My previous post got to the essence of why Carillion’s share price got dump! That was due to the use of trade receivables, especially “other receivables” to bolster their sales and profits. They were hiding their failings from their acquisitions strategies. (Most of the losses came from their poor timing in acquiring Eaga, as solar tariff subsidies were getting cut).
Proof of this lies in Carillion poor operating cash conversion of 55%. Also, average borrowings have grown past £1bn from £127m in 2005, not to mention pension deficits of £800m+.
But, having seen Carillion’s market capitalisation collapse from £2bn to £243m in two years, are there hidden value, where investors could exploit?
Also, how will the Carillion’s saga COULD play out in the next 12 to 18 months?
To do this, we need to first value Carillion’s divisions.
Carillion’s Construction Division
Carillion’s construction divisions, especially their Middle-Eastern operations is the biggest source of “uncontrollable receivables growth.” While investors saw stable trade receivables, it was their other receivables, especially their Construction’s receivables rising from £192m in 2003 to £614.5m in 2016.
For the purpose of segment analysis, starting from 2009, receivables would have grown from £328.8m to £614.5m at the end of 2016. Meanwhile, Sales from the division, including their Middle East operations actually fell from £2,821.4m to £2,188.5m in that period.
Therefore, receivables, as a % of construction revenue rose from 11.7% to 28.1%.
Although Carillion’s construction has stated total net asset value of £395m. It would be wise if we were to assume zero value because receivables write-down would wipe out equity.
Now, that leaves us with one division.
Carillion’s Support Services
This is Carillion biggest division with 2016’s sales of £2.7bn. It also recorded operating earnings of £152m with net asset value of over £1.5bn.
Operating margins have improved from 3% to 5.6% with the return on segment assets at 7%.
This division is Carillion golden goose and buyers would attach 10 times multiple of EBIT or £1.52bn.
Putting it together
With a price of £1.52bn valuation for support services and zero value for their construction businesses. Carillion has net debt of £1bn, add in pension deficit of £800m it would give Carillion a negative net valuation of £300m. If we include £150m in tax assets, then the negative value is cut down to £150m.
Is this a true valuation that buyers are looking for?
Yes, if they were to make money.
For, Carillion’s shareholders it would mean wipe out!
Another Way of Valuing Carillion
The above is a traditional way of valuing a business, but it would be impractical for Carillion.
What if the buyer isn’t looking to write off Carillion and pension deficit immediately, but is given a five-period to reduce their average net borrowings and pension deficits by half?
Support Services generate £150m in operating profits per year and assume it would grow by £10m extra each year for the next five years. Therefore, cumulative profits come to £850m.
Net debt got reduced to £500m and pension deficit down to £400m would consume all its operating profits.
At the end of year five, Carillion’s support services generate £190m in operating profits. Add in 10X multiple would give it a value of £1.9bn, minus debt and pension would leave Carillion with a £900m valuation.
This would the best outcome for shareholders, but time is Carillion enemy.
Immediate need for Cash Infusion, then Prosperity Later
For the above scenario to work, a more realistic approach is needed. When Carillion’s shares fell sharply, it signals one thing and that is heavy dilution by issuing more shares. This infusion should last the company, a good 18 months to 24 months if it to successfully restructure and focus on their core businesses.
Envisioning a likely scenario
Let’s say Carillion did a £500m Rights issue at 30 pence, leading them to issue 1.66bn in new shares, giving a total of 2.1bn shares. Initially, the shares would fall to 40 pence or £838m in market value.
If Carillion uses £300m to reduce debt and pension deficits by next year, it still leaves the company with £1.3bn in net debt and pension deficit.
That would cause the shares to fall, as cash gets eaten up, assume the market capitalisation fell to £400m or 19 pence per share. By then, Carillion can begin afresh and management is able to focus on a smaller, but a high margin business.
With £850m in cumulative profits in the next five years, Carillion would use £600m of this to reduce debt and pensions to a sustainable total of £700m.
So, the £1.9bn valuation minus £700m would give Carillion a market value of £1.2bn meaning that £400m could yield a 200% return.
(P.S. The above is a suggested scenario.)
The “Flaw” in my Argument
The above scenario would work out well IF Carillion’s support services data are legit. And given their poor reputation, this is a major concern and a major risk factor.
Also, the market and borrowers would need to agree with these plans.
But, most importantly, Carillion need to keep delivering results.
However, given the dire strait Carillion found itself in, it could sell out to another buyer at a very low price meaning shareholders’ equity losses all their investment.
What should you do?
The obvious advice (if you are a medium investor) is wait for the plan of their fundraising and see if there is an appetite to help the company.
Thanks for reading and remember to subscribe my posts if you think it is worthy. Feel free to leave comments below.
The opinions expressed by the writer is for entertainment and research purposes. It does not constitute professional investment advice. Data is correct on available information at the time.
Finally, the writer does not own the company’s stock, unless stated otherwise.