Contractor ups the pressure by identifying major cost savings and pledging refocus on services
Contractor Carillion has upped the stakes in its pursuit of Balfour Beatty, saying that a combined business would make savings worth £175m per year and publishing details of its proposed merger strategy.
Carillion said that should the merger go ahead, it would seek to downscale Balfour Beatty’s UK construction business along the lines of its own construction business, which reduced in size by a third in the last three years, and refocus on support services.
Carillion has until August 21 to make an offer for Balfour Beatty, with today’s statement including a pledge to provide Balfour Beatty shareholders with an additional 8.5p dividend per share worth £59m should the deal go ahead.
With Balfour Beatty continuing to oppose the merger, Carillion is looking to force Balfour Beatty back to the negotiating table by persuading its major shareholders of the benefits of a merger.
Carillion added that it had received assurances with its banks that they would fund a combined group, which would have turnover of £14bn, to the tune of £3bn.
Carillion said the proposed cost savings of £175m per annum would, when capitalised, add £1.5bn to the value of the company.
The firm’s statement said: “The Board of Carillion is confident that, as a direct result of the merger, the cost-base of the combined group could be reduced by at least £175m per annum by the end of 2016 and that earnings would consequently be significantly enhanced from that year.”
Carillion said the savings would come from back office savings, procurement efficiencies, IT standardisation, property consolidation, with the implementation of Carillion’s systems in a number of these areas. It said the merger process would entail a one-off cost of £225m.
Carillion said the envisaged business plan for the group was to “refocus significantly the UK construction services business” in a similar manner to its own rescaling, and that it would achieve this “principally through focus on contract selectivity.”
It added it would seek to “grow its services business, such that, within the medium term, two thirds of the combined group’s operating profit would derive from services and investments with one third coming from construction”.
Despite the reduction in construction business, it said the business plan envisaged that overall, the combined group’s UK revenue would rise throughout the merger and restructuring.
The statement made clear Carillion’s business plan involved the retention of Parsons Brinckerhoff, which Balfour Beatty is currently in the process of selling.
Carillion’s change of heart on retaining Parsons Brinckerhoff was the reason for talks between the two breaking down in late July.
Carillion’s statement comes despite the fact Balfour Beatty chair Steve Marshall told Building last week that Carillion was “not in a position to [make a hostile takeover bid] given the arrangements that we agreed”.
He added: “Anyone making a hostile bid needs money.”
Carillion’s statement said: “Based on initial discussions with banks and assuming the retention of Parsons Brinckerhoff, the board of Carillion is highly confident that £3bn of available funding would be accessible to the combined group, providing substantial headroom above its actual borrowing requirements after transaction costs and the costs of the proposed restructuring.”
Carillion added: “Carillion continues to believe in the powerful strategic logic and financial benefits of a merger with Balfour Beatty and is therefore continuing to consider its position.”
The City’s verdict: The deal ‘should’ happen
Joe Brent, analyst of Liberum, said that “egos aside” the Carillion and Balfour Beatty merger “deal should happen” because the “synergy prize is too big to walk away from”.
He said he thought synergies could be higher than the £175m Carillion says it is confident of achieving. “Our view is that synergies could be higher than this - perhaps £250m - making the economics of a deal difficult to ignore,” he said.
He added: “Historic deals would suggest that Carillion typically starts with an initial synergy target of circa 60% of their final objective, which would imply potential synergies of £290m.
Olivia Peters, analyst at the Royal Bank of Canada, said the strategy Carillion outlined for a combined business with Balfour Beatty “seemed sensible” and that the figure for savings from synergies between the two firms was “much higher than expected”.
Andrew Gibb, analyst at Investec, said Carillion’s continued desire to retain Parsons Brinckerhoff – which Balfour is in the process of selling –was telling.
He said: “We don’t see Parsons as being in the long-term plans for Carillion. However, it strikes us that the need to retain this business in the short term reflects the group’s view on the current state of Balfour Beatty’s construction division and the scale of the task ahead to implement a turnaround.
“The question for investors now is who is best placed to action this?”
Stephen Rawlinson, analyst at Whitman Howard, said: “Our sense is that the [merger] talks had been moving along quite nicely until Carillion realised that the cashflows from Parsons would be needed to fund the debt of the combined entity and possibly that strategically Parsons makes great sense in some territories as part of an integrated offering.
“Our view is that the level of potential savings could be much higher than indicated and the cost of achieving them much lower but Carillion is being cautious.
Rawlinson said the amount to be saved on an annual basis would be around 50% of the current level of underlying operating profit of the two companies.
Carillion has just reported £97m operating profit in the first half of 2014 and Balfour Beatty has promised around £150m of operating profit for 2014.
“We believe that such savings are credible and could be exceeded and are unlikely to be achieved without the two companies coming together,” he said.
“The opportunity to combine with Balfour Beatty has been on the agenda for some time in Carillion’s strategy discussions and the timing seems now to be right to move ahead.
“Balfour Beatty on its own seems to have had the chance to get its house in order in the recession but has not succeeded.
“Savings of the levels described are something that Balfour Beatty shareholders cannot ignore as the prospect of another six months without a viable CEO, the debt position worsening and possibly jeopardising operations, and the sale of possibly the best business in the portfolio is not attractive.
“[A] merger with Carillion is not risk free but provides a break with the recent inglorious performance and has no greater risk than going it alone but a much higher level of reward.”