G4S Debt Investors See Beyond 2012 Olympics Fiasco: U.K. Credit
Investors demand 200 basis points more yield to own its 350 million pounds ($531 million) of 7.75 percent notes due 2019 rather than similar-maturity British gilts. That’s down from 247 basis points in July, the month the U.K. government said it would draft in extra troops to augment protection for Olympic athletes and spectators after the world’s largest security company failed to provide enough personnel.
Since Chief Executive Officer Nick Buckles told lawmakers in July that G4S’s reputation was “in tatters,” the Crawley, England-based company has worked to win new contracts and restore its credibility. G4S ousted two executives, won deals from British Airways and a young offender institution, declined to bid for complex contracts at the 2014 soccer World Cup and the 2016 Olympics, and outlined plans to lift emerging markets sales as European margins get squeezed.
“They’ve clearly learnt from the Olympics debacle, so they can judge better than others what is needed for such big events,” said Volker Schmidt, a Luxembourg-based portfolio manager at YCAP Asset Management. “While the company’s size alone doesn’t ensure its competence, it makes it more and more difficult for the smaller players.”
YCAP Asset Management holds 0.5 percent of a 500 million- euro ($648 million) G4S bond due in December 2018, according to data compiled by Bloomberg.
The stock has risen 14 percent since the start of the year in London trading, valuing the company at 4.1 billion pounds and beating the 8.4 percent gain of the U.K. FTSE 100 benchmark index. On March 22, the stock rose 0.5 percent to 292.10 pence.
In February, G4S won a five-year deal to provide cleaning services to a U.K. public healthcare organization, showing that its relationship with the British government is improving.
The government had stripped G4S of a contract to run the Wolds prison in Yorkshire, northern England, in November. The jail will return to the public sector in July, after being run by the company since it opened in 1992.
G4S has several contracts with the U.K. government, including deals with the Home Office valued at 600 million pounds, Buckles said in July when he faced lawmakers questions over its Olympics security contract.
The company generated about 10 percent of revenue last year from U.K. government contracts and the Olympics contract represented 2 percent of its business. Europe, its biggest source of revenue, accounted for 39 percent.
“People are appreciating that actually there is a sort of rehabilitation going on with the U.K. government, which is where most of the sensitivity was,” G4S Treasurer Nigel Youngman said in a phone interview. “Bondholders have always seen us as an attractive prospect. Fundamentally it’s a steady growth business with a predictable cash flow from one year to another.”
Free cashflow attributable to shareholders was little changed at 341 million pounds last year compared with 350 million pounds in 2011, according to data compiled by Bloomberg. The company’s debt is rated BBB- by Standard & Poor’s.
G4S is expanding business in emerging markets such as the Middle East, Africa and Latin America as European margins, based on earnings before interest, taxes and ammortization, declined to 7 percent last year from 7.4 percent in 2011 at its secure solutions business, and to 10 percent from 10.6 percent in the cash business. Both exclude the Olympics charges.
The company said March 5 it would sell its U.S. Government Solutions business partly because of reduced government spending and tighter margins. It has received interest from 15 companies, Buckles said March 13 in a Bloomberg television interview. More sales may follow and some of the proceeds will go into expanding its presence in developing markets, he said.
G4S plans to generate 50 percent of revenue from emerging markets by 2019 compared with 33 percent last year.
“The whole point of the Olympics contract is that it was very different from their core business,” said David Greenall, an analyst at RBC Capital Markets in London, in a phone interview. “They’ve also got a mantra of moving much more towards emerging markets. It reflects a greater confidence in the long-term perspective.”
On March 12, the yield premium of G4S’s 7.75 percent notes, issued at a spread of 410 basis points in 2009, dropped to an all-time low of 195.13 basis points. The same day, companies with 5 to 7 year bonds and a BBB rating in a Merrill Lynch index had an average yield premium of 280 basis points.
G4S, formed from the merger of Securicor Group and Group 4 Falck A/S in 2004, has a total 1.68 billion pounds of debt outstanding, including a 389 million-pound revolving credit line maturing in 2016, according to data compiled by Bloomberg. There are no significant bond repayments due before then.
Demand in November for the company’s 500 million-euro bond due 2018 exceeded supply at least five times with 75 percent of the debt sold to investors outside the U.K., Treasurer Youngman said.
“It’s really only in the U.K. that sensitivity was heightened off the back of media and political comment,” he said. “We wanted to expand our investor base, as we’d issued a bond in the U.K. before.”
G4S debt is also attractive because of the company’s “tight control” over spending, Chief Financial Officer Trevor Dighton, due to retire on April 30, told analysts in a March 13 conference call.
The company will save about 25 million pounds in procurement this year, adding to the 35 million pounds of cost cuts achieved in 2012 while the ratio of debt to earnings before interest, tax, depreciation and amortization is set to decline, Dighton said.
“One of our key financial ratios is the net debt to Ebitda,” Dighton told analysts. “I said before that we are comfortable with it up about 2.5 times. It’s increased in 2012 to 2.6 times but we anticipate that it will return to our target range within 2013.”
In March, the company posted a decline in pretax profit to 175 million pounds last year from 257 million pounds, taking a hit of 88 million pounds from bungling the 2012 Olympic Games contract.
Organic sales growth, excluding the Olympics, increased 6.9 percent compared with 4.5 percent a year earlier.
As G4S bonds return to favor, the company’s shares are also in demand. G4S, which declined 17 percent in four days in July after the company said July 12 it couldn’t handle its Olympics contract, closed higher than its pre-crisis level for the first time on Feb. 19.
“The Olympics is behind the group now and they’ve effectively drawn a line in the sand,” said David Brockton, an analyst at Espirito Santo. “The way to sustain growth is to continue to build share in emerging markets and that’s what they’re doing.”
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