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Tarmac sets course for contractors

ANALYSIS

Events at Tarmac are the result of pressure being applied by the City to all contractors.

Major contractors are getting into the faith healing business. Belief that the construction sector can deliver decent margins and value for shareholders has been on the wane in the City for a decade. Contracting is facing the extraordinary prospect of a wholesale withdrawal of investment by pension funds, and repairing the loss of confidence is going to take more than a quick makeover.

Big shareholders are on the war path and intent on sparking a major consolidation as a cure for overcapacity in the market.

It was institutional shareholders who called for Balfour Beatty's parent BICC to hold talks with Wassall, the industrial conglomerate and venture capital group, when it launched a takeover bid in March. BICC decided to demerge its cabling business and hang onto construction as a defence and to offer better value for shareholders.

Amey recently asked the Stock Exchange to be relisted in the service sector, where it would be subject to the scrutiny of a new set of City analysts. It argued that its involvement in facilities management warranted this, but the company's request was rebuffed and Amey remains marooned in construction.

And a major investor in Alfred McAlpine has been supporting a takeover bid.

Tarmac is the latest to succumb to City pressure. Last week, the group announced the details of its plan to concentrate on heavy building materials and demerge the contracting business in the name of enhancing shareholder value. Construction will be renamed Carillion and floated separately on the stock market (see News).

Tarmac chief executive Sir Neville Simms will move across to become chairman and chief executive of Carillion, and pocket around £1.37M in cash and shares as compensation for a lower basic annual salary. He could also pick up a further £3.4M in share options under a new incentive scheme for senior executives, if Carillion's share price doubles within three years - or in the event of a takeover bid.

Why all this activity in the contracting sector?

'The basic problem is that the stock market is not enamoured with the construction industry and there has been pressure from institutional investors,' said JP Morgan analyst Mike Betts. Tarmac is just one example.

'Tarmac has been under pressure from Phillips & Drew, a major shareholder and known to be pretty active,' said Betts. 'Shareholder fatigue has turned into activism. It's not just construction. It's other sectors as well, where institutional shareholders perceive the management isn't doing enough to maximise value.'

Tarmac's rating with analysts has been low, and underperformance of construction has been seen as holding back the share price. Even so, the reaction to Tarmac's announcement was hardly ecstatic; shares crept ahead to close at 124.5p last Friday, short of the company's 52-week high of 127.5p. The demerger should see a boost in share price of the new all- materials Tarmac, but the outlook for Carillion shares is less certain, assuming that they get to be traded.

The City sees Carillion as the ideal target for a takeover. Indeed, Sir Neville said the demerger was partially driven by anticipation of future consolidation in contracting. The cash-rich Swedish construction group Skanska tops the list of potential suitors, not least because Skanska executives told a meeting of analysts in Helsinki three weeks ago that it intends to buy control of a large UK contractor. Other names in the frame are Costain, Bovis, John Mowlem and Taylor Woodrow.

'I'm not sure that Carillion will make it to the market,' said an analyst. 'It doesn't seem like a name to last. It's utterly forgettable and I can't believe that Neville is happy managing a company with a market capitalisation of only £250M.'

Tarmac has set a new course, but the contracting sector overall has some way to go before it will satisfy the City.

Some construction analysts are decidedly blunt about the perceived failings of contractors: 'We have a lot of highly paid executives with their knighthoods, and pay packets just don't correlate with performance,' said one.

But the majors are responding and developing new business strategies aimed at stripping out the potential for boom and bust.

'If you look back three or four years, the results to a greater or lesser extent show that contractors have taken some very severe hits. We're coming out of that period now and people are starting to think about the future,' said a senior contracting figure.

'A lot of contractors are at the same point of the cycle and many are desperately trying to get away from that because it is disaster to have a business that is cyclical beyond control.'

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