10th Nov 2014 10:51
LONDON (Alliance News) - Serco PLC saw its shares plunge again Monday after it issued another profit warning, revealed the scale of the provisions and writedowns it will have to book, and proposed an equity rights issue to shore up its balance sheet once more.
New Chief Executive Rupert Soames said the company will also sell businesses, including most of its private sector business process outsourcing operations, as it will specialise in outsourcing work for governments internationally going forward.
Soames, one of Winston Churchill's grandsons, took the helm of the struggling outsourcing company at the start of June, tasked with turning the company around after it was hit by the fall-out from issues with two UK government contracts that led it to being banned from getting new UK government work for several months in 2013. The company is undertaking a review of the whole business and its balance sheet, as it also tries to sort out issues with other contracts that are proving to be unprofitable.
Serco said it plans to tap its shareholders for up to GBP550 million more in the first quarter of 2015, through an equity rights issue that will be fully underwritten by Bank of America Merrill Lynch and JP Morgan Cazenove.
It had already raised GBP160 million in May to help shore up it finances whilst it undertook its strategic review. That came after the company issued a second profit warning for 2014 as more of its contracts began to struggle, but the continued deterioration in trading and cash flows mean its net debt is again rising.
On Monday, the company issued its third profit warning of the year, saying that 2014 adjusted operating profit would be between GBP130 million and GBP140 million, even before the impact of the contract and balance sheet reviews, some GBP20 million lower than its previous forecast. Its outlook for 2015 has also been reduced, and its now expects to report an adjusted operating profit of about GBP100 million as its margin falls to around 2.5%. It expects to report adjusted revenue of about GBP4 billion in 2015, down from about GBP4.8 billion in 2014.
It said it expects to report a mid-single digit percentage decline in its organic revenue for the second half of 2014, compared with 2% growth in the first half, mainly due to reduced volumes in its Australian immigration services contract, contract losses, and contract renogotiations.
A review of its contracts and the balance sheet has identified likely impairments and onerous contract provisions of GBP1.5 billion, half related to goodwill and intangible assets, the company said. That's much higher than the company had previously estimated, and comes after operational issues and talks with clients led it to raise its estimates of the costs needed to complete its obligations under some loss-making contracts.
The contracts affected include a deal to maintain the Royal Australian Navy's Armidale Class patrol boats and UK contracts including its asylum seeker support deal, its Royal Navy fleet support deal, and its Prisoner Escort & Custody Services contract. It expects the provisions increase related to the UK contracts to be between GBP150 million and GBP200 million.
It also cautioned that the range of possible outcomes of the review "is still wide". About GBP450 million of the total is likely to be down to onerous contract provisions, while it expects to have to book an impairment for a large proposition of the GBP500 million of goodwill currently on its balance sheet for its business process outsourcing businesses.
"Whilst it is a bitter pill, it is better for all concerned that we swallow it now and establish a really solid foundation on which to build Serco's future," Soames said of the initial estimate of the impairments and writedowns the company will book.
"As might be expected, the Contract & Balance Sheet Reviews have encouraged much turning over of stones, and reflects our changing strategy and the latest view of the challenges we face on a few large contracts. These challenges, together with a less pronounced improvement in trading in our second half than we expected, have led us to a more cautious view of 2014 and 2015," Soames said in a statement.
Serco also said it would hold talks with its lenders to negotiate amendments to the operation of covenants in light of the deterioration in its finances and its plans to shore up the balance sheet, and said it was targeting a medium-term capital structure of one- to two-times net debt to earnings before interest, tax, depreciation and amortisation.
The CEO said the company's review is continuing and it expects to complete it by next March.
"However, the direction is clear: Serco will concentrate on its core as a leading supplier of public services - an international B2G business focused on Justice & Immigration, Defence, Transport, Citizen Services and Healthcare. These are businesses which we are really good at, where we deliver outstanding service, and where our skills, experience and international reach can differentiate us. There are a tough couple of years ahead as we make this transition, but it will be worth it," he said.
Serco said it had made two strategic errors in recent years: over-expansion and over-diversification as it tried to maintain its own growth rates in the face of a slowing market and increased competition, and concentrating too much on winning new business rather than realising the public sector contracting market was changing and more risk was being put on suppliers.
"Hindsight is a wonderful thing, and it is easy for those who follow to critique the work of predecessors; but we have to have an understanding of the past to build a vision of the future," the company said.
It said its nadir could come in 2016, with revenue falling as low as GBP3 billion to GBP3.5 billion and margins as low as 2% to 3%.
"We believe we can transform ourselves over subsequent years to become a company growing in line with the market in each of our core areas and generating margins similar to peers at attractive risk-adjusted rates of return," Serco said.
"Research conducted as part of the Strategy Review tells us that the segments we will be focusing on will be growing at an aggregate of 5-7%, and that industry margins across our mix of business are likely to be in the range of 5-6%; if this turns out to be correct, and markets turn out as we expect, we believe that our performance will match this," it added.
Serco said it has been awarded work with an estimated total value of about GBP900 million since the end of June, bringing the total for the year to date to GBP3.4 billion.
The company's shares were down 30.5% at 220.43 pence Monday morning, the worst-performing stock on the London market. The stock is down 56% so far in 2014, and the shares were trading at above 600 pence before the issues with the two UK government contracts were revealed.
Liberum cuts its price target on Serco following the latest news, to 210 pence, from 300 pence previously. It is retaining a Hold recommendation on the stock, saying Serco's new management is making quick and decisive moves to get the business back on track.
Liberum also cut its 2014 operating earnings forecast to GBP135 million, from GBP155 million, and its 2015 forecast to GBP100 million, from GBP154 million, while increasing its net debt forecast to the top end of the company's guidance range of GBP650 million to GBP700 million.
Investec, meanwhile, is reviewing its price target on the stock and says the update underlines the extent of the issues within the business at present. It is also reviewing its earnings forecasts and is keeping the stock at Sell.
"It is important to note this might not be the end of the bad news and that any turnaround is going to be a long process," Investec analysts wrote in a note to clients. "Management are doing the right things, but this is going to be an expensive and long-term turnaround with risks still ahead."
By Steve McGrath; [email protected]; @stevemcgrath1
(Ian Edmondson contributed to this article.)
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