As the nation heads to the polls and its banking, construction and utilities industries, to name but three, fret one more night about the identity of the next government, it feels an appropriate moment to revisit the sad tale of Serco, the services business and former market darling that – for a while at least – appeared to do so well out of public sector outsourcing contracts won under Tory and Labour administrations alike.
Whenever the Government lacked the know-how – or occasionally the stomach – to cut costs, Serco was one of a number of companies that could be relied upon to step in and investors duly grew very excited about its prospects. Over the last two years, however, the company has fallen spectacularly from grace in the wake of a nasty run of setbacks we have catalogued in Turning Serco and, more recently, Eyes on the price.
On the bright side, April saw the so-called ‘rescue rights issue’ we mentioned in the latter piece largely supported by the market, as investors bought up some £520m of the £550m of ordinary shares on offer. Less positively, Serco’s most recent results were not only as bad as had been expected, they revealed some of the most dramatic changes to a company’s financial position we have ever seen in such a short space of time.
Most notably, as a result of the acknowledgement that some contracts have been lost while other have gone bad, in addition to various investments being written down, Serco’s book equity value dropped from almost £1.1bn to more like minus £65m. Clearly, that is not at all the same as saying the company is worth nothing but, in accounting terms, the entire equity value of the business was wiped out in the space of a year.
That is something you very rarely see – and is all the more extraordinary when you consider that Serco’s book equity was bolstered to the tune of £160m during 2014 by its share placing in late April last year. So what has happened? Despite the pain the business has already taken upfront in its accounts, the main driver of that fall in equity value is the increase in the company’s balance-sheet provisions.
These are the acknowledgements in Serco’s accounts of the real cash it believes it is very likely going to have to spend at some point – even if a portion of that is a good way off in the future – on putting right some of the mistakes of the past. The company’s expectations for future spending on that basis have risen tenfold from some £60m to almost £600m – again, in the space of just one year.
Obviously that figure should come down over time – primarily as the negative impact of bad contracts drops out of the accountants’ reckoning and the business restructures. Nevertheless, as things stand and despite all of the pain Serco and its investors have endured so far, this is still £600m-worth of costs that have now been recognised as eventually needing to be paid by the business.
Hopefully the next time The Value Perspective focuses on Serco it will be to note how it is on the road to recovery. Certainly, even if three articles in 12 months suggests otherwise, it has never been our intention to pick on the company but rather to highlight the dangers of the management of highly-rated businesses going out of their way to do what they think the market wants them to.
That can lead to some extremely poor decisions being made that – whether for reasons of bad luck, bad judgement or both – can destroy very large amounts of shareholder value in very short periods of time. Regardless of the plans the different political parties may have for UK businesses, this holds true whoever the inhabitant of Number 10 Downing Street might be.