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Capita collapse could create bigger headache than Carillion's demise

Capita won more than 10 times the number of UK public sector contracts awarded to Carillion over the past two years, according to data firm Tussell

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Capita admits its structure is “too complex”

Capita PLC’s (LON:CPI) profit warning and £700mln rights issue has raised alarm bells on whether it could meet the same fate as fellow contractor Carillion PLC (LON:CPI).

Carillion went into liquidation earlier this month after failing to secure a rescue deal in talks with the government and its lenders following a series of profit warnings and mounting debt.

Like Carillion, Capita holds several contracts with the government.

Contacts include managing the licence fee for the BBC, the electronic tagging of criminals for the Ministry of Defence, operating the jobseeker’s allowance helpline and administering the teacher’s pension scheme.

Capita the biggest supplier of local government contracts

A potential collapse of Capita could create an even more of a headache for the public sector than Carillion since it is the biggest supplier of local government services in the UK, according to Tussell data.

“If Capita were to fail the ensuing political fallout would make Carillion look like a tea party,” said Michael Hewson, chief market analyst at CMC Markets.

Capita CEO's bold turnaround plan

But new chief executive, Jonathan Lewis, has a plan to turn around the business.

He acknowledged that Capita was “too complex” and “too widely spread across multiple markets and services” so needs to sell non-core parts of the business.

His plan also includes raising £700mln from shareholders later this year and suspending the dividend until the company generates a "sustainable free cash flow".

In a bid to reduce its pension deficit, the group is undertaking a triennial review of its current scheme. It expects the deficit to fall below the £381mln announced last summer following the review.

Investors will need to practice some patience, however, as Lewis said the overhaul of the business would take at least two years.

“This is a bold move by new CEO Jonathan Lewis and the fact that he thinks that this sort of restructuring is necessary, speaks volumes to the current sentiment around the outsourcing industry in the wake of Carillion’s insolvency,” Hewson said.

“Concerns over debt levels and pension deficits, along with the over-diversification of the business appears to have prompted this significant slim lining approach.”

Capita’s net debt at the end of fiscal year 2017 was around £1.15bn.

Profits hit by contract and volume attrition

The company warned that underlying profits in 2018 were likely to be between £270mln and £300mln, well below the £406mln expected by analysts.

"There is likely to be a significant negative impact upon profits from contract and volume attrition, the dropping out of one-off items... and increases in some cost items,” it explained.

"These headwinds are particularly expected to impact upon the financial performance of the Private Sector Partnerships, in both insurance services and customer management, public services partnerships and IT services division."

READ: Capita shares plunge as it warns on profits and announces £700mln rights issue

In reaction, Capita shares were down 41% to 202p in late morning trade.

Where Capita's problems began

Capita’s profit warning should not come as too much of a shock to the market since its problems have been building for quite some time.

In December, the company said the market for major contracts remained subdued, particularly in the public sector.

A month later it announced the loss of a major contract with pensions giant Prudential PLC (LON:PRU).

Mike van Dulken, head of Research at Accendo Markets, said today’s update will have been “painful” for the market and “may well sting a while longer”.

“However, it may yet prove a case of honesty being the best policy and short-term pain being necessary to ensure a successful turnaround and deliver long-term gains for loyal shareholders who’ve had it tough to say the least,” he said.

'We can't afford another Carilion', says trade union

Frances O'Grady, the general secretary of the Trades Union Congress (TUC), urged the government to step in to address the issues at Capita to avoid a collapse. 

“We can’t afford another Carillion," O'Grady said.

"The TUC is calling for an urgent risk assessment of all large outsourcing firms. It’s essential the government completes this quickly and is prepared to bring services and contracts in-house if they are at risk.”

Labour also called on the government to oversee the activities of Capita, which employs about 70,000 people in the UK.

Jon Trickett, the shadow minister for the Cabinet Office, said: "The Tories’ privatisation dogma risks lurching our public services from crisis to crisis, threatening jobs, taxpayers’ money and leaving people without the services they need."

He added: “The government must end its ideological attachment to private profit in public services and instead start putting the public interest first.”

 

Quick facts: Capita PLC

Price: 148.55 GBX

LSE:CPI
Market: LSE
Market Cap: £2.48 billion
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