldn’t service.
…. they would buy competitors out in certain sectors for big premiums, then find out they bought a pup. ….
I know of someone who’s business model is exactly the other side of that coin: He has a small core team of really good people which he uses to set up a very competent and cost efficient consultancy business. The rumour spreads, he begins getting many contracts and he of course hires more people to meet demand.
When he begins getting good contracts, this will be noticed by one of the “big three” consultancy farmers, they don’t like this and after some time an offer is made and he sells his business to one of them.
The core team of competence exfiltrates and just happens to be hired by that new and upcoming consultancy firm that the same guy just started leaving a bunch of generic talent that the “big three” are already scorned for delivering.
I think he is on his third or fourth cycle now.
What the “big three” don’t seem to “get” is that talent does not scale and consultancy as such is not a scalable business model. At some point, at about 50 people, costs tracks turnover exactly and “growth” means to be doing a lot more work and assuming larger risks, while not being paid proportionally more for this. “Volume Disease” we used to call it.
Hi fajenson, great reply. I would say one in three businesses bought by capita was good. The outsourcing model worked until the UK government realised it could get more money for it’s buck. It went from paying for a good service to paying for the cheapest service.
What nobody ever considers about the Carillion mess is the likelihood of government kickbacks. This company rose dramatically and had governments throwing cash at them. The accountants looked away from the books and when the company was in trouble people just assume it’s folly to throw them more contracts but how many were riding this ponzi gravy train?
“At the height of the rout, the government released a statement insisting that Capita was “not another Carillion.””
The government statement means that it is now official, Capita is another Carillion and it’s collapse is imminent.
Fascinating story (in a sad way) and very informative comments. Can DQ cover USA? Would like to see his perspective on our Port Authority of NY & NJ with its murky public/private status as an ‘interstate compact’ authorized by US Congress, and a budget larger than some states with little transparency and accountability.
We were fortunate to get a glimpse of the scope of the corruption when Bridgegate surfaced. But quickly a couple scapegoats were identified, another few wrists were slapped, and then it was back to business as usual in short order.
Feels weird, I was discussing these guys with a co-worker yesterday over lunch. Kinda curious how it will unfold for the Canadian workers involved, confusing when international companies collapse before leaving. We see American stores pull out, then announce financial issues later but this was different.
“Meanwhile many of the fortunes amassed ….. sit quietly in private bank accounts ….. across the world.”
I sounds great & all is well with the world, the money did not go up in a puff of smoke, the story has a nice ring to it & it tells us that there are those, like the late Soros, who are untouchable.
Due to supernatural powers no doubt.
It is like the mysterious stories that there are unimaginable monies forgotten in private Swiss bank accounts & nothing could be further from the truth.
Private bank accounts came into being to afford criminal activity. Once you deposited the monies, a bank employee sought you out & you were extinguished, to the financial benefit to the bank.
It is a dog eat dog world of opportunity.
Nothing has changed.
If Soros had broken the bank of England.
MI5-MI6 would have conveniently blown his brains away in the name of Her Majesty Queen Liz … no less.