Russell Lynch: Why bell tolled for sorry Carillion

Carillion — the shimmering brand dreamed up 20 years ago after the break-up of the earthier-sounding Tarmac building empire — takes its name from a “carillon”, a musical instrument of pealing bells.

But it was only the death knell tolling this week for a firm with more than 40,000 staff facing an uncertain future, or cut pensions. That also goes for thousands of suppliers of Carillion who face losses and potential insolvency as a result of the collapse. Carillion’s glitzy corporate motto of “making tomorrow a better place” will soon ring hollow for firms expected to get back just pennies in the pound.

Throughout the Noughties, Carillion was a pushy acquisition machine, snapping up storied names such as Mowlem and then Alfred McAlpine. It even made a tilt at Balfour Beatty in 2014 when its larger rival hit trouble.

But for industry observers — and the short-sellers in the City — their demise has been a disaster foretold as its balance sheet creaked. Besides the immediate fall-out, the failure should also prompt soul-searching about how the industry operates, and the way the Government — whose ministers are always so keen to make political capital out of major projects — buys its buildings.

Even before its failure, Carillion was always keener to talk about its support services work, such as maintaining thousands of homes for Forces families, or cleaning hospitals. That provided the bulk of revenues, the City liked it, and the margins were better compared with construction, the fusty old aunt in the corner.

But it was construction which eventually killed the company as Carillion was sunk by problems on three major private-finance projects in the UK — the £350 million Midland Metropolitan hospital in Birmingham, the £335 million Royal Liverpool University hospital and the £745 million Aberdeen bypass — as well as payment problems with the vast Msheireb Downtown development in Qatar. Carillion was owed a rumoured £200 million on the project.

Though mismanagement played a big part — particularly on the delayed and now-shuttered Liverpool project — Carillion is not alone in paying a heavy price when PFI contracts go wrong.

As far back as 2000, Laing Construction was sold for £1 after racking up huge losses on a PFI project to build the new National Physical Laboratory in west London, among other projects. Much more recently another major player, Interserve, was forced to defer a test of its banking covenants after hundreds of millions in losses on energy-from-waste plants.

One former Carillion veteran traces recent difficulties faced by contractors to a “much more hard-nosed” approach from the Government after the Coalition took office in 2010, when minister Francis Maude set out to maximise the public sector’s buying power. And after the financial crisis, it was a buyers’ market. Some contractors were guilty of racking up exorbitant profits on early PFI deals, but now the pendulum has swung too far the other way, he reckons, adding: “The two other bidders for the Midland Metropolitan pulled out. Contracting has always been about what degree of risk you’re prepared to bear for the margin, but the Government was determined to become a much more aggressive purchaser. That’s good for the taxpayer but there are contractors now who won’t work for the Government.”

Contractors are supposed to bear the risk — that’s the whole point — but as Carillion’s demise shows, the margins between success and disaster are slender. Like other firms it balanced its business on the cash of others, taking up to 120 days to pay its suppliers.

Industry sources said that since July’s profit warnings, when the problems became clear, many subcontractors would have insisted on more stringent terms, exacerbating the flood of cash out of Carillion and the rise in its debts, creating a doom loop.

“A company only goes bust because it runs out of cash, and that is what it has done,” says a source at one of Carillion’s lenders. Unlike in Balfour Beatty’s recent rough patch, Carillion didn’t have a strong balance sheet to fall back on and give it the breathing space to sort itself out. The source adds: “There’s a difference between extending covenants and going to a credit committee and asking to put more money in. There was no sustainable future, just limping to its next crisis point.”

The question now is how many others Carillion will bring down with it. For Rudi Klein, chief executive of the Specialist Engineering Contractors’ Group, which represents smaller contractors, the episode is another argument for the use of project bank accounts: under this system a construction client releases cash to all suppliers on a project at the same time when agreed milestones are hit — rather than letting the main contractor distribute the cash.

He says Carillion should be a “catalyst for change”, adding: “Is it right to continue to use large undercapitalised companies to deliver these works which, in reality, are being delivered by the supply chain?”

But project bank accounts have only limited traction in the public sector, and the SEC is writing to the Cabinet Office minister David Lidington to clarify the extent of the protection available for Carillion’s suppliers on public projects.

But the truth is that most of the pain is yet to unfold: “We do not know the full extent of this yet,” Klein warned. “It is potentially disastrous.”