Connaught collapse: What went wrong?

By Laurence Knight
Business reporter, BBC News

image captionConnaught's sudden collapse left many housing associations in the lurch

In what is the biggest UK bankruptcy since Woolworths in 2008, property services giant Connaught has formally entered administration.

Accountants KPMG have been called in to wind up the company's social housing unit, which was terminally bleeding cash.

Other parts of the group, Connaught Environmental and Connaught Compliance, are not in administration and continue to trade normally.

Some say accounting irregularities were to blame for the collapse, others talk of the pressures of government cost-cutting.

So what really went wrong at Connaught?

Killer contracts

At the heart of the matter is a string of loss-making service contracts that the company entered into with local authorities and housing associations.

KPMG have indicated that the company's social housing group - which employs about half of its 10,000 workforce - is unlikely to be sold as a going concern.

Instead, its individual contracts to maintain and repair housing estates will be auctioned off one by one.

"The contracts currently delivered by Connaught on behalf of housing associations represent an attractive and solid business opportunity," claimed David Orr of the National Housing Federation.

"We would expect the administrator to find new contractors to take over existing deals very quickly."

But Charlie Parker, investment editor of Citywire, says that other companies may not want to take on the contracts at the same price that Connaught had agreed.

"There is mounting anecdotal evidence that [Connaught] were just bidding too low for contracts in order to get them," Mr Parker told BBC Radio 5 live's Wake up to Money programme.

"In the construction trade they rather unpleasantly call it 'suicide bidding', where you bid so low that it actually potentially jeopardises your company."

Austerity measures

In June, the company issued a profit warning, saying that 31 contracts had been deferred because of government cutbacks, meaning revenues would be lower than expected.

And local government austerity may have been what led Connaught to make desperately aggressive - and unprofitable - bids for some of its other contracts.

"Local authorities were worrying that central government would be forcing them to drive down costs," explains Mr Parker of Citywire. "So they were being very hard with their suppliers."

'Bleak' outlook

And according to unions, Connaught is not the only outsourcing company suffering from the councils' new cost-saving drive.

"The collapse of Connaught should be a huge wake-up call to to the damage that public spending cuts are having on the private sector," said Dave Prentis, general secretary of the Unison public services union.

"Sadly, government public spending cuts are leading to more financial uncertainty for companies with public service contracts across the UK."

Moreover, government cutbacks may also hit the supply of new social housing, limiting future market growth for companies like Connaught.

"The government's decision to scrap regional house building targets, withdraw funding for new affordable housing schemes and to cut budgets, means the future looks bleaker than ever," said Mr Orr of the National Housing Federation.

Lost confidence

Once the company was lumbered with loss-making contracts, there are suggestions that it then employed accounting discretion to paint a rosier picture in its financial statements than was justified.

"They were quite aggressive in the way they recognised revenue and not very prudent in the way they recognised costs," Tim Steer, fund manager at Artemis, told the BBC.

Acting on his suspicions, he shorted Connaught's shares - in other words, he "borrowed" the shares and sold them, profiting by buying them back later at a lower price.

Indeed, he would have made a handsome profit, as they have plummeted 90% since June.

"As a result of this, the company lost the confidence of its bankers, and more recently its suppliers or its creditors."

Banks refused to refinance £220m of debts, precipitating the firm's failure.

'Not outlawed'

Mr Parker of Citywire explained that Connaught may have been attributing too much revenue on these contracts to the current year, flattering the company's accounts.

"If you've won the right to service say a big block of flats in Hackney over the next 10 years, do you maybe put a little bit too much of it in this year than you should have done?" he asked.

"The reality is that it's not outlawed. There's still an enormous amount of this allowed, down to the will of the accountants doing it, and there will be questions asked about how they allowed this to happen," he added.

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