The Ups and Downs of Business

As we heard the other day from that Probation Institute article:-

"CRC is a business - that’s what it’s about."

and the trouble with that is businesses go up and they go down. Interserve's share price yesterday stood at 49.50, down further from this Motley Fool article of 2nd October:- 

Outsourcing and construction firm Interserve (LSE: IRV) announced the sale of its scaffolding business this morning, for up to £4.6m. The news follows the group’s recent half-year results. These showed that headline operating profit fell by 29% to £40.1m during the six months to 30 June, compared with the same period last year.

Management tried to put a positive spin on these figures by pointing out that they were better than the second half of 2017. That’s true. But this doesn’t disguise the fact that Interserve ended the period with increased net debt of £614.3m. This is more than six times trailing earnings before interest, tax, depreciation and amortisation (EBITDA).

The company’s lenders won’t allow it to pay a dividend until the group’s net debt-to-EBITDA ratio falls below 2.5x. In my view this is unlikely to happen until the company holds a rights issue to raise fresh cash from shareholders.

What comes next?

Analysts’ forecasts suggest the City holds a similar view. Although adjusted earnings are expected to triple to 19.3p per share next year, the current share price of 56p puts the stock on a 2019 price/earnings ratio of just 3.

In my opinion this indicates that the market doesn’t expect Interserve to deliver a sustainable recovery without raising fresh cash and diluting shareholders. I agree. I believe these shares are simply too risky for equity investors at the moment. I’d stay well away.

--oo00oo--

It's well known that Interserve got into big trouble with trying to make money out of rubbish and is desperately trying to exit the Energy from Waste market (EfW). Thanks to an alert reader, my attention has been drawn to the sad story unfolding in Derby that just might prove terminal. This from Derby News:-

Council has ‘right to terminate’ Sinfin ‘Incinerator’ contract on 1 October 2018. Time to be decisive!

By the end of this month, the contractor for the Sinfin Incinerator (Sinfin Lane), Resource Recovery Solutions (Derbyshire) Ltd (RRS) will have failed to have secured the Completion Certificate for the plant. This is considered to be contract default and, as such, a termination notice can be served for cancellation of the contract, by both Derby City, and Derbyshire County Councils (joint signatories).

Background

When the contract was signed in December 2009, it specified the planned completion date as 31 March 2017. It also defined a “Long Stop date”, being 18 months later, namely 30 September 2018. Subsection (m) of the clause on “Contract Default” states that default happens if a completion certificate has not been obtained by the “Long Stop Date”, 30 September.

The completion certificate is prepared by the Independent Certifier. The certifier confirms the results of a variety of defined tests which demonstrate that the plant is operating in line with the contract. A significant test involves the full plant running for 14 consecutive days.

RRS need to give the Councils, and the Independent Certifier, 20 days notice of the start of all of the acceptance testing. This notice has not been given, yet – there is not enough time left before the 30 September 2018.

Who’s involved? What is their financial state?

RRS is a Joint Venture company owned 50:50 ,through intermediary companies, by Interserve plc and Renewi plc.

RRS’s last set of published accounts (31 March 2017) showed that it was illiquid. It could not service its short term liabilities with available cash and short term assets. A note to the accounts highlighted that the Capital Contribution Loan of £42.5m was due for repayment on 30 June 2018. It was relying on the plant being in operation by then so the outstanding “completion” amounts from the Councils, of £50m, could be paid. The note continues that if:

“…full service commencement is delayed until after 30 June 2018…the Company (RRS) would not have sufficient funds to repay the loan”

By March 2018, the directors clearly knew that the plant would not be running on time so a 2nd mortgage was taken out on the leasehold land, and plant from Sumitomo Mitsui Bank.

Interserve plc is a large company operating on wafer-thin margins. It’s net worth has dropped by 90% in just over 2 years, and it is now technically illiquid. It declared a few years ago that it wanted to exit from the “Energy for Waste” Business of which the Sinfin plant is a part.

Renewi plc was formed from a merger including the original Incinerator contractor of Shanks Waste Management. Renewi also work on tight margins, and is technically illiquid in the short term.

What happens now?

A joint decision has to be made by both Derby City Council and Derbyshire County Council.

There are essentially 2 options under the contract:

1. Do nothing – continue to wait for RRS to commission the plant. There are no committed timescales. When formally certified pay the outstanding £50m
2. Submit a Termination notice on 1 October 2018. Theoretically, at that point, the plant would be closed to avoid further costs.

What might confuse matters if option 2 is chosen?

• RRS are clearly aware of the “Contractor default” clause in the contract. Have any “private guarantees” been given to RRS which might “kick back” on the Council?
• The Contract is not just for the Incineration plant, it includes all existing County wide waste management activities. This is not a profitable activity, so they might see it as an opportunity to get out, or negotiate a price increase.
• The £50m from the Councils is required for cash flow. Contract cancellation will almost inevitably mean that RRS would go bust, as well as Interserve plc. As they are a public limited company then there is an issue about “share price sensitive information”.

Comment

With a plant of this nature, there will be very few people, who have any real objective view of how far away formal completion is; Interserve plc have continually slipped their reported dates. If the Council allow RRS to “recover the situation” then the likelihood is of continuing programme creep.

The £50m, to be paid, by the Councils, will not improve the facility it will simply pay off loans. There is still no assurance over the long term financial viability of any element of this consortium. A worst case scenario is:

• RRS just scrape through on the acceptance tests which confirms completion
• The Councils pay the £50m
• One, or many of the company’s go into administration – the plant is seized by the bank, leaving an unknown party to run the facility.
• Councils “Wasted” £50m

There has been some disquiet over the fact that the decision on the contract will be taken by Cabinet in private. It is a matter of normal process for commercially confidential matters to be conducted in Cabinet after the Press and Public have been asked to leave. Given that the consequences of a termination decision could be share price sensitive then, in my opinion, it has to be done in private. This could include Cllrs from the affected wards, plus cross party representation.

Should there be a different set of circumstances where the Councils decide to pay the £50m, then I believe that that should be held in public, before any payments are made. It should also include a detailed financial viability of the contractor companies.

The £25m contribution from Derby City Council could be better spent on facilities that the people of Derby actually want. There is a question mark over whether the business case savings of £2m pa are still valid. The “Long stop date” was set in the contract for a purpose,… to be used! It is now time to be decisive!

If the decision to terminate is taken, then I’m sure it will be messy….but it will be the right thing to do for the long term prosperity of the City and, especially, the immediate neighbourhood.

--oo00oo--

The latest situation is outlined here again on the Derby News website:-

Sinfin Incinerator : the pressure to terminate the contract mounts! Full facts will be available on 19th October…

The Council’s cross-party Executive Scrutiny Board robustly challenged the Council Cabinet’s position on the termination of the Sinfin Incincerator (to be formally presented on the 10th October)

“To defer any decision on the Council resolutions until they can be considered alongside up-to-date and appropriate technical, financial and legal information.”

This is despite the Full Council passing 2 resolutions on 27th September calling for the contract to be terminated. The resolutions don’t state a timescale. Although the Full Council’s opinion has strong weight, the Cabinet has the Executive authority to make the decisions.

Cllr Eldret asked a direct question as to whether Resource Recovery Solutions was in breach of contract. A legal Officer, confirmed that the “long stop date” was the 30 September 2018 and that RRS were in breach under the terms of the Project Agreement

The Chief Legal Officer made the point that the Cabinet must make “rational” decisions. He highlighted that all technical ( i.e. state of the readiness of the plant), legal and financial ramifications were in the process of being assessed and would be available to the administration by 19th October 2018.

Cllr Holmes, Deputy Leader from the Conservative administration attended the meeting. He further added that:

• the plant had cost around £190m so far (Neither Derby City, nor Derbyshire County Council have paid any money so far. They are due to pay £25m each, on successful completion- if the contract is terminated then no money will be paid.)
• there were on-going discussions with the contractor RRS, over how much compensation it would pay to the Councils for agreeing to waive the contract termination until 31 December 2018. [This was a surprising revelation ]
• the Conservative administration was now looking to have internal cross-party discussions with the various leaders. Cllr Eldret, angrily, pointed out that no one had previously approached her, or the other leaders, to have discussions that were desperately needed a few weeks ago – in her words ” you have messed up the politics”.

2 recommendations were made to the Cabinet, the primary one was to re-assert that termination should take place with immediate effect.

Comment

No one would be comfortable with the Cabinet making a decision in the absence of complete information. There was general consternation as to why this work had not been done many months ago – the end date of 30 September 2018 was specified in the 2009 contract. Of course it was also well within the gift of the previous Labour administration to have initiated this before May 2018.

The politics certainly have been messed up, the direction of the Full Council, and the local residents is clear, the opportunity exists to correct this sorry situation in the lead up to the full information being available by the 19th. Time for full, frank, open, consultative decisions to ensure that the next step is the correct one.

The balance of proof is now with the contractor – they must unequivocally demonstrate that they have a plan, a process, and a plant that can deliver to their agreed contractual obligations, including the savings. One that is demonstrated with such rigour that it justifies the payment of £25m. If they can’t, then the Councils must proceed with termination – there is no other choice! And they have 10 days!

As Cllr Holmes said, this contract termination is ”one of the biggest decisions that the Council will ever take”.