From bad to worst

IN MID-SEPTEMBER, a group of academics gathered in the tawny brick offices of Nottingham Business School to sift well over 200 frank responses to a questionnaire circulated to top UK companies and leading investment analysts.

The results, published two weeks ago, could hardly have been music to the ears of troubled conglomerate Trafalgar House. It was already a laughing stock over the debacle over the botched refit of the QE2. And its standing in the City was at rock-bottom after it bid for but failed to win Northern Electric.

The latest annual survey inManagement Today of 250 top British firms slated Trafalgar as "Britain's least admired company". In a damning five out of nine categories - management, financial soundness, product quality, innovation and long-term investment value - Trafalgar ranked last against nine of its biggest peers.

As for financial stability, Trafalgar ranked 249th overall, sneaking ahead of just Eurotunnel, the Channel Tunnel operator whose pips are squeaking under pounds 8bn of debt. What's more, since the surveys began in 1989, Trafalgar "earns some form of distinction by recording the lowest-ever score of any company for the quality of its management", the top executives' magazine wrote.

Last Friday, the dunce's cap looked thoroughly deserved. With pre-tax losses of pounds 321m, far worse than expected, Trafalgar came perilously close to going under. Net debt rose to pounds 229m, from just pounds 20m, and assets almost halved to pounds 355m, way below a pounds 500m guarantee to its bankers. Only some nifty renegotiation of its banking covenants, plus last-minute disposals like the Ritz, kept the wolves from the door.

"It's a complete bloody disaster. Losses and provisions were far higher than expected. They had the covenant removed, otherwise they'd be technically bust," one leading conglomerates analyst said.

Some pounds 318m of one-off charges - on practically everything from the Cunard cruise line to a host of problem engineering and construction contracts - brought total write-offs to over pounds 800m over the last four years.

Several thousand jobs have already gone, with 600 further losses to come immediately and many more likely as Trafalgar puts its house in order.

Chief executive Nigel Rich says this time Trafalgar has thrown in the kitchen sink in a root-and-branch clear-out of long-running sores.

"In all the contracts we think we've had a fundamental review...we're comfortably within our banking facilities," he told the Independent on Sunday.

But Trafalgar has been here before. In the last four years, it has swallowed nearly pounds 1bn of investors' money from three rights issues. That includes over pounds 200m pumped in since October 1993 by Mr Rich's backer, Hongkong Land Holdings, which holds a 26 per cent stake.

Then, with the shares languishing at around 60p - less than a fifth of their 1989 high of 318p - HK Land looked to be making a canny long-term move. The property group forms part of the huge Jardine Matheson empire, run by the colony's powerful Keswick family. With sales of pounds 4bn, but losses of pounds 11m, Trafalgar then looked a sure-fire recovery play, a profitable bolthole for Jardine as Chinese rule loomed ever closer.

The Keswicks had long been astute investors in Britain too, with a highly successful stake in discount grocers Kwiksave, via Jardine's food offshoot Dairy Farm.

At Trafalgar, though, analysts expect even more trading losses next year, with another pounds 100m of cash flowing out in the next six months. Mr Rich insists debt will peak at pounds 370m next year and that Trafalgar will trade out of the mess. The market, though, believes a further capital restructuring is inevitable and a rights issue, Trafalgar's fourth, is certainly not ruled out by brokers long impatient of management's failure to deliver.

Today Trafalgar shares languish at just 24.5p, against the 85p HK Land originally paid in 1993. So how on earth did the usually smart Keswicks get things so spectacularly wrong?

Trafalgar started out in 1965 as a humble property business, floated on the stock market by Sir Nigel Broackes, a flamboyant tycoon later to become one of Margaret Thatcher's favourites. Sir Nigel's early property deals quickly brought together one of the most buccaneering triumvirates in British business: Sir Eric Parker, a working-class accountant and Trafalgar's long-time chief executive; and Victor, later Lord Matthews, the former head of Express Newspapers, who died aged 76 just over a week ago.

By 1990, in 25 years of dealmaking, the trio had bought - and sold - some of the finest baubles in British business, including Express Newspapers, snapped up in 1977 and spun off in 1982. By the end of the wheeler-dealing 1980s, Trafalgar's trophies included Cunard, Ellerman shipping, the Ritz, Ideal Homes, builder Trollope & Colls, civil engineers Cementation and John Brown Engineering, one of the world's largest builders of power stations and chemical refineries.

As recession struck and property prices tumbled, market concern was already growing about Trafalgar's mounting debt. Oblivious to the danger, in June 1991 Sir Nigel and Sir Eric pounced on Davy Corporation in a pounds 114m takeover gamble, plus a pounds 310m rights issue, which was to break the camel's back.

The bid was conceived as an ambitious attempt to fuse two of the most famous names in British engineering, Davy and John Brown. Davy was on the verge of collapse over problems with a pounds 118m contract to convert an oil rig, the Emerald Producer, and - like Trafalgar later to the Keswicks - its shares seemed cheap. Instead, problems mounted, and the bid simply saddled Trafalgar with yet another sprawling division leaking cash like a sieve.

The group finally agreed to sell the Emerald Producer for pounds 21m this October, but only after the so-called "rig of doom" had cost all involved over pounds 200m.

Trafalgar's troubles were far deeper rooted, however, than one problem contract.

"The main problem was really the style of the 1980s agglomeration. The group went round making acquisitions that were not bedded in," says analyst Zafar Khan, at broker Societe Generale Strauss Turnbull. "You had a lot of businesses that were really fiefdoms, independent operations."

Sir Nigel and Sir Eric never truly integrated Trafalgar's sprawling engineering and construction empire, by now one of the world's largest. As a result, costs remained high, management controls hardly existed and information flowing to the centre was suspect, to say the least.

Often Davy, John Brown and Trafalgar House Construction might be vying for contracts in an already highly competitive industry. Where they worked together, clients would often get confused dealing with the plethora of different Trafalgar arms.

Trafalgar's huge, long-term contracts include power stations in the UK, the Faslane submarine base, Malaysia's controversial Pergau Dam and oil refineries and chemical plants around the world.

Not all the problems were of Trafalgar's direct making. Year-long delays to the pounds 400m Keadby power station on South Humberside were caused by defective, new-technology gas turbines supplied by General Electric of the US.

Trafalgar's position, however, as the so-called "turnkey contractor", responsible for getting the plant up and running was a high-risk route, put it squarely in the firing line. Earlier this year, power station owners Norweb and Scottish Hydro Electric issued a pounds 50m writ against Trafalgar, which has yet to reach a settlement with GE. On Friday, Trafalgar said it would no longer put itself in such high-risk predicaments, as well as announcing a shake-up of financial controls and, indeed, the group's whole culture.

"In nearly all cases losses emanated not from technical shortcomings or lack of market presence but from inadequate leadership, lack of operational control and weak financial disciplines," chairman Simon Keswick said in a damning indictment.

What has really astonished the market, though, is how long it has taken HK Land to get to grips with its problem child.

On the face of it, the Kes-wicks moved quickly to gain management control after their hostile share raid in October, 1992. Sir Nigel was booted upstairs as honorary president, and Sir Eric was ousted after Trafalgar was rapped by watchdogs over a pounds 100m property black hole caused by creative accounting.

By June 1993, Mr Keswick had installed himself as chairman, replacing ex-ICI finance director Alan Clements. HK Land's finance director David Gawler, merchant banker Rodney Leach and Mrs Thatcher's former foreign affairs adviser, Sir Charles Powell, also came on board.

But crucially, the board and top management - used to a hands-off approach from the centre - remain-ed wracked by power struggles and Mr Rich, formerly managing director of Hong- kong Land, was installed only in August 1994.

Far from tackling the problem divisions like engineering, however, Mr Rich turned his immediate attention to "financial engineering". A pounds 1.2bn bid last December for regional electricity company Northern Electric, the sector's first, was supposed to provide the cash flow for Trafalgar to trade out of its difficulties. Mr Rich also believed - correctly as it turned out - that the sector was seriously underpriced.

"I was very quickly immersed in the Northern Electric bid. Mr Gawler's main priority had been had been in refinancing the business and to install a financial reporting system," Mr Rich said. "There was quite some resistance to it and only in the first quarter this year did my arrival push it through," he added.

Northern Electric was a nice idea but the timing was wrong. Three days before the bid's close, the regulator announced a price review. By the time it ended, the market had woken up to Mr Rich's wheeze, and catapulted electricity share prices beyond the reach of Trafalgar.

Mr Rich now promises a two-year slog back to acceptable profitability, positive cash flow and nil net debt. Highly profitable Ideal Homes, Britain's fifth largest house builder, is to be sold, along with commercial property as Trafalgar retrenches towards engineering, con- struction and cruise shipping.

But for all the pluck, Trafalgar's problems remain legion. Ideally, it would like to also sell Cunard, but there are no buyers. Cunard has just made losses of pounds 134m after write-downs to the value of the fleet, as each of its ships underperformed. That came despite pounds 200m of new investment in the last two years, including the ill-fated refit of the QE2 and the purchase of the liner Royal Viking Sun.

Mr Rich reckons getting Cunard back to profit may take over two years. In the meantime, rivals such as P&O invest in ever-more expensive liners, making the haul back much harder.

On the contract side, Trafalgar has now belatedly installed a weekly finance committee to review all tenders above pounds 40m. Even if the write- downs so far are enough, however, Trafalgar still faces a depressed construction industry that shows few signs of picking up.

Trafalgar shares have stabilised since a freefall to 18p in October, when HK Land re-iterated its long-term support.

Investors can look forward to no dividends for the foreseeable future, however, and with negative distributable reserves of pounds 281m, a balance sheet reconstruction is thought inevitable.

No-one yet believes HK Land will cut loose, letting Trafalgar go spectacularly bust. But Trafalgar refuses to say what its new banking covenants are, and analysts are warning risk-averse investors to stay well clear.