Carillion Plc workers look on during renovation works aiming at boosting peak-time capacity 30 percent at London Waterloo train station in London, U.K., on Monday, Aug. 7, 2017. The 800 million-pound ($1 billion) renovation at Waterloo, which will open four platforms mothballed since Channel Tunnel express trains switched to St. Pancras station and extend four more, should deliver a service boost matching the London Bridge project but without the upheaval, Stagecoach Group Plc Chief Executive Officer Martin Griffiths said in July. Photographer: Simon Dawson/Bloomberg
Some £1bn has been shaved off the market capitalisation of Carillion in a year © FT montage / Bloomberg

In 2015, nearly two-thirds of investment bank analysts were advising their clients to buy shares in Carillion, the UK construction and services company that is one of the government’s biggest contractors. On Monday, as the company entered liquidation, investors and lenders faced major losses or even a complete wipeout.

Although Carillion was a popular stock to “ sell short” or bet against in 2016 and 2017, how did so many in the City fail for years to spot its mounting problems? Superficially, it had appeared a reasonably healthy and profitable company in a construction sector struggling to recover after the financial crisis.

A deeper delve into Carillion’s accounts, however, shows that as far back as 2011, all was not as well as it seemed. Buried within its financial statements were signs that customers were taking longer and longer to pay, while at the same time the company was taking on large debts that were hidden to anyone who did not look for them over 100 pages deep inside its annual reports.

The first warning sign was that the amount of money unpaid by its construction clients as a proportion of construction revenues ballooned from 13 per cent in 2009 to 31.6 per cent by 2016. For its non-construction revenues, the figure rose from 14.4 per cent in 2009 to 30.5 per cent by 2016.

The small number of investors who spotted these problems started to ask questions. Why were Carillion’s customers, many of whom were in the UK public sector, taking so much longer to pay? And what was the company doing to plug the gap in its cash flow to enable it to pay its own employees and contractors?

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In the years after the financial crisis, Carillion was operating in a ferociously competitive market in the UK, where it had to aggressively bid for contracts to win business while also ensuring that it was being paid enough to make a profit.

“UK construction and services companies are in a very low-margin business,” said one London-based investor. “There are no real barriers to entry, no real brand, and they are providing unskilled labour. This means there is fierce competition, lots of players bidding on the same contracts, and this means many go out and bid for work on basically zero margin. They then need to later try and find a way to recover lost margin down the line.”

Carillion was at this time involved in several contractual disputes with its UK public sector clients, either over the quality of its service or where it was asking for more money. One example was a lengthy wrangle with Somerset council over a road project Carillion had demanded to be paid more for than was originally agreed in the contract, while Swindon’s Great Western Hospital voiced frustration with the company for its standards of service. A spokesman for Carillion when contacted said they were unable to comment on the company or any historical issues it had with customers.

The collapse of Carillion

The increasing amount of time Carillion’s clients, some of whom were in contractual dispute with the company, were taking to pay meant that there was a growing shortfall of the cash the company needed to meet its own day-to-day obligations.

It is here that Carillion’s accounts showed another warning sign of dangers to come, buried in a small line item at the end of its 150-page annual reports.

At the same time that Carillion was being paid more slowly, it started to make use of a series of UK government schemes introduced in 2011 to speed up payments to smaller businesses and contractors.

In order to pay its own suppliers and bills, Carillion started to use the new “Early Payment Facility”. Under this scheme, suppliers owed money by Carillion could take their invoice to a number of partner banks, including RBS, Lloyds and Santander, and be paid in advance. The banks took a small fee on the invoice and the debt was transferred from Carillion owing its suppliers to Carillion owing money to the banks.

The problem for investors was that this new and rising amount of debt the company was taking on did not show up in the main debt numbers on its balance sheet. From 2011 to 2016, Carillion’s published net debt rose from £839m to £850m but the actual debt was much larger.

Not included in those net debt numbers were the amounts it was using in the Early Payment Facility, which in its accounts were buried in a footnote on its “Trade and other payables”, simply labelled “other creditors”. This number ballooned from £263.1m in 2011 to £760.5m.

One analyst who declined to be named said: “It is an old accounting trick of pushing financing cash flow into operating cash flow to disguise a problem. The company never lied or misrepresented it, they always told you if you asked them but most investors would not have even known it was there.”

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