Where it went wrong for Balfour Beatty in Wales

In the most recent £75m profit warning, Balfour Beatty located a £15m profit over-statement in the south-west and Wales. Construction Manager focused on this area in an online search for Balfour Beatty projects that were late, over budget or both, to examine the underlying reasons. This threw up the £45m Fferm Penglais student halls for the University of Aberystwyth, still a building site when it should have welcomed 600 students to its first phase in September.

The project is a PFI deal, where Balfour Beatty is thought to have secured 90% finance from Legal & General to build the 1,000-bed scheme, then manage it for 35 years. CM asked Balfour Beatty whether the Fferm Penglais problems contributed to the £15m shortfall at Construction Services UK acknowledged in September. Its response was that it “was not detailing which contracts are covered by the trading update”. However, the timing of the Aberystwyth problems – with Balfour Beatty only telling its client at the end of July that the project wouldn’t hit deadline – suggest it is implicated.

Counting the costs

Calculating the financial damage to Balfour Beatty, it is likely to be paying interest on the debt finance without any income to cover it – that’s 600 students not paying £120 a week. Then there is the cost of 10 weeks of temporary accommodation for the 256 students who are expected to move in “during the autumn term”. Plus, there could be compensation payable to the university for failing to provide the central student “hub” – a shop, cafe and other facilities that was part of the overall package – on time.

The project had a tight programme, with Balfour Beatty appointed preferred bidder in February 2013 and just over a year between financial close in August 2013 and the opening date in September 2014. Balfour Beatty says the project was hit by “severe bad weather” with heavy winds and rain closing the site for several days at the start of 2014, and “an uplift in construction activity which put pressure on the supply chain”. On the other hand, accommodation blocks are not the most complex building type around, so what else went wrong?

Lack of wiggle room

Consultant Jason Farnell of CR Management points out that the PFI contract would have left Balfour Beatty with no recourse to extensions of time or price negotiations, and speculates that it might have struggled to procure subcontract packages on terms that reflected this lack of wriggle room.

“If they sublet contracts that are not on back-to-back terms with their own, there’s nowhere to go upstream. If you haven’t got the supply chain bolted down to the same terms and conditions you have, you’ve got obligations you have to deliver that you’re not passing on to your supply chain.”

And every building type presents its own technical issues, he suggests. “In student halls, if the sequence [of trade contract packages] goes out, you’re into issues. Or if you have a subcontractor that fails, the sequence goes out. Then you find people try to make progress for progress’s sake – but then that stores up more problems.”

Fferm Penglais: delayed student halls for the University of Aberystwyth have suffered delays

Did Balfour Beatty underestimate the ‘fudge factor’?

At accountant Smith & Williamson, audit partner Jonathan Pryor anticipates that KPMG will have a brief to go through all aspects of Balfour Beatty’s operations that could be flawed, produce a parallel set of accounts for each project, validate their findings then report. “I’m willing to put my money on the table that there has been control weaknesses. I very much doubt there will be huge surprises. There is likely to be weaknesses in reporting processes that just about all construction companies and consultancies would recognise.”

“I have sympathy with Balfour Beatty, because [profit taking] is so dependent on forecasting. It’s not like Tesco, which knows what they’re paying and receiving at any one time. In construction, there can be all kinds of disputes and challenges in the background. It’s fine [to predict the impact] when you’re nearly at the end, but it’s harder when things go wrong as you’re going through. Sometimes, a relatively small event in the sequence can have knock-on effects.   

“Profit-taking in construction is inherently quite difficult to judge, but it’s a skill that all the construction companies should be focusing on. A small percentage swing in either income or expenditure can shift the prediction from profit to loss.
And it’s in the nature of the industry that construction people tend to have an optimistic view of life. Also, individuals might want to paint a better picture if there’s a bonus involved.”

As Pryor points out, higher echelons of management generally are aware of site teams’ tendency to take an overly rosy view of the project, and might try to bring the figures back to reality by inserting a “fudge factor”, perhaps by normalising the predicted profit against the closing position of previous similar projects. However, if the site team has got badly out of synch with reality, even the fudge factor won’t save the final account.