UK entrepreneurs have ‘failed’ business models, watch group says

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Some of the UK’s largest government contractors – including Capita, Serco, Interserve and Mitie – have “failed” business models and worrying balance sheets, according to a company used by Whitehall departments to review private sector bidders for outsourcing contracts.

The four companies, whose services range from running detention centers to cleaning government buildings, have “eerily similar” financial health profiles to Carillion’s in the years leading up to its January collapse, with profit margins or losses. positive liquidity, but little on their balance sheets. to fall back on if the cash flow evaporates, Company Watch said.

“Our analysis leads to the conclusion that the economic model adopted by the main listed players in the market is essentially bankrupt,” said Jo Kettner, CEO of Company Watch.

The analysis is used by government departments, including the Department of Defense, to help them decide which companies should receive contracts. This will raise concerns that a sector that emerged from Margaret Thatcher’s privatization drive in the 1980s and driven by New Labor under Tony Blair is vulnerable to yet another Carillion-style collapse.

UK subcontractors are struggling to rebuild their balance sheets following a series of profit warnings and contractual errors that have caused their stock prices to drop sharply over the past five years.

Capita, Serco, Interserve and Mitie took issue with Company Watch’s analysis, arguing that their turnaround was on track and that they had only suffered in the UK because contractual risks had increased since 2010, when the government decided to extract more from its suppliers.

“Our business is about contracts and people, just like any other service or consulting company,” said Phil Bentley, Managing Director of Mitie. “We are already 18 months into our transformation agenda and are now seeing the benefit of all of our hard work with revenue growth, cost savings and restoring our balance sheet strength. ”

UK subcontractors grew rapidly by winning contracts and seizing smaller players in sectors and countries in which they had too little expertise. This generated income – and therefore returns to shareholders and executives – but not necessarily earnings growth, racking up future problems.

What companies are saying

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FILE PHOTO: A sign indicating the start of the congestion charge zone, which is operated by Capita, is seen in London, Britain January 31, 2018. REUTERS / Toby Melville / File Photo

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Services for the UK government include the management of the London congestion charge and the collection of license fees for the BBC. Capita has sold assets and had a rights issue to repair its balance sheet, but these steps appear insufficient as it had short-term liabilities of £ 2.5bn – but cash and other liquid assets of just £ 2bn of pounds sterling. Capita said it was “incorrect” to compare it with Carillion, “given the fundamentally different balance sheet profiles, profit margins and business models of the two companies.”

“Our proposition is more value-added, technology-driven and service-oriented. With our successful rights issue and completed divestitures, low financial leverage and a strong order book, Capita is in good financial health, ”he said. It has sold other assets since June.

Serco

The scene outside Bedford Prison after a riot that reportedly saw up to 200 inmates break out.

Managing prisons and accommodation for asylum seekers for the UK government, Serco reported a decline in profit margins from 2.5% in 2013 to 1.9% in its latest interim results. He came out of the brink of bankruptcy under Rupert Soames, after issuing four profit warnings in 2014. Serco said he expected “underlying business profit growth of between 30% and 40% for 2018” .

“We have a strong balance sheet with our net debt to ebitda leverage ratio expected to be less than 1.5 times at the end of the year,” he added. “We are implementing our strategy, defined in early 2015, and we expect underlying business profit growth to be between 30% and 40% for 2018.”

It has also left companies with high levels of intangibles – mostly goodwill – on their balance sheets. Goodwill is the amount paid for an acquired business in excess of net assets and is essentially an estimate of future profitability.

An industry analyst said that “a balance sheet enlarged by goodwill may give an overall impression of financial strength, but stability is measured by tangible assets that a company owns and can sell or are owed to it. “.

Company Watch’s analysis revealed that intangible assets – primarily goodwill – were the largest item on Capita and Serco’s balance sheets, and almost the largest for Interserve and Mitie.

While having more intangibles than fixed assets is not necessarily an indication of risk – tech companies, for example, may have few fixed assets – it is one of many. measures, including profitability, working capital, liquidity, debt, capital base and proportion of funding, used by Company Watch to indicate vulnerability.

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Carillion’s liabilities were 34% greater than its tangible assets even in 2016, when auditors and analysts considered it healthy, Company Watch said. If the same measure were applied to Interserve, liabilities would exceed tangible assets by 28%, Serco by 41%, Capita by 67% and Mitie by 53%.

The study also found that the profits of the four companies were affected by ‘one-offs’ – such as restructuring costs, terminations, or penalties – at such a rate that it made them ‘non-exceptional’. “. This includes provisions for onerous contracts such as Serco’s deal to provide housing for asylum seekers for the UK government, which runs until next September and on which it loses money on every resident it does. it hosts.

“When you think that such contracts can span 10, 15 or even 20 years, it is obvious that such provisions are part of the very fabric of the business model,” Ms. Kettner said.

The subcontractors argued that the competitive process to win contracts ensures accountability and that they bring cost discipline and innovation to services.

But it became more difficult when contracts were awarded for a second or even a third time, when all the easy savings such as job cuts had been made and margins were inevitably lower, said Graeme Swan, partner of the consulting firm EY.

“By the time you get to a second generation contract, the idea of ​​saving 15% on a contract seems incredibly difficult and third time heroic, but companies don’t necessarily adapt to it,” he said. he adds.

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Interserve

D3C9HT Bournemouth, UK 15th February 2013. Bulldozers begin to demolish the front window of one of the "most hated buildings" in the UK, the Imax complex on Bournemouth seafront.  Once demolished, the site will be transformed into an open-air event arena, ready for the summer season.  Credit Carolyn Jenkins / Alamy Live News

© Alamy

Managing probation and cleaning services for the government, the group has seen its pre-tax profit margins drop from 3.1% in 2013 to minus 0.4% today. He narrowly avoided bankruptcy in February by reaching a deal with creditors to extend borrowing terms. Interserve said their “plan is on track and we will achieve a significant improvement in operating profit in 2018”.

Mity

Mitie Plc.  Hammersmith and Fulham Housing Services.  Credit: Ed Robinson / OneRedEye

Britain’s largest manager of immigration detention centers had profit margins of 3.1% in 2014, which fell to a negative 1.1% in March 2018. It has since improved to a pre-tax margin positive 1.8% in the last half of the year. results. The company said it was progressing with “revenue growth, cost savings and restoring our balance sheet strength.”

According to Company Watch’s analysis of previously bankrupt companies, companies with such weak balance sheet structures, which have constant pre-tax profit margins below 3 percent, tend to be more vulnerable.

In its latest half-year results, Interserve reported losses, while Capita, Serco and Mitie improved their pre-tax profit margins (after exceptional items) to around 2%.

Last week, the government asked vendors including Serco and Capita to write “living wills” so that there are plans in place to take over the provision of key services, such as school meals. , cleaning hospitals and managing facilities in the event of a Carillion-style collapse.


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