“Not another Carillion,” says UK government to soothe frazzled nerves, as entire industry is teetering.
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
Since the sudden downfall of the British infrastructure giant Carillion two weeks ago, investors’ nerves in London are frayed. And short-sellers, scanning the horizon for their next prey, seem to have found it.
Its name is Capita. It is one of the UK government’s biggest outsourcing firms with contracts to provide services to government entities, such as NHS cleaning, school dinners, and prison maintenance. It has 70,000 employees in the UK, Europe, South Africa, and India.
On Wednesday, its shares tumbled 47.5% to a 15-year low after its new CEO, Jon Lewis, slashed profit forecasts, announced plans to tap the capital market for £700 million, and suspended a dividend that was worth more than £200 million to shareholders last year.
On Thursday, the rout continued , with shares dropping a further 13%. On Friday, shares bounced off a tiny 2.3% to close at 162.3 pence, down 77% from June 2017 and down 88% from July 2015.
In a desperate bid to calm market nerves at the height of Wednesday’s rout, the UK government released a statement insisting that Capita was “not another Carillion.”
But whatever the government might say, there is a striking resemblance between the two companies:
Like Carillion, Capita is massively dependent on government contracts. In the last two years alone it was awarded 226 public sector contracts — 10 times more than Carillion — making it the biggest supplier of local government services in the country, according to public sector data provider Tussel.
Like Carillion, Capita is massively in debt, with an estimated £1.1 billion of funds outstanding. And like Carillion, it’s been exceptionally generous with its dividend policy in recent years. So did it, as Carillion is accused of doing, borrow money and sell-off assets in order to pay its dividends, in direct contravention of UK law?
Like Carillion, Capita has a pension shortfall, estimated to be around £380 millioin, but, as happened with Carillion, it could grow in the coming days as the full extent of its long-term liabilities becomes clear.
Capita also shares the same auditor as Carillion, KPMG, whose alleged role in cloaking Carillion’s financial reality is already under investigation by two parliamentary inquiries.
There are also important differences between Capita and Carillion, not all good.
On the positive side, unlike Carlillion, Capita has over £1 billion of cash on its balance sheet. And Capita doesn’t have high-risk high-cost construction projects bleeding it dry.
But Capita is hemorrhaging funds at a startling rate. And it has been losing important business contracts, partly as a result of the political uncertainty over Brexit. Whether Capita gets through the immediate storm it faces will depend largely on its ability to raise £700 million from shareholders, for which it claims it already has full “standby underwriting” — but his undertaking has gotten immensely more difficult after the crash of its shares.
If it fails, the implications for the UK government could be huge. It already has to take over many of Carillion’s sprawling public service operations, which will no doubt be funded by an expansion of public debt, while concerns are growing about the gaping deficits at UK pension funds, estimated to be worth a combined £210 billion. If Capita were also to collapse, the sheer scale and scope of its operations would make it even more complicated to replace. As the UK Independent reports, Capita doesn’t just provide some services, it runs entire councils:
Created from humble beginnings in 1984 as a for-profit consultancy arm of the Chartered Institute of Public Finance and Accountancy (CIPFA) – Capita became the Vampire Squid of business process outsourcing, its money grabbing tentacles extending through every layer of Government, from pensions, to council finance, from parking and congestion charges to NHS GP primary care support, funeral services, and even the privatised food safety agency.
If the financial situation becomes untenable at Capita, not only would the government have to mobilize a herculean effort to ensure the firm’s sprawling, diffuse web of services continue to be delivered; it could also have serious knock-on effects for other outsourcing firms such as Serco and Interserve, both of which have their own share of problems.
In the last 12 months, Serco’s stock has fallen 40% and is down 78% from July 2013. Shares of Interserve, which is already on a watch list, plunged 25% over the past two days, 35% over the past two weeks, and 88% from June 2015. In the event that Capita’s turnaround plan fails, contagion could spread throughout the teetering sector, at which point the viability of the UK’s public-private service model could even be threatened. For the country’s already slowing economy, the timing could not be worse. By Don Quijones.
Has the Carillion collapse triggered the “Next Arthur Andersen?” No, the “Final Four” audit firms are “too big to replace.” Read… Fallout from Carillion Collapse Hits KPMG