Serco seeks to restore trust – and profits – after gaffes

by William Cain, Shares magazine

"A little" is not "a lot", but news that Serco is trading "a little better" than expectations has, for some, signalled that a turnaround in fortunes at the government outsourcer is finally on the cards.

Serco's shares have gained 6.3 per cent to 128p since a 1 July trading update. That's still not much consolation for investors in a stock which traded higher than 500p in 2014. Analysts at Berenberg, Germany's oldest private bank, believe the market may already be getting too far ahead of itself. "We would advise against reading too much into this," writes analyst Simon Mezzanotte.

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"Indeed, from our meeting with management, it appears that the slightly better performance is due to Serco's asylum seekers contracts in the UK and Australia which are inherently volatile and in the past have proved extremely difficult to forecast."

Refocusing the business, rebuilding margins and its bidding pipeline are all challenges which should not be underestimated, according to Mezzanotte.

Serco still has a lot of work to do to recover from a string of high-profile embarrassments and financial missteps.

Revelations it overcharged the UK Government by millions of pounds on electronic tagging contracts, including invoices for the monitoring of dead offenders, damaged its reputation and finances.

Profitability had become dependent on a few key contracts – notably an Australian border control deal – which would ultimately have to be renewed on less favourable terms.

Seeking to restore trust in the business, chief executive Rupert Soames' plan is to refocus around Serco's core strengths. Its 30-year history of working with governments in the UK, US, Australia, New Zealand and across the Middle East means it has a track record of delivery across a range of geographies and government service 'verticals'.

'Typically, competitors can offer one of these verticals in more than one country; others can serve several verticals in a single country,' Soames says. 'Only Serco can offer all of them.'

Government outsourcing markets are growing in the region of five per cent to seven per cent annually, according to the company, providing a reasonable economic tailwind for Soames' strategy.

Serco's private sector outsourcing division, which includes back-office systems, call centre management and finance and accounting services, is being sold off.

Proceeds from the sale will be used to revive an ailing balance sheet. Losses in the 2014 calendar year and spiralling debt have already forced the company to raise £550 million from shareholders in April to keep its lenders onside.

Year-end net debt, which is net of the £550 million raised this year, is expected to be in the region of £347 million by 31 December 2015, according to Berenberg estimates.

Facing obstacles of that scale, investors expecting a quick fix at Serco will need more than a little luck.