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The Gleeson giveaway

AGENDA

Following problems with a series of complex projects, Gleeson's building division is effectively being given away to a management buyout team, along with a large pile of money to cover liabilities. David Rogers finds out what went wrong

WITHIN last week's six-page announcement that Gleeson had finally agreed a deal with the management team negotiating to buy its building arm, one admission ? and there were a lot to choose from ? stood out.

Under the headline 'Background to and reasons for the transaction', the board said it had reviewed a number of 'exit options' for the division.

The statement ran: 'No market appetite for either a trade sale or a standard management buyout structure employing third party funding was found. The board also reviewed the option of closing the operation but considered this unattractive given the risk of further escalation in project overrun costs and the level of retained divisional overhead required to manage through the ongoing contracts.

'Therefore, the board has concluded that the most appropriate option for reducing the Gleeson group's exposure to building risk over a period of time is to transfer the operations to a management buyout vehicle with sufficient financial resources to enable it to complete the ongoing contracts and to develop a portfolio of new contracts independently from the Gleeson group.' The management buyout, led by current building boss Martin Smout and commercial director Peter Stone, is being funded by Gleeson and the directors of the MBO company, which is known as MBOCo.

The statement added: 'The Gleeson group will retain liability for all retained contracts. In addition, the Gleeson group will retain the ultimate legal liability to the employer for ongoing contracts which are not novated to MBOCo.' What all this means is that Gleeson has had to pay somebody else ? in this case the MBO team itself ? to take the business off its hands. The MBO has taken a line from the Ray O'Rourke school of negotiating and left problem contracts ? and at Gleeson there are a fair few ? with the old regime. The group retains liability for work on ongoing contracts prior to June 30 2005.

One analyst was left wondering how on earth all this happened: 'This is a £300 million turnover firm that has been turned down by the rivals. They can't find any buyers. The venture capitalists won't touch it even after the liabilities remain with the parent. There has been an almighty cock-up and the group has obviously lost complete control of it somewhere.' Mr O'Rourke famously managed to leave 13 legacy contracts ? liabilities ? with the Laing group when he too pulled off a similar deal four years ago and bought that company's construction arm for £1.

It is not too difficult to see why Gleeson has found it hard to off load the business. In the days after it announced the sale of the division, which had just posted a £16 million loss in the first half, executive chairman Dermot Gleeson summed up the prevailing mood at the group. He said: 'We decided that the risk-reward ratio in building was unattractive and unlikely to improve.' That is management speak for 'cut and run'. He added for good measure that the firm, which celebrated its centenary in 2003, had better things to do with its time and money.

And now more bad news, as Mr Gleeson intimated in the spring, has duly arrived. As if to underline why the group was getting rid of building, the firm is now expecting the £16.6 million loss it posted to exceed £34 million for the full year. It said these losses had been uncovered on a number of recently completed contracts for which final accounts have not been settled.

Completion of the deal is expected at the beginning of next month. It will see the group pay £7.1 million to MBOCo in debt and equity investment, a £14.7 million cash payment to the MBO relating to the transfer of net current liabilities plus a further £2 million-plus in management charges and supply agreements. And the firm has agreed to a maximum of £2.9 million in relation to 'particular ongoing contracts'.

Gleeson will say part of the cash payments it is making are an investment in the new company. But for Gleeson's shareholders it all makes pretty grim reading. Last year's pre-tax profits at the group were £17.6 million. The cost of closing the whole thing down must indeed have been truly prohibitive.

Not since the days of the Laing debacle have the problems that piled up been accompanied by such gruesome numbers. As one analyst put it: 'It's easily the most spectacular fall for quite a while. What on earth was going on?' The original hope was that a restructure of the building business, announced last December, would sort things out. After all, the civil engineering business was in a similar mess and had been transformed to an extent that the then group managing director Andrew Muncey ? he quit when the decision to sell the building business was announced in March ? hailed its recovery as a model for building.

The cost of the restructuring was put at £5 million and by the time the MBO takes over around 150 jobs will have gone. But the issue seems to have been one of sheer scale.

What has been uncovered is of Everest proportions.

In dribs and drabs, the scale of the problem has slowly slipped out. To recap, the £16.6 million loss for the half year has been outstripped in the second six months.

Gleeson has not actually named any of the contracts which have cost it all this money but the firm has admitted in the past that the losses have related to 'large and highly complex' design and build projects.

What is known is that one of these was the £60 million Evelina children's hospital, which ran 10 months behind schedule.

Then there was the £30 million Clissold leisure centre in north London, and another north London scheme, a £40 million mixed-use job called Tallyho!

The main problem was summed up by one insider at the building arm: 'The division was taking on a lot of highly serviced projects, some PFI, which carries a lot of risk. Most of the problems were related to complex M&E work.' The company estimates that the losses at building plus the £5 million restructuring costs and the costs of off loading the business will see year-end figures somewhere between £5 and £10 million in the red.

When the decision to dump the building business was announced, analysts at Teather & Greenwood forecast full year pre-tax profits of £15.5 million.

Put another way, what Gleeson expects to end up with is some £25 million off what even the house broker said it would achieve. Gleeson insists that its core operations ? house building, civil engineering and property ? remained st rong in the second half.

How the new Gleeson-free building business will cope remains to be seen. Given that the Gleeson group is effectively giving the business away with a lump sum in cash, it is not off to a bad start.

Before he went, Mr Muncey had decided that the restructure would take two years. The premise was that 80 per cent of the firm's workload would be partnering or negotiated contracts, with the remainder traditional jobs. Bosses belatedly realised that the division had grown too fast and that the resources it had in place were not adequate.

Mr Muncey said it would not bid for any jobs over £50 million in the future and most projects on its radar were worth around £20 million. This surely will be the plan the new team in charge will follow.

Mr Smout and Mr Stone have something of a rebuilding job on their hands. Morale and reputations have taken a knock.

The Gleeson group also has to restore its reputation.

One analyst said: 'What building is costing them is years of accumulated profits.' It has a bit of credibility issue to overcome as well.

In 2002 it saw problems at its housing arm and a year later it lost millions on a cement project in Buxton, Derbyshire. That triggered the shake-up at its civil engineering business. All was well, the company said. Last year it forecast a recovery.