Research & Commentary

The stench of debt deflation in the UK

A key UK company has died, overloaded with debt and unable to raise capital. This is a harbinger for what is to come.

Carillion PLC, the UK based construction company, went into administration on Monday after last-ditch weekend attempts to save it failed. The company, which employed 43,000 people in the UK, Canada and the Middle East, was carrying $2.2 billion of debt and its pension plan has a deficit of $790 million. Shareholders will be wiped out and creditors including banks and bond investors will be lucky to see any of their money back. Carillion was involved in a number of high-profile UK government infrastructure projects as part of the so-called Public Private Partnership, whereby private companies take on key government projects and services as part of a public sector, cost-reducing outsourcing program. In Carillion’s case, these included projects such as HS2, the new high-speed train service linking London with more northern cities such as Birmingham. A question mark now hangs over the sustainability of these projects and the local economies they supported.

As the chart below shows, Carillion’s share price topped out in 2007 (!) and really started to accelerate lower from 2016. A falling share price, against an overall FTSE All-Share market that was rallying strongly, was a clear warning that something was not quite right. In fact, as our Elliott wave labelling makes clear, there was a strong case that the second wave of a three-wave correction ended in 2015, via a wave b triangle. People sometimes ask whether the Elliott Wave model can anticipate companies going bust. Well, this example shows that a Cycle degree wave c was unfolding from 2015. C waves are destructive in nature and, in some cases, anticipate a situation from which the company cannot recover. To anyone paying attention, it was obvious in July 2017 that Carillion was in dire straits.

What is particularly interesting about this case, however, is that despite issuing three profit warnings in the space of six months, the UK government continued to award lucrative contracts to Carillion up until the end of 2017. This reminds us of the first, and certainly the most famous, public private partnership in the UK – that of the South Sea Company in the early part of the 1700s. The South Sea Company was formed with a “front” of trading with countries in the “south seas” but, in actual fact, was a scheme aimed at reducing the government’s debt. In that case, after the famous 1720 bubble collapsed, the recriminations uncovered that many serving politicians had accepted South Sea stock as bribes in order for them to support the project. To be clear, we’re not accusing the current UK government of anything underhanded in this case (naïve, wishful and in denial, sure), but when bureaucrats continue to support a failing company, as politicians are fond of saying these days, the optics are not good.

The most worrying aspect of Carillion’s case though is that the company tried to dispose of assets in order to raise capital and reduce the debt. Unfortunately, no buyers could be found. This is what happens in a debt deflation. Assets are sold off to raise capital, which corresponds with falling asset prices, which means that more assets have to be sold in order to liquidate the debt, the value of which stays constant. It’s a bit like trying to walk up an escalator that is going down. Eventually, exhaustion takes over and you collapse.

The UK property market is already showing signs of weakness and London property prices are declining on an annualized basis. The collapse of Carillion is a sign that social mood is turning more negative. Expect to see many more such corporate failures in the years to come.

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