Was Carillion’s Collapse the Beginning of the End for the UK’s Outsourcers?

By Don Quijones, of Spain, the UK, and Mexico and an editor at Wolf Street. Originally published 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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  1. PlutoniumKun

    Its hard to exaggerate just how much this is going to cost the UK – picking up the pieces from collapsed contracts, and requiring additional security for new service/construction contracts will hugely increase the costs of maintaining existing services. At a time of cutbacks and austerity, the impact will be most severe in poorer areas, which are proportionately most dependent on government services to keep local economies going.

    On my way to work I regularly pass piles of rubbish left uncollected by private waste collectors, the aftermath of a botched attempt in my city to privatise and ‘create competition’ in the waste collection ‘market’. I often fantasise that a law could be passed creating compulsory street work gangs made up of economics lecturers and think tank authors who have promoted these policies. They would certainly be more use to society as litter pickers than theorists. One day when I’m emperor….

    1. paul

      Crackpot economics leads to crackpot accounting,justifying crackbottle thinking.

      if this has worked for you
      3. try again.

      Its like dry rot, easy to avoid, hard to remove.

      institutional knotweed.

      1. Colonel Smithers

        Thank you and well said, PK and Paul.

        I would just add that the neo-liberal politicians and civil servants, active and retired, who sit on the boards of these parasites or advise them as consultants / lobbyists should be forced into Emperor PK’s street cleaning gangs and for such gangs to use their toothbrushes for the cleaning.

    2. Abi

      I personally think its a good thing for Britain, this will force the government to get back into certain businesses and the general public will be better for it

  2. jackiebass

    Studies show that outsourcing seldom lives up to its promises. The big one is it saves money. Actually it rarely saves money and in many cases it cost more. Unfortunately these studies are ignored by those that want to privatize all government services. The losers are taxpayers and those that depend on these services.

    1. realize

      I’m beginning to better comprehend the concept of “tar and feathering.” Perhaps one day the “winners” will be outed.

    2. Skip Intro

      The effect of outsourcing, from what I’ve read here, is more of a cost transfer. The company pays lower wages to the outsourced lowly former-employees but has increased costs expended on managers. It is basically a transfer of expenditures from labor to management.

    3. seanseamour

      “The losers are taxpayers…” and before them the workers squeezed to break out profits where there are evermore profit centers to feed, then they join the gig economy and zero hours contract employers. One striking phrase that sums it up well “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.”

      1. visitor

        Personally, I found that sentence

        companies are not required to disclose the money owed in their financial reports


        It shows how old I am, but when I learned the basics of accounting, there was something variously called accrued, or deferred, or transitory liabilities. How come “reverse factoring” does not fall squarely in that kind of itemization?

        1. Mel

          I don’t know, but I can only imagine that the liability is already on Carillion’s books in Accounts Payable, and they don’t write it up twice. Maybe the bank treats it as a loan to the subcontractor — which will someday be payed off by Carillion. Maybe it would allow the subcontractors to stay in business all the time that Carillion is stiffing them for the sake of its own cash position.
          I know that Carillion are responsible for road maintenance here, and the crews haven’t been off the job lately.

          1. Mel

            Out of curiosity, If I’m not totally off target, and this is the kind of thing that gets done, could this give us a glimpse of some of the kind of Non-Performing Loans that are haunting the south side of the Eurozone?

  3. David

    Thirty-five years ago, when this nonsense first began, people asked how it was possible to outsource activities generally provided cheaply by public employees paid unexciting wages, to private companies with higher cost-bases and the need to make profits. Competition, we were told, markets and stuff. In reality, and as had been predicted, such companies tendered at unrealistically low prices to get the work, and tried to squeeze the taxpayer later. But that only worked for a while, and poaching staff from the public sector, operating on razor-thin margins and cutting services could only work for so long as well. Now it’s stopped working, but an entire generation’s worth of expertise has gone from the public sector, and it’ll take a long time to rebuild it.

    1. Colonel Smithers

      Thank you and well said, David.

      The involvement in the public sector extends to the Ministry of Defence, including areas that one would think would or should be out of bounds to the public.

      One parasite feasting in true blue / Tory one party state Buckinghamshire, my home county, is a construction firm. It has diversified into various activities, including prison and school transport. The school transport contract was sub-contracted to a taxi firm owned by a clan of NW Frontier origin. There was no vetting of the drivers. Some of the drivers have gone to prison for grooming. Others are waiting trial or have fled to the NW Frontier. Some of the girls are under police protection in advance of the trial(s). At no time has the outsourcing and negligence been mentioned. The Tory and Liberal councillors and management of the contractor involved have not been brought to account.

      1. Colonel Smithers

        In case anyone is wondering why the above has no made the MSM, Buckinghamshire is too far from the London media bubble and the local press is a sick joke.

        Whitehall is about to take over the running of social services from the local authority and its private sector contractors after over 100 children in various forms of care were unaccounted for.

    2. PlutoniumKun

      The problem is, so many of the costs of outsourcing were hidden. Three anecdotes from my time in the West Midlands in the early 1990’s:

      1. A local council outsourced office cleaning, the superficial cost of the daily clean was reduced, if you compared the cost of employing the cleaners to employing a cleaning company. The problem was, the Council then had to have 2 full time employees just monitoring the contract – the cost of this far outweighed even the notional savings.

      2. The engineering section of a Council was sold off to a major Civil Engineering company. The engineers were in the same offices, doing more or less the same job, they just had cards for the outsourcing company instead of Council ownership – a small number of senior staff remained as the ‘client managers’. But what emerged was a gigantic bureaucracy where things which were once sorted out with a quick phone call: ‘Hey, can you tell me if there are any sewer pipes under this site, we need to do some digging?’, suddenly required invoices, time sheets, new budget headings, etc. There was no discernible benefit whatever.

      3. During one rare very hot and dry summer, I remember talking to a manager in the Parks Department of a Council who was driven crazy with complaints by the public about seeing dried, dead grass being mowed. He said there was nothing he could do about it – the company had been contracted to cut the grass 6 times a year, and that’s what they were going to do. In the ‘old days’ as he put it, he would have had the grass cutting gangs out catching up with non-urgent maintenance, things like painting rails, tidying up flower beds, and so on. But his hands were tied as they were now all contractors.

      1. The Rev Kev

        Hi PK. I think that the best example of the hidden costs of outsourcing was the 2012 London Olympics. A big chunk of security, you will remember, was outsourced to G4S who then proceeded to make a complete dog’s breakfast out of their preparations for the games. They got a £284m contract to provide 13,700 guards for the Olympic Games but bailed just before the games so that thousands of troops had to be brought in to plug the massive breach. And that is what can happen when you outsource a primary responsibility.

        In passing, just thinking about the uncollected garbage that you mentioned in your first post by private waste collectors when a thought occurred to me. You think that it would be possible for a group of rate payers to take the council to court for non-performance of waste collection by the Council? The Council, after all, is the primary contractor and I am willing to bet that you too have an item entry on your rates notice about how much you pay the Council for waster collection. Just a thought.

      2. JTMcPhee

        As to the complaint by the Parks Department administrator about “hands being tied by the all-holy contract,” why is it (rhetorical question, of course) that G4S and Carillion and “defence contractors” and the like can just take the money and walk away from “the all-holy contract,” where the Parks guy can’t just tell the contractor to either do what’s actually needed, or bugger off? “Rule of law,” eh? That wonderful one-way street…

        I recall a video from the “We Love Russia” set, over in youtube, that collected a whole bunch of inappropriate-isms from both Soviet period and more recently. One was an obviously in-drink fellow mowing the middle of a large roundabout, which was covered with a couple of inches of snow with more snow falling… Not so many pictures of Party and government accepting gratuities and such…

  4. Jesper

    The repercussion of large zombies finally dying is yet another reason why payment terms should be regulated by law. Those companies would have been killed off sooner with less losses to suppliers if payment terms were 30 days and and the terms enforced by regulators .
    Contracted payment terms are killing small businesses. Businesses go under due to cashflow problems, profitability might be an issue but cashflow problems can and will kill off a profitable businesses.

    The current system with contracted payment terms benefits the large business at the expense of the small business and many/most/all politicians claim to be arguing for the small businesses. Oh, and banks profit greatly out of the current contracted payment terms as well, they borrow from the big business at low interest and the charge high interest on the loans that the small business has to take (due to the contracted long payment terms) to remain in business.

    Legally enforced payment terms would be easy to enforce as well and with the current low interest rates then big businesses might not even bother to fight a change – quarterly earnings would not be affected much so why would a CEO (and CFO) bother about what would happen to profitability after they’ve gotten their gains and moved on….

  5. JTMcPhee

    My answer to the rhetorical question that headlines this post, after watching “progress” for 70-odd years, is “Of course not.” Temporary disruption in the flow of wealth from public to looters, momentary attention from the “public” and “media,” brief episode of “tsk-tsk”ing, the scurrying sounds of MPs and Government types who’ve “effectuated these policies” running for cover, and then lobbying and corruption being what they are, just more of the same. With better cover.

    I recall a social psychology professor postulating about corruption in human social structures, and insisting that there is a “natural and necessary quantum” of what he chose to call “slack” in all such systems.

    So the cop in the small town takes the miscreant kid home and reports to the parents, instead of booking the little vandal into jail (more likely if the kid is privileged/”connected,” or the child of a relative or friend). In Chicago, where there are two types of land titles, Torrens and recording, if you want your title transfer to be timely recorded, you “shook hands” with the clerk at the Torrens desk — a folded $20 bill held between your middle and ring finger, and the clerk adroitly and surreptitiously nicked the $20 into his or her palm, “all’s good, sir!” The Council official “has dinner” with the developer. The naval Captain “accepts gratuities” of sex, drugs and money from come guy named “Fat Leonard” for secret military information.

    The trick is always how to “regulate” the “jovial corruption” to a level that does not strangle the larger system. Since all this stuff happens mostly in the dark, or in a space where everything is “winked at” because there’s so overwhelmingly much of it, and because there are no immediate or often even long-term personal consequences, and since past a certain point the corrupters and corrupted cooperate, in either changing “the law” to make this stuff “not illegal any more,” or just not enforcing such proscriptions, there are no negative-feedback structures to rein in the looting.

    Mechanical systems need clearances and tolerances to function, too. I used to be a helicopter mechanic in another life, and all kinds of rotating and sliding and meshing parts had to be measured and shimmed to achieve operating tolerances, and then properly lubricated, with the right kinds of oils and greases — too tight or too loose, and the machine would self-destruct and crash. Seems to me there are no more, or far too few, qualified and dedicated “social-political mechanics” dedicated to maintaining just working amounts of “slack” in the political economy. Too many have figured out that a bigger mordida, a lot more baksheesh, a huge dip into the Real Wealth that mopes just have to generate, ineluctably, through their daily labors, will “set them up for life” and let them titillate their pleasure centers to a vastly greater degree. All the training these days is in the direction of mastering the arts of “get away with it” corruption. Tony Hayward, remember him? “I want my life back.” Leona Helmsley, “Taxes are for little people.” Warren Buffett — “Of course there’s a class war, and my class, the rich class, is waging it. And we won…. It was a rout.”

    So there’s an argument that “we” need a certain amount of “slack” in the political economy, to keep things moving. It’s to the point that the accumulated clearances and poor fits and inappropriate lubricants, in both type and quantity, have the great machine at or past the point where it will self-destruct. “There’s an art to it—” http://www.nytimes.com/2011/04/10/arts/design/swiss-institutes-destruction-pays-homage-to-jean-tinguely.html

  6. David

    I always tell people – to their dumbfounded surprise – that until the nineteenth century, most state activities were privatized anyway, under systems conceptually similar to those of privatization today (tax farming and justice are obvious examples). These were systems of primitive rent extraction designed to raise money for the sovereign or the prince. Many were “monopolies” ie long-term contracts to supply services in return for a cash payment.
    So we’re actually reverting to the pre-modern era…
    And yes, outsourcing destroys trust because the people who used to be your colleagues are now business partners, what used to be done with a phone call needs a contract.

    1. JTMcPhee

      And then “government” came into focus and operation, to produce the necessary (if one accepts the idea that “the general welfare” has any meaning) “regulation” of the predatory inclinations of those bits of older social-political forms that can be characterized as “conceptually similar” to the privatization of today. But of course there were some social controls in those older forms of “pre-government privatization” on the degree of predation, and limits in both technology and finance and such, controls that have been extinguished in the profitable rush to the development of Carillion and Correction Corporation of America and GoldmanSachs/”The Fed” and Waste Management and LockheedMartin, etc., style privatizing of what non-libertarians tend to think of as “necessary government functions.”

      Outsourcing destroys trust because it destroys the PUBLIC function outsourced, in favor of rapacious wealth transfer and race to the bottom. There are very few people who fit in the category of people who used to be colleagues and now are “contractually obligated (sic)” business partners. And a whole lot of what used to be done by phone calls is STILL done by phone calls — ask a lobbyist how it works, or the many corporate types who price-fix and such.

    2. PlutoniumKun

      Didn’t Marcus Licinius Crassus become one of the richest men ever to live by ‘running’ the Roman fire brigade system?

      To refer back to waste collection – it never seems to have occurred to the supporters of outsourcing waste collection in cities that nearly every civilized city has either a government run, or heavily regulated, waste collection system for a very good reason – i.e. the systems in place before didn’t actually work. Even the richest cities of the 18th and 19th Centuries were filthy places where waste of all sorts was either burnt openly or tipped into rivers – and this despite a huge network of businesses based on recycling (‘rag ‘n bone men’, etc). There are simply too many incentives to cheat. It is simply easier and cheaper to just set some regulations and have public employees collect everything unwanted.

      1. Colonel Smithers

        Thank you, PK.

        Was he, as is said in France, a pompier pyromane? Is he the Larry Olivier character is Spartacus and the one killed leading the troops against the Persians?

        1. PlutoniumKun

          Ah yes, I’d forgotten about Olivier’s performance. Crassus seemed to have made his billions in using his fire service to, shall we say, make valuable property in Rome more easily available for his purchase. So he was not just one of the first parasitic outsourcers, he was a disaster capitalist par excellence.

          Plutarch says that the Persians killed him by pouring molten gold down his throat, which shows that the possession of a darkly rich sense of irony is not a modern or western invention.

          1. animalogic

            “Plutarch says that the Persians killed him by pouring molten gold down his throat,”
            Quibble: Pathians, not “Persians”.

              1. Oregoncharles

                Which is clearly the source of “Persian”.

                This site’s content is both challenging and stimulating; that’s what makes for the commentariat, combined with effective moderation.

                I hope everyone involved feels suitably appreciated.

      2. visitor

        Very close equivalents can be found nowadays in other sectors. Thus, the Netherlands have been one of the first to privatize their postal system. The experience has been dismal — with private mail distributors going bankrupt even while providing poorer service than the previous state system.

        I read a report a few years ago where what you mention for waste management was exactly happening in post distribution: private companies to which mail distribution had been outsourced simply threw away entire bundles of post (without telling anybody, of course) because they just could not organize the delivery profitably while fulfilling the servicing parameters. But they wanted to keep the contract anyway…

      3. Synoia

        One could reflect on the Roman custom of providing bath houses and hot water for all, to control diseases.

        People in the past may have no concept of the science we have now, but one has to respect their ability to understand cause and effect.

  7. Mel

    I wonder if some business models might not have been to use steady government-contract cash flows as collateral for loans, then the familiar asset stripping. If Bill Black ever writes this up, I’ll be happy to read it.
    (Although the last sentence is meaningless; if BIll Black writes up anything I’m happy to read it.)

  8. Ignacio

    When the real-estate bubble exploded in Spain many spanish companies migrated business to the UK, then seen as the golden opportunity for construction contracts. Airports, motorways, waste management… I now that some projects went badly but I am wondering what is the current state of these companies in the UK and if they are abandoning because of brexit, or if they are also bankrupt.

  9. Altandmain

    The lesson here is that governments should keep what they can in house.

    Using third parties like Carillion have huge risks and does not save money. Often the neoliberals want the hiring of third party consultants too, which has additional fees. McKinsey is notorious for this, but there are others in specific industries as well. In most cases, I find that it is only the small management consulting shops that are specialized that justify their cost. A far better idea would be to nurture in house talent and use that in house talent over the years of projects.

    Often private public partnerships tend to lead to the the taxpayers getting screwed over and the private sector getting all the profits. In many cases, it would have been far better to keep the work in house. That would be a win – for society as a whole.

    Plus barring a sovereign debt crisis like Greece, we don’t have other unexpected costs like bankruptcy.

    Yet another option is a state owned enterprise. That would allow some degree of independence.

    The reality is that we know what to do. Dismantle the neoliberal ideology that is the root cause of this mess. The issue is that the rich are going to put up a fight. That is why neoliberalism exists to begin with, to provide intellectual cover for the rich to loot society. So is pretty much every economically Conservative ideology. The conversations here around rent seeking are right in the money.

    1. animalogic

      “That is why neoliberalism exists to begin with, to provide intellectual cover for the rich to loot society.”

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