Carillion is refusing to abandon its $5bn merger with Balfour Beatty, despite the increasingly adamant rejections coming from the boardroom of its would-be conquest.Â
Carillion is continuing its strategy of going over the heads of Balfour’s management and appealing directly to its mutual shareholders, and indirectly to those investors with the control over their target.Â
It is also claiming that the deal would lead to "synergies" that would raise the market value of the combined business by $2.5bn thanks to cost-savings of at least $290m a year by 2016.
Balfour would cut its UK business – it has already closed three offices in the south-east of England – but it would be a much gentler process than Carillion was envisaging– Kevin Cammack, an analyst with Cenkos Securities
Balfour has resisted, responding today that the value uplift would be "materially lower" owing to a reduction in revenue at its UK construction arm. It also pointed out that, to begin with, costs would rise by $375m because of redundancy payments and other expenses associated with closing offices.
The first deal fell down after Carillion decided that it wanted to retain Balfour’s Parsons Brinckerhoff business. It had initially agreed that the sale, begun by Balfour after a profit warning in May, could go ahead.Â
The second deal was substantially the same as the first, but with a cash incentive for Balfour’s shareholders in the form of a final dividend, and an offer to compensate the bidders for Parsons.
Balfour’s board rejected this proposal during its online interim results presentation on Monday, with executive chairman Steve Marshall saying that Carillion would need to take capacity out of Balfour’s business at great cost, with no real confidence that what they would be left with would have been worth having: a point made again today.Â
Kevin Cammack, an analyst with Cenkos Securities, told GCR that Balfour would cut its UK business – it has already closed three offices in the south-east of England – but that it would be a much gentler process than Carillion was envisaging.Â
"Steve Marshall says the company aims to downsize, but this is much more modest than it would have been in the hands of Carillion," he said. "I would have put the downsizing in the next two to three years at no more than 10%. In Carillion’s hands it would be double or even treble that."
Cammack also said that it could now be too late to abort the Parsons sale because its staff and clients would be demotivated.Â
"There is a risk that if the merger doesn’t go ahead you’ve seriously devalued the business of Parsons," he said. "Its management will be utterly demotivated and whoever they’ve been talking to will say, ‘come and join us anyway’. They’d lose staff and they’d lose clients. I didn’t agree with the strategy of selling it but I sympathise with the view that it’s a hell of a risk to abandon it now."
Andrew Gibb of Investec said he expected Carillion to return to its previous strategy of shrinking its contracting arm and moving to a more services-orientated business. He said: "I don’t think they’re looking round for another target. I think this was a one-off driven by pretty significant value creation. Carillion has a big UK presence and that led to the synergies that were there, and there was the balance protection of the PPP portfolio on top of that."
Balfour’s equity holdings in public-private projects are thought to be about $1.7bn, although this is presently being revalued.
In terms of the future of Balfour, analysts consider a further offer to be likely, although not from a UK contractor.Â
"Balfour are not out of the woods yet," Cammack said. "In effect they’re going backwards by getting rid of Parsons and becoming an old-style contractor. They’ve been fairly open that they’ll get rid of the joint venture companies in the Middle East and Hong Kong – Hong Kong should be the easier to sell – and flagged that there’s a more active churn of the PFI portfolio."
Opinion in the City has been that if you had to pick a time to go back to being a main contractor, then market conditions in the UK were ideal right now. As one analyst quipped, "there’s never been a better time to mess it up".Â
But Cammack says that Balfour’s future is still uncertain.Â
"They’re having to go back to the very basics of the business to get it profitable again," he said, "and much of that will depend on who they get to oversee it. Steve Marshall was a non-executive chairman who was put into the spotlight after the chief executive was sacked, and I don’t think his strategy went beyond ‘what the hell can we do to appease shareholders in the very short term to pay down some of the debt?'"
The City also had views on why the deal fell through.Â
"It’s not often that an entire management team indicates that it’s willing to step down, so Carillion might be entitled to think that they had surrendered," said Gibb.
"The next question is why Parsons need to be kept in, and I think that’s the question people need to ask themselves: what was there in the rest of the business that made Carillion think they had to keep these profits?"