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Why Carillion has gone into liquidation rather than administration

UK companies

Why Carillion has gone into liquidation rather than administration

The failure of the construction company indicates there was no viable business to sell

© Reuters

Contrary to popular — and populist — opinion, outsourcing is a messy business with little margin for profit. Or for error. Serco boss Rupert Soames has a lavatory brush on his desk to remind himself not to bid for work below the average cleaner’s 5-6 per cent margin. He calls it his “Shitometer”. But if former Carillion boss Richard Howson had something similar on his desk, he ignored its proximity to the fan.

Today, the former hit the latter — and Carillion entered liquidation.

But among the many questions this outcome raises, the most pertinent is: why liquidation rather than administration?

Administration allows a company to continue to operate, as the administrators attempt to find a buyer for viable parts of the business. Liquidation means a company ceases trading, and the liquidator merely tries to realise any remaining assets and distribute them to creditors.

Carillion’s “compulsory liquidation” proves it had already reached a point where there was nothing worth buying. All it had was its contracts, on which the margins were evidently too low to cover its ever growing liabilities. There was no viable business to sell. There were no meaningful assets.

As one industry rival hinted last week, this absence of assets is not as surprising as it may seem. “All we really do is pre-sell labour and make bets on the long term costs,” he told the FT. And, even if Carillion’s contracts could be thought of as assets, they were too complex or insufficiently valuable for its banks to lend against. They were never going to advance another £300m against low-margin government-linked assets over which they had no control.

Administration may be an option in support-services outsourcing, such as cleaning, where contracts can easily be sold on to a new provider. Carillion managed to offload its hospital facilities work to Serco, for example. But outsourced construction projects, bid for in consortia and involving layers of subcontractors, are too difficult and unprofitable for administrators to unpick.

This begs a second pertinent question: why did Carillion keep bidding for such low-margin work? Why did it not stop bidding years ago, writedown bad contracts and attempt to restructure when its market value was nearer £2bn than £61m? Serco managed to do so. Even Balfour Beatty.

It was evidently because Carillion needed new contracts to keep bringing in the cash it needed pay suppliers and lenders. Adding more construction work, such as the HS2 rail line, was the only way to keep cash coming through the door. It had, in effect, become a lawful sort of Ponzi scheme — using new or expected revenues to cover more pressing demands for payment.

A further similarity with such schemes was the incentive for senior managers to keep bidding, acquiring and chasing cash. Many in the industry are paid bonuses based on revenue growth, not efficiency. Mr Howson assured the City last May that Carillion had made “an encouraging start to the year”, with “increased revenue visibility”. He then resigned after July’s profits warning, having gained £1.5m in pay and bonuses for 2016.

Like all dubious revenue models, however, Carillion’s strategy was ultimately unsustainable. Some hedge funds wondered why Carillion was taking 120 days to pay subcontractors back in 2013 and began short selling its shares to profit from future falls. But it is typically only when key staff leave, and suppliers lose faith, that the strain of trying to transact £10m a day becomes more widely recognised.

Could Carillion have avoided liquidation if it had stopped bidding?

Serco turned itself around after avoiding unprofitable work, and asking shareholders to bear the pain. But with Carillion so desperate for cash, it was clearly willing to bid at any margin.

So the final question is: why did the government allow it to win bids on disastrous terms?

A week after its first profit warning, Carillion, with joint venture partners, secured £1.4bn-worth of work on HS2. It later won half of a £158m contract from the Ministry of Defence and a £62m contract with Network Rail.

Under procurement rules, the government is required to exclude any outsourcer whose bid is “abnormally low”. As one lawyer claims, though: “Carillion has tendered at very low margins, possibly unsustainably low, in order to win these huge volumes of work. If such bids have succeeded, that can only mean either that the regulations themselves are ineffective or that public sector clients lack the confidence or the expertise properly to enforce those rules.”

Evidently, the government does not see any complicity in the Ponzi-like running of Carillion. David Lidington, Cabinet Office minister, made it clear where he saw the irresponsibility lying: “We will continue to maintain partnerships with responsible firms in future,” he said, pointedly.

But, after allowing Carillion to win so many irresponsibly low-margin contracts in the past, giving it that HS2 deal was not a rescue — just a fast track to collapse.

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