What does Carillion mean for investors in infrastructure?
The Carillion debacle has put the spotlight firmly on the outsourcing model whereby a company wins a contract and then uses contractors to provide some or all of the services. There are plenty of people who have serious questions to answer, including the directors of the company, the auditors, government procurement and The Pensions Regulator.
But what does this mean for investors, and particularly pension funds, who have put substantial money into the closed end funds which have often financed the PFI deals which were Carillion’s bread and butter business? Some quoted infrastructure funds, such as HICL Infrastructure, have already taken a hit to their NAV as they put in place more expensive alternatives to Carillion. Private funds are certainly going to have to do the same, which will in due course affect returns and valuations, though the nature of their valuation process means this may take months or even years to come through.
The longer-term threat is a move away from the PFI model, with the public sector - and this is chiefly about infrastructure investment - choosing to do more in-house. It is no secret that PFI is expensive - tales of £500 to change a lightbulb abound – and pension funds have been one of the beneficiaries. In my view public opinion is less and less willing to accept this price-gouging aspect. A renationalisation under a left-leaning government is unlikely, simply because unwinding the legal contracts would be horrendously complicated. However, like BBC (male) salaries, the pressure voluntarily to change the terms of the contracts to make them less expensive could become unbearable.
Ultimately, I see Carillion as a governance problem: outsourcing can work well but the entity at the centre needs to be incentivised to ensure the business model is sustainable. That includes prioritising cashflow so that senior executives and shareholders only get their hands on it when suppliers have been paid, the pension fund has been funded and the contract has been delivered on terms which are fair to the customer in the long term. Capita’s Directors seem to have seen the light at the eleventh hour, with yesterday’s announcement moving away from the Carillion model.
From an investment perspective, infrastructure still makes a good match for a pension fund’s long-term liabilities. However, investors need to cast a sceptical eye over how sustainable the business model is.
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