A few months ago I wrote about the collapse of Carillion, and drew comparisons between their collapse and the Government outsourcing industry in general.
This week Interserve have announced they are negotiating a financial recovery package. This news led their shares to slump to 24p each, down from 660p 3 years ago.
Interserve turn over roughly £3.5bn a year, a bit smaller than Carillion, which had revenues of £5.5bn before it went under. Like Carillion, they have a huge book of future contracts worth £7.5bn, and they operate in the same outsourcing/PFI space. Interserve’s revenues come largely form Government contracts, including school meals, hospital cleaning contracts, school building programmes. Most of this work is often called facilities management (FM). Hard FM is stuff like buildings maintenance. Soft FM is cleaning contracts.
Its also a big part of the consortium building new Colleges for Durham University.
Some of Interserve’s problems stem from the risk in their contracts. Costs and revenues in areas like facilities management are stable and predictable, but as public bodies have squeezed contracts profit margins have fallen.
Interserve’s response has been to move into other areas of Government business. They are the UK’s largest provider of outsourced probation and criminal justice services, areas where costs are being squeezed and penalties for performance are starting to bite. It is just tougher to make the kind of predictable profits that investors like from services like probation than from FM. This is essentially the same problem that Circle Healthcare had with running an NHS Acute Hospital – the techniques that the private sector use to control cost, drive efficiency and build profit don’t really work with volatile public services.
They also made a bold attempt to diversify their revenues borrowing heavily to invest in an energy from waste business. This business area was a disaster for them, and it has taken them years to unwind these investments. It was problems with these deals that prompted the most recent fall in their share price. This is an area where the Government tried to encourage investment in EFW to reduce the amounts of landfill, but ended up with a lot more capacity than the UK needs.
This is starting to look like an endemic problem with the outsourcing market. There isn’t enough profit to be made from outsourced facilities management contracts to support all of the big players. Once these companies expand outside of traditional FM work they take on risks that they don’t really understand, and debts they can’t service. A lot of the contracts involve a large capital investment up front (funded through borrowing) so secure future revenues,
Call me a heretic but I don’t really have a problem with the public sector outsourcing FM services. Interserve probably have a really good FM business somewhere under all of these other debts and contracts. But there are too many companies trying to do outsourced FM and not enough profits to support them all.
There will be a shake up, and companies who can divest of their too risky bits of business will survive, others won’t.
Underpinning all of this is the concept of what outsourcing of public services means. It is often regarded as the epitome of free market neo-liberalism but in reality when the Government incentivises companies to invest in areas like EFW it is actively distorting markets in a which that is contrary to neo-liberalism. It is more like old fashioned Keynesianism. But you have to wonder when the state can borrow at tiny interest rates why it should pay a risk premium to a private company? Particularly a private company than now finds itself sinking under that same debt?