The warning signs that preceded Carillion's fall
Carillion’s 2016 accounts received a clean audit and contained a three-year viability statement from its directors. A reassuring AGM statement in early May was followed two months later by a warning of £845m in losses on construction contracts. Another £200m of provisions for losses in support services were added in September, rendering the company technically insolvent, with negative net worth.
Applying my ‘spot the dog’ checklist to the 2016 accounts, Carillion flashed at least amber on most counts – for example, sales rising faster than profits in a low-margin business where the winner’s curse can apply to long-term contracts. Carillion was a poor money collector and covered this by increasing debts to suppliers. Year-end net debt was rising, but in construction the year-end number is flattering and the cash netted off against borrowings is largely customer advances. Average gross debt is a better indicator of balance sheet health.
Strategic risks were also clear: an acquisitive company with diverse activities and a wide geographic spread is hard to manage. Low margins and weak cash generation leave little margin for error, and once credibility is questioned, operational problems can quickly escalate.
Governance issues compounded the case. Opportunities were missed to bring in new brooms, either through a change in finance director at the end of 2016 or via a new auditor (KPMG had been in place since 1999). These days, with 10-year tenders mandatory, one would have expected a change. By the time the chief executive and cheerleader, Richard Howson, departed in July, it was probably too late – hence the failure to get a share issue away.
As for the pension deficit, falling bond yields had swelled liabilities, as they have elsewhere. Carillion was fulfilling its obligation to pay in nearly £50m a year to help close the gap, as accepted by both the trustees and The Pensions Regulator.
This time last year, the Department for Work and Pensions was complacent about the state of defined benefit pension schemes, denying there was an affordability problem. In my view, a taskforce for the Pensions and Lifetime Savings Association came nearer the mark in saying: ‘The risk that defined benefit scheme members won’t receive their benefits in full [because of sponsor failure] is poorly understood.’
Should the final dividend for 2016 have been cut? If all had gone to plan in 2017, Carillion believed it could cover both dividend and pension fund payments, while stemming the rise in debt. These assumptions now look heroic. But if the dividend had been cut, it would have undermined confidence in the plan and quite possibly have hastened the collapse.
No one, including the UK government, one of Carillion’s most loyal customers, comes out of this well. But the political backlash will probably make things worse.
Jane Fuller is a fellow of CFA UK and serves on the Audit and Assurance Council of the Financial Reporting Council.