Carillion plc offices in Wolverhampton. Picture PAWire

James Penn looks at the issues surrounding the collapse of the giant construction firm Carillion in his latest Business View column.

A word needs to be said about the collapse of Carillion, at one time the second biggest construction company in the country.

Its sudden ending (this wasn’t an administration, but a liquidation, and a compulsory one at that) is still sending shock waves through the infrastructure and support service sectors two weeks later. For these areas, it was a ’Lehman’ moment.

It still seems inconceivable that a company like Carillion, which incorporated historic and once highly respected entities such as Alfred McAlpine, and Mowlem, could disappear so quickly.

One may crow that one didn’t own the shares, but one has to feel sorry for those that did - mainly private investors, as institutional shareholders had largely fled the stock after the first profit warning in July last year when the company wrote down the value of its contracts by £845m.

The shares were suspended on January 15 , and shareholders are likely to receive nothing. Some creditors may recover as little as one penny in the pound.

Looking back, Carillion had a number of things going for it. It had raised the dividend every year for 16 years after being spun out of Tarmac in 1999. It had £4bn in revenue, making £145m in pre-tax profit in 2016. With over 400 government contracts, and a host of private sector contracts on top, it had ample work.

The company’s success rate in winning new contracts was pretty good (too good according to some, who argue that the government should have stopped awarding them contracts after Carillion’s difficulties emerged last year).

However, there were some clear governance issues raised by the company.

In 2016 the company’s Remuneration Committee amended its ’clawback’ arrangements for past bonus payments to executives, meaning that past bonus payments would not be reclaimable in the event of a bankruptcy (only for gross misconduct or if the financial results had been misstated).

The downfall was rapid. From zero net debt several years ago, debt had shot up to £900m at the time of liquidation, owing to losses on three big public-private contracts in the UK, as well as losses from exiting Canada and the Middle East.

Debt levels can run wildly out of kilter when a construction company gets into trouble, as we saw when Balfour Beatty got into trouble four years ago.

But while Balfour Beatty had assets that it could sell (it raised a net £750m from the sale of its US professional services firm, Parsons Brinkerhoff) Carillion didn’t, despite Balance Sheet assets of £4.4bn in 2016. The sale of some of its health contracts to Serco for £50m late last year didn’t remedy its problems.

The list of companies affected by the fallout is a ’Who’s Who’ of everyone who is big in the construction and the support services: Balfour, Galliford Try, Speedy Hire, Kier, Eiffage, Amey, Severfield.

Generally the impact has not been too serious on the quoted companies, though both Balfour Beatty and Galliford took charges of £40-£70m on contracts for which they were jointly and severally liable, including the Aberdeen Western Peripheral road project. The most serious knock on effects will be on the unquoted private companies that supplied Carillion on a sub-contracting base.

There will be opportunities in terms of taking on Carillion’s contracts, while one less credible bidder in future will make the tendering process a bit less competitive in future.

What are the lessons? There are always risks with low margin construction companies, particularly when desperation for work has caused them to take on uneconomic work. Mowlem itself nearly went bust when building the Dublin Port Tunnel in an earlier decade, perhaps a warning sign.

There are also implications for the future of Private Public Partnerships. Unhelpfully, almost immediately after Carillion’s demise, the National Audit Office highlighted the higher costs of Public Finance Initiative contracts versus government funding them itself.

It is conceivable that a future Government could back in-house previously outsourced services.

However, this is ultimately a political issue and would depend largely on the results of future elections.

Overall, the Carillion episode is not enough in itself for the current UK Government to stop outsourcing work to Support Services companies.

The opinions stated are those of the author and should not be taken as investment advice. Any recommendations may not be suitable for all, so please contact your financial adviser for further guidance. The value of investments can go down as well as up.