M954PX Interserve Ingenuity at work demolition work in Berwick Street, Soho, London, UK
Interserve's market value is less than £18m, meaning its equity value is dwarfed by its £650m of net debt © Alamy

Shareholders in Interserve have had a tough week.

The UK outsourcer’s fall into administration has wiped out the investments of powerful US hedge funds and retail investors alike.

This naturally brings back memories of last year’s collapse of Carillion, the UK construction services company, given that Interserve is in a similar business. Yet beyond that, the two cases have some critical differences.

Control of Interserve, whose London-listed shares were cancelled on Monday, has already passed to its lenders in an orderly fashion, a choreographed transition that should mean business as usual for suppliers at its main operating companies.

In contrast, Carillion tipped straight into liquidation, triggering near total losses for lenders and suppliers still awaiting payment.

While this may have served as a wake-up call to Interserve’s management, helping them avoid the same fate, a deep dive into the outsourcers’ balance sheets is illuminating.

Carillion’s fall was more disorderly and destructive because, unlike Interserve, the company relied heavily on a peculiar financing technique.

The technique, known as supply-chain finance, allows a company’s suppliers to get paid more quickly by banks if they accept a small discount. The company then pays the full amount back to the banks.

This kind of thing makes sense for large multinational companies, which are in effect paying a small fee for financial institutions to more smoothly manage lumpy payments. But it can also disguise a troubled firm’s mounting borrowings, because accountants do not class such facilities as debt, even though money is owed to a bank.

Shareholders who took Carillion’s net debt figure at face value did not see the danger lurking in the footnotes to its annual accounts. The same was true for investors in Abengoa, a stricken Spanish clean energy firm, in 2015.

Even for healthy firms with no risk of sudden failure, supply-chain finance can flatter balance sheets.

Vodafone, the UK telecoms company, has a substantial supply-chain finance scheme that it too does not classify as debt. But the FTSE 100 company has gone one further and parked about €1bn of cash in a dedicated supply-chain finance fund, which in turn buys up some of the company’s own IOUs to its suppliers.

A Vodafone spokesman told the FT that it has no influence over which assets are put into this fund, adding that it chose to invest primarily due to the safety of the underlying assets.

But it has one clear outcome: Vodafone classes its investment in this fund as a financial asset, reducing its reported net debt figure by the same amount.

“It is totally circular and makes their balance sheet look better,” says one executive at a supply-chain finance firm.

Auditors have signed off on all these cases, as they are within the rules. Yet investors should beware: they have the troubling side effect of making it harder to get a sense of a company’s true financial position.


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