Serco in Billing Probe Limbo Seeks U.K. Contracts Recovery

Serco Group Plc has lost a prison contract, a CEO and a fifth of its value in six weeks. It may take longer than that for Britain’s largest government outsourcing provider to win back work -- and investors.

Serco can’t gain new U.K. public contracts before the government completes a probe into bills submitted for electronic tagging of criminals, including some who had died. The company, with management contracts for everything from hospitals to London’s Docklands Light Railway, may struggle to win work even when the investigation is done.

“Even if the review is concluded sooner rather than later, it’s probably still going to be 9 to 12 months before investors get their confidence back,” Stephen Walker, head of equities research at Ashcourt Rowan, a London-based wealth manager that holds about 240,000 Serco shares, said in an interview.

Serco’s stock has plunged more than 20 percent since Chief Executive Officer Christopher Hyman resigned in late October, erasing almost $1 billion in value. The contract limbo comes ahead of national elections in May 2015.

“If there’s any risk to politicians in awarding contracts to these companies, clearly it will be difficult,” said Robin Speakman, an analyst at Shore Capital. “Politicians’ first priority before an election is to get re-elected.”

‘Good Progress’

Serco got more than half of its 4.9 billion pounds ($8 billion) in 2012 revenue in the U.K., while G4S Plc, also accused in the tagging scandal, garnered less than one-quarter. In mid-November, Serco said profit will decline next year as it wins fewer contracts “as a consequence” of the inquiry. A week later, the leader of the U.K. and Europe division resigned after his unit was split in two, following CEO Hyman out the door.

Serco is “firmly committed to rebuilding the confidence of our U.K. government customer” and is “making good progress” on corporate restructuring, it said in an e-mailed response to a request for comment about the dearth of British work. A G4S spokesman declined to discuss a potential slowdown in contracts.

The Justice Ministry canceled a tender Nov. 22 for a contract worth as much as 30 million pounds a year to run three prisons, due to “uncertainty” about the investigation. Serco was the lead bidder. Serco and partners withdrew from a competition for military purchasing, and Defense Secretary Philip Hammond has said he may keep procurement in public hands.

Wariness over Serco’s reputation means it may not get contracts before the 2015 elections even if the company is given a clean bill of health, according to Speakman.

Election Overhang

“Politically driven initiatives” may be “difficult to work through,” said Tom Gash, research director at the Institute for Government, a London-based group that has criticized outsourcing oversight. “As you get closer to the pre-election period, people will start to look at those quite questioningly and think about stopping the process.”

Several Serco contracts are up for renewal next year, including Northern Rail, Britain’s biggest train franchise, which expires in April, and management of Docklands Light Railway, ending in September.

The contracts constitute about 7.3 percent of Hook, England-based Serco’s 2013 revenue, according to Credit Suisse Group AG. Pre-election contracts hanging in the balance also include British Army training work worth about 55 million pounds.

Serco has said it still sees opportunities in a Justice Ministry plan to outsource probation work worth 600 million pounds a year. The government is hiring private contractors to do more of its work in the midst of a recession-driven austerity push.

Long Game

Outsourcing will continue to create business, so Serco investors should be optimistic in the long run, Ashcourt Rowan’s Walker said. Serco’s earnings before interest, taxes, depreciation and amortization have gained every year since at least 1988. The company is scheduled to report annual earnings in March.

While competitors could benefit from the travails of Serco and G4S, few companies offer similar breadth, said Graham Brown, an analyst at Canaccord Genuity. “Sodexo and Mitie were thinking of moving in to a certain extent, but they don’t have the commercial scale.”

Ruby McGregor-Smith, chief executive officer of Mitie Group Plc said in an interview last month that the company has a “huge amount of work to do” in its current markets and isn’t dwelling “too deeply” on areas vacated by competitors. Mitie primarily provides facilities management. A spokesman for Sodexo, the world’s second-largest catering company, declined to comment on the matter.

‘Drift Back’

Capita Plc and Atos compete with Serco for administrative work, while Babcock International Group Plc contends in defense and transport.

That leaves politicians in a difficult position in which they rely on Serco and G4S to increase outsourcing.

“A lot of this work will de facto drift back to these companies,” said Speakman. “The government is between a rock and a hard place.”

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