Carillion shows a black heart linking PFI and private/state interrelations

The weekend just passed has seen the midnight oil burnt in Westminster as increasingly desperate attempts were made to rescue the company Carillion. You may wonder why as of course it is not a bank?! But the story emerging is one that is sadly familiar in many ways but with a few credit crunch era twists. For those unaware of what it does here is how it describes itself.

Carillion is a leading integrated support services business.

Not the best of starts as we wonder what that means? Later we do get some more precise detail.

Support services –  Facilities management, facilities services, energy services, rail services, road maintenance and utility services.

Public Private Partnership (PPP) projects – Our investing activities in PPP projects range from  defence, health, education, transport, secure, energy services and other Government accommodation.

Middle East construction services – Our building and civil engineering activities in the Middle East.

Construction services (excluding the Middle East) – Our market leading consultancy, building, civil engineering and developments activities in the UK.

I recall rumblings of trouble not so long ago with the Middle East projects but the most notable issue here is what it calls PPP but what we have discussed on here as the Private Finance Initiative or PFI.

We work in partnership with the public sector to deliver important services which offer value for money and make a positive difference to the lives of people in the communities where we work.

The company embedded itself in two areas in particular that are both considered vital but also have been ridden with PFI scandals.

 Some of the country’s largest and most prestigious NHS Trusts rely on us to deliver services critical to the safe care of over three million patients each year.

In the education sector,we have designed and built 150 schools, many as Public Private Partnership projects. We provide to 875 schools, clean more than 468,000m2 of school accommodation across 245 schools and provide mechanical, electrical and fabric maintenance services in 683 schools.


What has happened?

They say that in war the first casualty is the truth well it is true in company collapses as well. Only on the 3rd of May the Chief Executive Richard Howson announced this.

We have made an encouraging start to the year

Yet after only a short journey to the 11th of July Reuters were reporting this.

Shares of UK construction services firm Carillion (L:CLLN) slumped again on Tuesday with a profit warning, suspension of dividends and a CEO departure now wiping out half the company’s value in two sessions.

Danger! Will Robinson Danger!

A few words at the end of the Reuters article leapt off the page at me.

one of the UK’s most heavily shorted stocks

We move in those few short words from the “Why?” of Carly Simon to the “Who Knew?” of Pink. This is because shorting a stock on such a scale indicates that more than a few people knew something was wrong here. Yet we get a sniff of possible corruption as we note that even so new contracts were awarded for example these on the 6th of November.

Carillion is today announcing two contract awards, both in respect of Network Rail’s Midland Mainline improvement programme.

Were these part of an attempt to bail the company out at the expense of the taxpayer? Even worse was this from Construction News after the July problems.


Carillion / Kier / Eiffage clinched the central packages, picking up the £742m C2 North Portal Chiltern Tunnels to Brackley and the £616m C3 Brackley to Long Itchington Wood Green south portal.

Yes just when you thought it could not get any worse we see that Carillion is embedded in HS2 and we got an official denial of trouble!

Transport secretary Chris Grayling has defended the choice of troubled contractor Carillion as one of the firms to build phase one of HS2.

I guess we will find out what a “secure undertaking” is.

Private Finance Initiative

This was a large strand of business and as I reported on the 1st of September last year the main sound for the companies involved was ker-ching as they counted the cash.

The capital value of the assets which have been built is £12.4bn. However, over the course of the life of the contracts, the NHS will pay in the region of £80.8bn to PFI companies for the use of these assets.

However on this road the clouds darken again as we mull how a company with contracts which gave guaranteed profits baked by the taxpayer mostly in the UK but also abroad could go broke? Either much of its other business was appalling or it spent the money profligately.

Number Crunching

There are/were some real issues here so let us start with the dividend paid last June 9th. Shareholders received some 12.65 pence each which has to be questioned as only a month later came the announcement of financial distress. Of course those who held their shares have been wiped out by the compulsory liquidation but the real issue is with the board. On what grounds did they feel able to make the payment as allowing the business to carry on as normal mostly benefited them? There is a large moral hazard here especially after they told us this.

The Board and its Committees continue to benefit from a strong balance of expertise, experience, independence and knowledge of Carillion and our business sectors.

Next comes the issue of goodwill.

I queried as to how on earth Carillion could claim this? This has led to quite a debate where the real issue is why were the numbers not downgraded as the situation worsened. We of course return to denial of the state of play and the dividend payment but it is hard to move on without mulling this from @dsquareddigest.

Force of habit means that whenever I see the word “goodwill” I read “overpayment”

Or this from @SieurdePonthieu

What evidence did the supply to their auditors to substantiate the £500m? How did the auditors test the valuation? Post auditors were supposed to be very hot on that.

Pension problems

The next piece of number crunching comes from the pension scheme. From the Financial Times.

As a result of the liquidation, the Pension Protection Fund will take over payment of pensions for the company’s 28,000 retirement scheme members, and ensure scheme members who are not yet drawing a pension receive a capped level of benefits, with their retirement income cut by around 10 per cent.

Will they end up funding the goodwill via reduced pensions? Then of course there is the Pension Protection Fund can we find the goodwill here too? From the pensions expert John Ralfe

My take on pensions. Buy out deficit = c £1.4bn. PPF deficit = c £800m.


There is a lot to consider here as we look at the collapse and liquidation of Carillion. Let us open with two pieces of good news which is firstly that the road to privatisation of profits and socialisation of losses was not open this morning as there has been no bailout. Next whilst some benefits will be reduced pensioners will get a lot of protection albeit at the cost of the PPF or other pension schemes.

But there is damage across a wide range of areas. Contractors and sub-contractors must have been dreading the news today as not only will future payments stop at least for now but due to the 120 days payment policy past payments will not be made. There should be an investigation into this as we note that there was money to pay both dividends and directors. Next we come to PFI schemes and whether such companies become mini-monopolies and how if so they can manage to fail?

Yet again we find the issue of accountancy and auditing as in spite of all the supposed checks another large public company turns out to be an emperor with no clothes. Then we find that PWC get work on the liquidation after being one of the architects of PFI as we again find ourselves mulling another monopoly of sorts. They seem to benefit whatever the outcome.

Lastly I suggest that if you find someone called Phillip Green at the top of a pension scheme you immediately get very nervous albeit it is a different one this time around.

Is housing a better investment than equities?

As you can imagine articles on long-term real interest-rates attract me perhaps like a moth to a flame. Thank you to FT Alphaville for drawing my attention to an NBER paper called The Rate of Return on Everything,but not for the reason they wrote about as you see on the day we get UK Retail Sales data we get a long-term analysis of one of its drivers. This is of course house prices and let us take a look at what their research from 16 countries tells us.

Notably, housing wealth is on average roughly one half of national wealth in a typical economy, and can fluctuate significantly over time (Piketty, 2014). But there is no previous rate of return database which contains any information on housing returns. Here we build on prior work on housing prices (Knoll, Schularick, and Steger, 2016) and new data on rents (Knoll, 2016) to offer an augmented database which can track returns on this important component of national wealth.

They look at a wide range of countries and end up telling us this.

Over the long run of nearly 150 years, we find that advanced economy risky assets have performed strongly. The average total real rate of return is approximately 7% per year for equities and 8% for housing. The average total real rate of return for safe assets has been much lower, 2.5% for bonds and 1% for bills.

If you look at the bit below there may well be food for thought as to why what we might call the bible of equity investment seems to have overlooked this and the emphasis is mine.

These average rates of return are strikingly consistent over different subsamples, and they hold true whether or not one calculates these averages using GDP-weighted portfolios. Housing returns exceed or match equity returns, but with considerably lower volatility—a challenge to the conventional wisdom of investing in equities for the long-run.

Higher returns and safer? That seems to be something of a win-win double to me. Here is more detail from the research paper.

Although returns on housing and equities are similar, the volatility of housing returns is substantially lower, as Table 3 shows. Returns on the two asset classes are in the same ballpark (7.9% for housing and 7.0% for equities), but the standard deviation of housing returns is substantially smaller than that of equities (10% for housing versus 22% for equities). Predictably, with thinner tails, the compounded return (using the geometric average) is vastly better for housing than for equities—7.5% for housing versus 4.7% for equities. This finding appears to contradict one of the basic assumptions of modern valuation models: higher risks should come with higher rewards.

Also if you think that inflation is on the horizon you should switch from equities to housing.

The top-right panel of Figure 6 shows that equity co-moved negatively with inflation in the 1970s, while housing provided a more robust hedge against rising consumer prices. In fact, apart from the interwar period when the world was gripped by a general deflationary bias, equity returns have co-moved negatively with inflation in almost all eras.

A (Space) Oddity

Let me start with something you might confidently expect. We only get figures for five countries where an analysis of investable assets was done at the end of 2015 but guess who led the list? Yes the UK at 27.5% followed by France ( 23.2%), Germany ( 22.2%) the US ( 13.3%) and then Japan ( 10.9%).

I have written before that the French and UK economies are nearer to each other than the conventional view. Also it would be interesting to see Japan at the end of the 1980s as its surge ended and the lost decades began wouldn’t it? Indeed if we are to coin a phrase “Turning Japanese” then this paper saying housing is a great investment could be at something of a peak as we remind ourselves that it is the future we are interested as looking at the past can hinder as well as help.

The oddity is that in pure returns the UK is one of the countries where equities have out performed housing returns. If we look at since 1950 the returns are 9.02% per year and 7.21% respectively. Whereas Norway and France see housing returns some 4% per annum higher than equities. So the cunning plan was to invest in French housing? Maybe but care is needed as one of the factors here is low equity returns in France.

Adjusted Returns

There is better news for UK housing bulls as our researchers try to adjust returns for the risks involved.

However, although aggregate returns on equities exceed aggregate returns on housing for certain countries and time periods, equities do not outperform housing in simple risk-adjusted terms……… Housing provides a higher return per unit of risk in each of the 16 countries in our sample, and almost double that of equities.

Fixed Exchange Rates

We get a sign of the danger of any correlation style analysis from this below as you see this.

Interestingly, the period of high risk premiums coincided with a remarkably low-frequency of systemic banking crises. In fact, not a single such crisis occurred in our advanced-economy sample between 1946 and 1973.

You see those dates leapt of the page at me as being pretty much the period of fixed(ish) exchange-rates of the Bretton Woods period.


There is a whole litany of issues here. Whilst we can look back at real interest-rates it is not far off impossible to say what they are going forwards. After all forecasts of inflation as so often wrong especially the official ones. Even worse the advent of low yields has driven investors into index-linked Gilts in the UK as they do offer more income than their conventional peers and thus they now do not really represent what they say on the tin. Added to this we now know that there is no such thing as a safe asset more a range of risks for all assets. We do however know that the risk is invariably higher around the time there are public proclamations of safety.

Moving onto the conclusion that housing is a better investment than equities then there are plenty of caveats around the data and the assumptions used. What may surprise some is the fact that equities did not win clearly as after all we are told this so often. If your grandmother told you to buy property then it seems she was onto something! As to my home country the UK it seems that the Chinese think the prospects for property are bright. From Simon Ting.

From 2017-5-11 90 days, Chinese buyers (incl HK) spent 3.6 bln GBP in London real estate.
Anyway, Chinese is the #1 London property buyer.

Perhaps the Bitcoin ( US $4456 as I type this) London property spread looks good. Oh and as one of the few people who is on the Imputed Rent trail I noted this in the NBER paper.

Measured as a ratio to GDP, rental income has been growing, as Rognlie (2015) argues.

Meanwhile as in a way appropriately INXS remind us here is the view of equity investors on this.

Mystify me
Mystify me

UK Retail Sales

There is a link between UK house prices and retail sales as we note that both have slowed this year.

The quantity bought increased by 1.3% compared with July 2016; the 51st consecutive year-on-year increase in retail sales since April 2013.