Carillion PLC (LON:CLLN) is in bad shape and analysts see a debt for equity swap as the mostly likely route to survival.
The construction company on Friday said it will be in breach of its loan conditions, which could lead to possible collapse into administration.
The contractor also warned that profits for the year would be “materially lower than market expectations” and that its debt pile would increase. It marked the third profit warning for the year and comes on the back on falling revenues, rising costs and project delays in the Middle East.
READ: Carillion says it will breach banking covenants as it warns on profits and debt
“We now think one of the most likely routes towards a recapitalisation is a debt for equity swap,” UBS analysts said.
“Given the current level of debt (H2 implied now c£1.1bn plus pension and reverse factoring), if fresh external equity can be raised, it may be highly dilutive for existing shareholders.”
Under a debt for equity swap, shareholders are given the right to exchange their stock for a predetermined amount of debt. The value of the swap normally set at current market rates. It is one way of financial restructuring to avoid an emergency takeover or bankruptcy.
Asset disposals will make no difference, says UBS
UBS added that potential asset disposals are unlikely to "materially change the picture" unless these businesses can be sold materially above the implied leverage ratio, which is approaching 10 times ‘all-in’ net debt dividend by earnings before interest, tax and depreciation. “Our valuation was already in slight negative equity value today and with higher debt and lower earnings this would widen.”
Liberum also continues to expect a debt for equity swap. It noted that the financial liabilities are more than £500mln higher than the enterprise value and thinks there is “limited value on the equity”.
In an effort to cut debts, Carillion in October said it had signed a head-of-terms agreement to sell a large part of its UK healthcare business to outsourcing company Serco Group PLC (LON:SRP) for £50.1mln. It expects to dispose of the remaining contracts in its UK healthcare facilities management portfolio during 2018.
“The group has made some progress on asset sales, and it sounds like some cost savings are being made,” said Nicholas Hyett, equity analyst at Hargreaves Lansdown.
"It’s not what the group expected though, and it’s clearly not enough. It’s also probably irrelevant given the state of the balance sheet, with net debt already many multiples of the group’s market capitalisation.”
Carillion still winning contracts but is there hope?
On the upside, Carillion is still winning contracts, including a £240mln contract to build a hospital in Oman and another £120mln deal to be signed soon. On top of that it has contracts with Network Rail worth £192mln over the next three years and a £1.4bn contract to support the HS2 project.
“However, the overhang remains the same: a steadily increasing debt pile at odds with poor cash flow, uncertain transaction timing (contracts and disposals), transitioning leadership and waning investor confidence,” said Mike van Dulken, head of research at Accendo Market.
“The share price reaction today suggests acceptance that what we foresaw as an inevitable and highly dilutive rights issue to 'encourage' shareholders into participation, to keep the restructuring ball in the air.
“Shorts who stayed the course (most shorted stock on FCA disclosure data), even adding, will be grinning smiling all the way to the bank, having expected already serious corporate and financial troubles to worsen.”
Shares fell 34.21% to 27.30p in afternoon trading.