After Balfour Beatty yesterday revealed that its own management processes had identified a further £75m profit overstatement, commentators have suggested that the forthcoming site-by-site analysis by accountant KPMG is likely to uncover yet further losses.
But an alternative explanation for the shock announcement is that it formed an example of “kitchen sinking” – a tactic used by a company with an incoming new chief executive to announce all the bad news at once to contrast with the subsequent recovery.
If correct, this theory would suggest that the new CEO is waiting in the wings, with an announcement due imminently.
The company’s statement said that “the process to appoint a new group CEO is now at an advanced stage”. Asked if an announcement was imminent, a Balfour Beatty spokesman told CM: “Yes, that’s the signal we’re giving, we’ll make an announcement on the new CEO shortly.”
Asked to clarify the timing of KPMG’s appointment, the spokesman said the firm had been brought in “at the weekend”. “Our internal processes identified the profit shortfall, and the board decided it was appropriate to extend the work KPMG is already doing in the Balfour Beatty Engineering Services portfolio to the rest of the Construction Services portfolio [ie Regional, Major Projects and BBES]. So they’re basically extending and adding to that brief.”
"… it’s a massive cock-up by the board, risking the profits of the company when they could have made a deal [with Carillion]. If the board had any inkling that this might happen [during the merger talks], you would think it would be better to sell and achieve the value for shareholders."
One industry expert told CM: “If they found a £75m hole on their own, and then called in KPMG, that gives the message it might be worse. I have seen this happen with other construction companies, they get accountants in to look at all the books and they find major losses.
“In construction, profit-taking is very reliant on people making judgements, about the size of the claim from a subcontractor, or whether they’re likely to finish on time. A lot of judgement creeps in. Then you bring in accountants who’re not able to make those judgements and so they tend to be super-cautious.
“It’s a massive cock-up by the board, risking the profits of the company when they could have made a deal [with Carillion]. If the board had any inkling that this might happen [during the merger talks], you would think it would be better to sell and achieve the value for shareholders.”
Analysts at Liberum said:"We hope that we are now finding our way to the bottom. The risk is that the KPMG review identifies further problems."
Before yesterday’s announcement, Reuters said that the market’s average forecast for Balfour Beatty’s profit was £133m, which would now be reduced to around £58m.
Yesterday, Balfour Beatty’s share price crashed 25% from Friday’s closing price of 225p to 168p, although by close of trading it had recovered to 190.5p, amounting to a 15.3% drop. This equates to a new market capitalisation of around £1.3bn.
Balfour Beatty’s board (l-r): Steve Marshall; Duncan Magrath; Peter Zinkin
On 19 August, Carillion made a third offer for Balfour Beatty which it said valued the business at £2.086bn. At the time, the actual shares stood at 257.6p, giving a market capitalisation of £1.77bn.
Executive chairman Steve Marshall, who put up a spirited defence of Balfour Beatty’s independence during the Carillion merger talks and has therefore taken a severe dent to his credibility, will leave as soon as the new CEO is installed.
Yesterday’s £75m profit warning was the third in five months and by far the largest, with the problem contracts lying wholly within the Balfour Beatty Construction Services UK portfolio. It was broken down into: Balfour Beatty Engineering Services £30m; large London area projects £20m; regional construction £15m; and major infrastructure projects £10m.
The spread of the problems worried analysts at JP Morgan Cazenove, who said: “In our view, if anything, this warning is more disconcerting than the last, not only because of the magnitude, but also because issues are split across all subdivisions of UK construction, including regional construction, where we had assumed we’d seen the last of the issues following a full contract review.”
The industry insider added that it was “easy for construction companies to push the numbers” [on profit-taking] due to natural optimism bias. The counterbalance was to have board members with extensive operational experience in construction, but “Marshall, Zinkin and Magrath aren’t actually construction people”.
The three executive members of the board are outgoing executive chairman Steve Marshall, a former finance director and chief executive of both Thorn and Railtrack; chief financial officer Duncan Magrath, and planning and development director Peter Zinkin who also has a finance background.
Another case of accountants running, sorry, ruining the world
Oh dear, another bad judgement by non construction people in charge! When I was at Mitchell Construction in the 60’s it was said that engineers should be in charge not accountants!