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.

Comment

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.

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Smart Meters and HS2 pose problems for the concept of Investment

One of the sacred cows of economic theory is the concept of investment. The text books have it as what 1066 and all that would call a “Good Thing”. We see this repeated by the media and there are many cries for it to be increased because of the low-cost of it in terms of interest-rates and more importantly bond yields. From a UK perspective that is invariably an easy thing to say or write because we have a culture which leads to strong consumption levels and usually growth which tends to crowd out at least some investment. So as a starter let us look at what investment means.

An investment is an asset or item that is purchased with the hope that it will generate income or will appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will be sold at a higher price for a profit. ( Investopedia ).

In essence the major feature is that it is for the future rather than the now as opposed to consumption which is for now. In some ways it is similar to a catalyst in a chemical reaction which makes a change without being used itself. Of course if we move from the text books to the real world we see that nearly all types of investment do in the end run out via wear and tear or simply getting out of date. Even more problematic is the issue of time. What I mean by that is in its own the concept of deferral seems rather moral and good as well of course of being completely contrary to the zeitgeist of these times. But what if it takes so long to be developed that by the time it arrives it is already out of date? That issue does not apparently trouble the world’s statisticians who changed the GDP calculations a few years ago to include Research and Development as an investment regardless of whether it actually led to anything. A dangerous move in my view.

Smart Meters

These are devices for measuring your domestic energy consumption ( gas and electric ). These allow you to see what you are consuming in pretty much real-time and save you the trouble of reading your meter as they send readings to your supplier. So gains but very minor ones. You might believe from the constant stream of both TV and radio advertising that they help you to cut your bills along these lines.

#GAZNLECCY have been causing mayhem for too long. Get them under control with smart meters!

How exactly? There is a radio version which says they will help someone with their favourite dinner but never says how. Actually as we stand it is very misleading as whilst the meters are given for no individual cost they are in fact collectively added to people’s bills. So in the future the “cheaper” dinner will be more expensive!

According to the Financial Times the rollout is not going to well.

 

But as energy suppliers work towards a government target to offer every home in Britain a smart meter by 2020, people in the industry warn the £11bn infrastructure delivery programme is increasingly shrouded in complexity, while costs are mounting.

Not only is it more expensive it is not turning out as promised.

 

So far the devices fitted are first generation technology — known as “Smets1”. These are generally more expensive, less sophisticated and are considered less secure than the second version — Smets2 — which was intended to be the main model rolled out to the market…….Crucially there is a chance the older devices will go “dumb” if a customer chooses to switch energy provider, as the new utility company may not be able to access the data.

Against this there are two possible types of gain. The first is that once people see their energy use they will cut back on it, how they tell that from those who cut back due to higher prices I am not sure. The second impact comes from this described by the Guardian.

Over the longer term they will also allow consumers on smart tariffs to take advantage of off-peak deals – cut-price electricity at night, or when there is a plentiful supply because wind turbines are working at full capacity – at which point it is expected that everyone would run their washing machine.

As someone who lives in a block I could immediately see the problem in everyone’s washing machine coming on at 3 am! Hardly good for neighbourly relations especially as we all became more sleep deprived. But after the Grenfell fire disaster there is a much darker issue to face which the proponents of this technology have either overlooked or ignored.

HS2

This is the project for a High Speed railway to the North and the 2 refers to the fact that the line to the Channel Tunnel was 1st. That is not an auspicious comparison as Eurotunnel went bust and for a long time the trains actually crawled past my area on a back line in Battersea. It is in the news today.

The winners of £6.6bn worth of contracts to build the first phase of HS2 between London and Birmingham have been announced by the government.

In itself we see investment in infrastructure and in our future with even a green tinge as railway transport is greener than cars. But there are more than a few possible problems with this particular investment.

But critics say the £56bn project will damage the environment and is too expensive.

Actually more and more doubts are emerging over the final cost. From The Independent.

The HS2’s first phase between London and Birmingham will cost almost £48bn, according to expert analysis commissioned by the Department for Transport (DfT).

That highlights two problems. If we start with costs then if this report is accurate we will have the most expensive railway in the world at £1.25 billion per mile on the first bit from Euston to Old Oak Common. The next is that by 2026 if everything is on time we will only have a new railway to Birmingham which is way short of the “Northern Powerhouse” promises. Assuming that the bits to Leeds and Manchester are eventually built will it all be out of date by then?

Oh and we have an official denial which of course we know what to do with…

Mr Grayling told the BBC’s Today programme that the high-speed rail network will be “on time, on budget” and the government has “a clear idea of what it will cost”.

The whole concept will not be helped by the fact that Carillion is one of the contractors although it looks as though Carrillion will be happy.

Carillion, which last week issued a profit warning and announced the immediate departure of its chief executive, has won two “lots” within the central area. Its share price rose by 7.7% to 60.5p on Monday but it has fallen by more than 76% over the last 12 months.

Comment

The reason for the clamour for new investment plans has support from the price of it. Here we return to the subject of Friday which is the fact that interest-rates and bond yields are very low in historical terms. The UK has existing debt running into the mid 2060s and none of it yields more than 2% currently. Frankly we could look further than 50 years ahead and could follow Argentina, Ireland and Belgium in issuing 100 year debt. It would be likely that the cost would be low and we would pay maybe not even 2% on it.

Against such a low-cost many investments look affordable as it is a low hurdle to overcome. The problem is that if we look at the examples above we have two enormous projects that seem set to not only fail to clear the hurdle but injure the hurdler in the process. Meanwhile I am sure that plenty of smaller projects would bring genuine gains but less publicity. Is this another flaw of the QE era that the investment generated goes to the wrong places and areas?

 

 

 

The UK Spring Budget will have good economic news but not for the OBR

Yesterday saw some good news about the UK economy announced by the Chancellor of the Exchequer as he did his pre Budget tour of the television media. The Financial Times has put it like this.

Philip Hammond’s first and last spring Budget will be delivered against a backdrop of economic resilience since the EU referendum last summer.

Most people would welcome this although apparently not the economics editor of the FT Chris Giles.

Economy may be stronger than hoped

The details of this are shown below.

The economy has performed better than the Office for Budget Responsibility expected in the latter half of 2016 and started this year with significant momentum which will raise the growth numbers for this year. Headline growth forecasts for 2017 will be revised sharply higher from 1.4 per cent to close to 2 per cent.

These are of course concepts of which regular readers on here will be well aware and indeed prepared for. I pointed out after the UK leave vote that the fall in the value of the UK Pound would provide a powerful economic stimulus which as of the end of last week was equivalent to a 2.75% cut in the UK Bank Rate ( the official interest-rate). This of course is a bazooka compared to the 0.25% peashooter announced by the Bank of England which it called a “Sledgehammer”. Although of course the second part of the Sledgehammer was due last November but never arrived in another Forward Guidance failure.

Also of note here is the fact that the Office for Budget Responsibility was wrong yet again. So the first rule of OBR club “the OBR is always wrong” works again! In essence the economic growth it took away in November it will now be forced to (mostly) put back. Also whilst the UK has growth momentum for the first half of 2017 it is much less clear for the latter part as the other consequence of a lower exchange-rate arrives which is higher inflation.

The Public Finances

The FT reports on some good news for the UK public finances.

Tax receipts for 2016-17 have proved stronger than was expected at the time of the Autumn Statement and the deficit is likely to be around £12bn smaller than feared in November.

Good except as I look back I note that the OBR told us this only last November.

the budget deficit has been revised up by £12.7 billion this year, thanks primarily to weakness in income tax receipts that largely pre-dates the referendum. The weaker growth outlook means that our pre-policy-measures forecast revision rises to £18.1 billion by 2020-21. Again, weaker income tax receipts are the biggest factor, reflecting the downward revision we have made to productivity and earnings growth;

So has the OBR and our official forecasters run hard for us to stand still?! Yesterday I switched on the television and there on ITV was Robert Peston demonstrating an almost touching faith in the forecasts of the OBR in spite of the fact if anything it manages to be even more wrong than before. The addition of Professor Sir Charles Bean seems unlikely to improve this after the way he signed off the official post EU leave forecast for an immediate recession of between 0.1% and 1% in the next quarter. As to weaker income tax receipts forecast here are the January numbers.

Self-assessed Income Tax and Capital Gains Tax receipts increased by £2.0 billion to £19.8 billion in January 2017 compared with January 2016; this is the highest January on record (monthly recording of self-assessed tax receipts began in April 1999).

So the “improvement” that will be announced is giving back what was taken away in November whilst reality remains mostly unchanged. It is like the television program Soap which used to start with “Confused? You soon will be!”

Debt Interest and QE

I noted that the Chancellor Phillip Hammond pointed out that the UK is spending some £51 billion a year on debt interest. There are a lot of factors at play here so let us go through them. Firstly the government is in my view the main beneficiary of the QE ( Quantitative Easing) bond buying program of the Bank of England. as it pays interest on £432 billion of its debt and then gets it repaid by the Bank of England. This saves it quite a lot of money explicitly and also implicitly because there are regular buyers of UK debt ( insurance companies and pension funds etc.) and they have less to buy which pushes up the price and lowers the yield. For example the UK sold a ten-year Gilt at a yield of only 1.18% around a fortnight ago so for the next 10 years we have borrowed £2 billion cheaply.

However there is a problem from rising inflation and in particular the rise in the Retail Price Index. As it rises and the RPI was 2.6% in January then we will have to pay more in interest here and also find these more expensive to redeem when they are repaid. As they are a bit under a quarter of the market the sums here are not insubstantial.

If you think this through this may be why the new Deputy Governor of the Bank of England Charlotte Hogg was caught off guard by questions about rolling back QE in parliament last week. The UK establishment simply has no plan for this at all as it fears what would happen to debt costs in such a scenario.

HS2

For those unaware this is the grand scheme to improve the UK railways from London to the North first stopping at Birmingham and then going onto Manchester and Leeds. The catch is summarised by this. From the FT.

A law providing for the first phase of the £56bn line was enacted last month and enabling works should start within weeks. The first trains are expected to arrive in Birmingham in 2026.

It is very expensive and will take a long time leading to fears it may be out of date before it even starts. But how does that work with this from its chief Sir David Higgins?

“You look at EasyJet or Ryanair or Eurostar. These services are full all the time. People will want to know they can book in advance, they can always get a seat and it is reliable. It is everyday efficient low prices,”

High costs and low prices anyone? One rather relevant reply points out the over optimistic forecasts for the HS1 line ( to the Channel Tunnel) which have led to problems over time. Also in a scheme badged as a northern regeneration scheme it has not passed people’s attention that the first bit to be built is to London,or is that a “Northern Powerhouse” now?

Comment

No doubt Wednesday’s Budget will throw up a surprise or too. For example Chancellors who major on fiscal rectitude in the public relations spinning like to pull a rabbit from the hat as a “surprise”. Also I am curious as to how and indeed if he will address the fact that the self-employed pay a much lower rate of national insurance as they would reply that they get lower state benefits.

The good news is that the UK economy has performed as we expected on here to the embarrassment of the official forecasters such as the OBR and the Bank of England. So I suggest you have a bit more than a wry smile as the media take their forecasts seriously and perhaps take the advice of some of the replies on here and get some popcorn in.