Yves here. Forgive us for being a bit heavy on UK stories, but it is proving to be a case study in how end-state neoliberalism produces incompetence and corruption. As Don Quijones described, the failure of a second major outsourcing player in barely more than a year provides strong evidence that the UK approach to outsourcing government activities was deeply flawed.
By Don Quijones, of Spain, the UK, and Mexico, and editor at Wolf Street. Originally published at Wolf Street
Shares in UK outsourcing giant Interserve, which employs over 65,000 people worldwide including 45,000 in the UK, were suspended today after almost 60% of the firm’s shareholders, led by the US hedge fund Coltrane Asset Management, rejected a last-ditch debt-for-equity swap with Interserve’s creditors that would have diluted the shares of current stockholders to nearly nothing, leaving them just 5%. The company has thousands of government contracts, including for hospital cleaning, probation services, school meals and the maintenance of military bases.
Interserve now faces a “pre-pack” administration that — it is hoped — will see its various divisions and 45,000 UK staff insulated from the fallout. The firm’s lenders, including HSBC and RBS, and bondholders, will agree to write off £485 million of Interserve’s crippling £631 million debt and inject £110 million of additional funds, in return for ownership of the company’s stock. By Friday’s close, all of Interserve’s business and assets are expected to be transferred to a newly-incorporated company, which will be owned by the existing lenders.
Current stock holders are out of luck. They’d already seen the stock tumble 96% over the past two years, will now be wiped out altogether. That includes Coltrane, which owned 28% of the shares and has threatened to take legal action for unfairly favoring lenders over shareholders.
Interserve said the deal was “the best remaining option to preserve value, protect the jobs of employees, and ensure the Group can carry on as normal with minimal disruption.” Once the pre-pack is in place, Interserve should be able to continue trading, thus mitigating potential disruption to the key public services that Interserve manages for the government. At least that’s the plan.
Interserve had been working on this contingency plan in advance of the vote to prevent a possible repeat of the disorderly collapse of Carillion in January 2018, which shook the foundations of Britain’s outsourcing industry, triggered the collapse of hundreds of supply firms, and left the British government holding a tab for at least £148 million, of which an estimated £50 million will go to auditor PwC for its work in the liquidation.
A Cabinet Office spokesperson said the Carillion debacle will not be repeated. The announcement of the pre-pack administration “will not affect jobs or the provision of public services delivered by Interserve,” he said. “We are in close contact with the company and we are confident a positive way forward will be found.”
Ironically, just three months ago the same UK government was confidently assured that Interserve would not be another Carillion and was even awarding the company fresh tenders — whatever it would take to keep the company solvent. It clearly wasn’t enough.
The question now is whether Interserve’s new management will be able to turn the company around. While Carillion’s collapse was largely the result of Enron-esque accounting that was eventually unearthed by a finance director who was swiftly dismissed for his troubles, Interserve’s decline can be traced back to an ill-advised foray into the waste recycling business, which produced compounding losses that proved impossible to absorb.
In 2017 the company alerted, in the first of a string of profit warnings, that those problems had spread to its core UK businesses, almost all of which were under-performing. Like many in the UK’s outsourcing sector, the company was unable to reverse thinning margins on major contracts — a result of fierce competition and belt tightening by the UK government in the wake of crisis. Those margins are unlikely to grow in the months ahead.
More importantly, Interserve’s demise lends credence to the notion that Carillion’s collapse last year, rather than being a one-off episode, was in actual fact the swan song of a deeply flawed and dying business model that has made a very small few fabulously rich while saddling future generations with huge amounts of debt for increasingly shoddy public services the private sector is no longer able to provide.
A scathing parliamentary inquiry last year accused successive British governments of using the Public Finance Initiative (PFI) to keep many of its current liabilities off balance sheet, Enron-style, while also awarding well-connected businesses and investors lucrative public work contracts. Even if the government doesn’t enter into any new PFI-type deals, it will end up having to pay private companies almost £200 billion, including in interest to lenders, until the 2040s for existing deals, in addition to some £110 billion already paid. That’s for 700 projects worth around £60 billion.
What’s not clear is how many of those businesses will still be around in the 2040s to pick up the bill. Research last year by the weekly publication Construction News revealed that the average pre-tax margin for the 10 biggest UK contractors fell for the fifth consecutive year, to -0.9%, while their combined debt rocketed 24% year-on-year to €3.9 billion. Dividends have also been slashed, as evidence emerges of firms tightening their belts ahead of Brexit.
To make matter even worse, banks and investors that had already incurred large losses on Carillion and are now having to take over Interserve’s business are likely to be even more reticent about backing the industry, particularly as it faces greater scrutiny from regulators as well as the rising risk of local authorities taking contracts back in-house. The ultimate irony is that some of the same banks that feasted on the absurdly high interest rates the UK government agreed to pay on its PFI deals — at times as high as 3.75 percentage points higher than the cost of government borrowing — are now themselves, thanks to Interserve’s collapse, public service providers.
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” thinning margins on major contracts”
Let me guess, this hasn’t stopped the current top management and shareholders siphon millions from the company? All those loans have been used for executive pay?
So first there was Carillion and now we have Interserve imploding. Certainly this is a cause of concern due to the large number of contracts that they had with different governmental bodies in the UK. It did not have to be this way but ideologues determined that everything possible of the government should be out sourced except for perhaps the armed forces, the police and foreign affairs. And if a few mates made a little money on the side, well, that was just a happy coincidence that. What concerns we most though is how stuff like water and power have also been outsourced. What if that had been a major private water company that had gone down in flames? Is this possible? You would think that the government be on top off it but after the past coupla years I am assuming nothing.
I am not sure about the others, but a lot of the U.S. military’s core functions (food service comes to mind) have been outsourced. What used to be done by qualified, trained, and integrated military personnel is now carried out by the private sector on the cheap. One for The Bezzle.
“Done on the cheap” not being the same as “done for a cheap price” of course:-)
There seems to be a contradiction here: if PFI was wildly profitable, then Interserve should be going gangbusters! The problem is that large infrastructure projects inevitably run way over budget, partly because they would never get the go-ahead if the truth was out at the beginning: the skill is to get the business with a low bid and then find a way of elegantly pulling off the bait-and-switch. In this time of ‘austerity’ the mostly-municipal sponsors of infrastructure have been refusing to play this game. The Western world badly needs new infrastructure, but neither state nor private models seem to be working: we can see this paradox affecting prospects at GE: if the future is electric and robotic, how come no new power generation?
Yes, and not just infrastructure. In the IT world too, projects and programs overspending like drunks in a bar and similarly slipping uncontrollably to the right are legion.
Even my lumpen and incompetent TBTF is consciously re-examining where you can safely outsource and where it is just going to become a no-good lame useless all-round trouble magnet. This is borne out of bitter experience. But it’s taken nearly 20 years of repeated, persistent failures for it to even become an agenda item as opposed to echo chamber perceived wisdom that, well, of course you just have to do outsourcing, it’s obviously going to be cheaper. In’nit?
If the Dothraki were employed by my TBTF’s management, I would have undoubtedly heard, in response, many times, “it is known”.
The problem is, we’re seemingly doomed to be trapped, endlessly, in a merry-go-round of consultants, outsourcers, auditors (who are often one of the former, too, if not both) and management who have built the ultimate self licking ice cream cone.
I could write a book on the flawed models these deals were based on. It’s why I laugh at “externalities”. Oh you mean things like teaching thousands of people how to do a job someone has been doing for a decade or two in 60 days? We shall secure the networks, they are just not allowed to print. Time zones? The “organization” will adjust.
I reflect back on my earliest years in fintech on how freaking naive I was. Visiting an ivy league masters degree colleague’s desk and seeing a copy of The World is Flat and The Art of War, thinking, what the hell does that have to do with anything we are doing?
The last couple of years in my gig was interesting though. Agile methodology created quite the outsourcing conundrum. The “thought leaders” shifted from ‘must outsource to India’ to ‘must hire $1500 a day consultants to embed the new culture within.’ Of course, that was code for our organization is broken and we don’t know how to fix it ourselves, which is the same underlying rationale for what got them there in the first place.
Could someone please tell me what problems Agile is supposed to be solving?
Avoid the shitstorm of the 6th step of projects: Punishment of the innocent.
I am biased to the point of being jaded, but my own personal view is that Agile is the development methodology to enable cloud services. You simply cannot run agile development at any decent scale without instant provisioning provided by AWS or Google.
Many will advocate the benefits of failing fast and often, scrums, incremental value add releases vs big bang and there is definitely some merit to that.
But when you get under the covers, it’s the same ingredients to successful software development. SME’s and knowledge experts, business people that are dedicated to development and can make decisions, smart planning for the inevitable unknown and constant reiterative testing. Big bangs fail because of bloat and bureaucracy. Agile puts a lots of stuff out there fast that has little actual value.
To me, good development is good development. Agile exploited the problems of the economics of internally provisioning development environments, as well as the bureaucratic processes that arose out of complexity. It perfectly positioned scale cloud providers and drove the sense of urgency needed to convince Boards and Regulators to abandon control, ie transfer dependence, which is the core business model of tech companies.
My first exposure to agile programming was though the book “Foundations of Agile Python Development”, by Jeff Younker. That book described agile programming in terms of a small team — six people or so — working closely together to slowly and iteratively get a program running. First get something to sorta run, show it to the end-user to see what they thought about it and collect their suggestions before going back to the drawing board. The book also advocated for the open source tools available for python development. In essence agile programming was a lot like programming had been before the age of giant programming teams working the waterfall process. My take away was the importance of getting together a good set of basic development tools, working closely with a few other people and with the end-user to slowly evolve a software application. The problems agile programming was supposed to be solving were the problems of large teams working on extensive sets of requirements and specifications developed by proposal teams. The agile process was supposed to slow down a drive-to-market and instead slowly work toward supporting end-user needs and doing continuous and thorough testing of software as it was developed.
The next time I saw ‘agile’ it had become ‘Agile’ and evolved many forms following whatever wisdom the current Wise and Expensive consultant/trainers came up with. It was sold to management based on their understandings of the word ‘agile’.
Thank you, Bankster.
You should see the eye watering and alarming % of staff employed in India by Barclays, RBS and Deutsche. It’s staggering how regulators miss such an obvious source of risk.
Oh, I am well aware, and so are the regulators. But as you now, risk management, both internally and externally is full of doers, not independent thinkers, and by definition all they can do is write up reports for others to review. Their scope is limited to jurisdictions which makes it easy to deprioritize global implications, a convenient feature of global neoliberalism. Nor are they equipped to fundamentally challenge the core business model. They only point out tactical flaws that “must be remediated”.
In my experience, the Singaporean and Australian regulators were far more advanced than their UK or US counterparts, but their focus was entirely in country. It was common knowledge that if the Asian regulators flagged something, the UK regulators would be on it within 9-18 months.
Interestingly, I never once dealt with the Indian regulatory regime, mainly because 99% of what we did there was internal operations. We did almost zero fin services business, so they just weren’t involved.
Thank you.
Thank you, Clive.
I am glad that your TBTF employer is having second thoughts. No such luck at mine. The parasites are licking their chops at the prospect of the merger with Commerzbank.
Although PFI came about under the Tories, the long suffering UK taxpayer can thank Gordon Brown as chancellor and de facto day to day PM under Blair for its expansion and insane terms.
Colonel & perhaps Clive & others.
I was wondering whether as reported here some time ago, whether the very creaky IT within Deutsche would lead to a situation similar to that which occurred with TSB, when they merged with Sabadell.
I apologise for being O/T & perhaps also for being way off the mark.
All the TBTF banks, Europe’s and the USA’s, are just accidents waiting to happen. They are the terrestrial equivalent of Betelgeuse — bloated giant barely-stable bodies held only loosely in one piece by their own gravitational pulls. But ultimately the flaky systems version of physics will win out and they’ll, inevitably, one fine day, go supernova.
There will be no squishing everything back nicely into place afterwards. TSB had an advantage of being a relatively straightforward retail bank with plain Jane varieties of checking accounts, loans, residential mortgages and credit cards. There was some commercial stuff but it was very limited and the product offers were basic. And it still took over three months to stabilise things after their IT meltdown, £176M (c. $230M) and counting to even start to fix (I reckon it’ll top out at £200-250M) it all.
When — and it is a “when”, not an “if” — DB goes bang, it’ll make Lehman look like a Buckingham Palace garden party.
Thank you Clive.
Speaking of TSB, what is the status on that? It was (inevitably) flushed from the news after a while but I imagine the mess is still far from conclusively fixed, isn’t it?
Lots and lots and lots manual kludges and workarounds. You can keep a simple enough bank like TSB operation with sticky tape and string, albeit at the price of blowing out your cost base.
Something like DB, however, impossible.
Say what? DB isn’t big enough yet?
20 years of failure and they still have a job?!
I was pointing out to someone critical of P3s that the companies themselves didn’t really benefit from contracts, giving their low overall margins. Instead the big beneficiaries of the complex contracts are the management of said companies, the bond holdlers for the P3 contracts (who get a higher interest rate for essentially government debt), and the consultants. P3s have so many consultants and other involved at each stage of the process, from the analysis to drawing up and evaluating bids for the governments to consulting the bidders, without adding much value to the process.
On a different note, it will be interesting to see what happens to P3 in Canada with the SNC Lavalin scandal as that company is deeply involved in these arrangements in our northern neighbor.
Did you see the new Moscow metro map? I wanted to cry. Here in Boston it took 15 years just to break ground on a 6 stop extension on an above ground trolley line on state-owned land, at a starting cost of $500 million per stop. We truly can’t afford the infrastructure the rest of the world has. Everything is CALPERS + Brexit + US healthcare system.
i wonder what the tipping points are for the collapse of our society are; with the collapse of large institutions we’re on our way to find out.
I am deeply troubled by my impression the tipping points for the collapse of our society are numerous, coupled, and nearing the edge. The time to save and preserve what can be saved and preserved is growing so short.
It’s fractal. There is no small, easy set of universally valid “tipping points”.
So Coltrane want so sue because debt holders are getting a better deal? Maybe they should re-take Corporate Finance 101 – equity takes higher risk for a chance of higher returns and is bottom of the list in bankruptcy. I hope the court throws out the case.
Reducing America’s consumption/resource footprint, de facto open borders (ie chain migration, jus solis citizenship), reducing income inequality.
America can have two of the three—-barring Star Trek levels of tech breakthroughs in the next 10 years.
Sorry to be a non-techno-optimist. just being realistic.
With government contracts, the rule is lowest bidder. This is often the case with corporate contracts too. So while expenditure is minimized, in the short run (and not in the long run if you allow contract extension) risk isn’t minimized. Minimizing risk might cost more in the short run, and even cost less in the long run. The problem is management, particularly by committee. There aren’t any leaders.
I don’t think it is the lowest bidder. Isn’t it a bid somewhere in the middle?
I think there’s supposed to be an evaluation step in there somewhere, where the government agency is supposed to somehow determine whether or not the bidder is actually able to perform the task at the bid price. I think it’s usually skipped over, as we saw with “disaster relief” for Puerto Rico. I think Public-Private Partnership or Public Financing Initiative are guaranteed losses for the public.
Avoid the shitstorm of the 6th step of projects: Punishment of the innocent.
But if the innocent go unpunished how can management justify lay-offs and the hiring of new cheaper teams to replace them?
“Neo-liberalism means never having to say you’re sorry.”
(Taken from yet another story about a collapsing system.)
So cold … so cold a world … if even true-love can be related to Neoliberalism.
That a hedge fund was Interserve’s largest stockholder and that it had a “crippling” amount of debt for its size and income, about 630 million pounds, are perhaps not unrelated to each other and to Interserve’s bankruptcy.
“Current stock holders are out of luck,” in the contemplated restructuring package. Coltrane, the stock holder with the largest position, apparently plans to litigate that priority.
I hate to tell Coltrane, but it’s called business risk. I realize that ever since peak Friedman, PE has tried to invert the normal priorities in bankruptcy (and everywhere else). But the normal legal position of equity holders remains first in, last out. Their interests are subordinate to debt capital and other claimants.
Any suit by Coltrane challenging that priority might be pursued for ideological reasons, but it would seem ill-founded and properly so.
That the government refuses, like its private sector counterparts, to consider the robustness and sustainability of its outsourcing contractors – whether in choosing, regulating or contracting with them – is a position that would seem badly in need of revision.
This.
Elsewhere, I found this:
Which makes me wonder what the terms of the loans they took to enter into that venture were, and from who they borrowed the money.
At least in the UK, outsourcing began in the 1980s without any clearly defined logic, as a way of raising money, asset-stripping the state and apparently reducing the size of the civil service. The idea that it was cheaper was never demonstrated, just assumed to be the case.
It soon developed a rough and ready sequence. Government puts some function up for sale, as a way of saving money in the short term (buy and leaseback was a favourite). The long-term can take care of itself. Companies submit bids at below cost to get the work. Companies then find that they don’t have the staff to do the work, so they poach them from government. Government loses the capability to be an intelligent customer. After a while companies start adding costs. Government then depends on the outsourcing companies to run the country, so has to renew the contract at whatever price is demanded.
There are two problems though. As time goes on, more and more functions are externalised, the scope for cutting costs get progressively smaller. And the level of services provided is continually cut to make larger profits. Something has to go bang.
The other problem, which has been discussed but not, so far as I know, really analysed, is what happens when these contracts come to an end. Some government departments funded the renovation of their buildings by a sale and leaseback contract, which means that in a number of years the departments could be homeless …