The Lessons of Carillion's Demise
Government contractor Carillion Plc's collapse into liquidation is an embarrassment for all concerned.
After the inevitable finger-pointing, blame-shifting and political backlash, the U.K. will hopefully knuckle down and strengthen a construction and procurement market that's too fragmented and weak to support its Brexit dreams without help.
Carillion's demise may have been triggered by a perfect storm of several projects going wrong at the same time, but the long-term causes lie in its racy expansion and over-reliance on debt. Net debt to equity doubled between 2012 and 2016, from 15 to 30, according to Bloomberg data.
Carillion tried to sober up too late: the hard work of cutting debt and dividends only began in 2017. Short-sellers sniffed blood as money owed to the company from clients piled up.
The U.K. government also seems to have had an equally over-optimistic approach to Carillion. Last year, as Theresa May promised a modern industrial strategy fit for "Global Britain", her government was still doling out contracts to Carillion even after it issued profit warnings.
One unnamed government official defended this approach to the Financial Times, saying the only option was to carry on as normal. If normal means conducting stringent due diligence to make sure contractors are able to deliver a project, then fine -- but the government will need to prove that it did its homework in this respect.
The structural problems in the U.K. market, though, go way beyond Carillion. The market is fragmented and highly competitive. Operating margins are estimated to be in the low single digits, about half those of France.
Competition is a double-edged sword. It's good if taxpayers get a better price from a diverse array of bids, but bad if overly aggressive bidding to secure contracts leads to delays in completing projects or even their failure. A March paper commissioned by the Business Services Association warned that only one in five of the largest public-service providers made a commercial return in five years. Focusing myopically on price can lead to unexpected long-term costs.
The likelihood is that the rest of the industry will try to absorb most of Carillion's contracts. In particular, French companies like Eiffage SA are likely to spy more opportunities for growth in the U.K. as the domestic competition struggles.
Even without Carillion, the British market remains fragmented, according to UBS analysts. With jobs and the prosperity of Brexit Britain at stake, Carillion's demise will hopefully jolt the U.K. into improving its procurement market. That means, at least, paying more attention to a contractor's financial health while also doing what it can to keep trading ties with European partners, including France. There are lessons here for all.
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