Serco Group PLC’s (LON:SRP) acquisition of the naval engineering arm of US defence technology group Alion looks sensible, according to RBC Capital Markets.
Last week the outsourcer announced a £130mln share placing to help fund the US$225mln deal to buy Alion’s Naval Systems Business Unit (NBSU).
READ: Serco launches £130mln cash call to fund acquisition of US naval engineering business
RBC on Wednesday raised its rating for Serco to ‘outperform’ from ‘sector perform’ and lifted its target price on the shares to 150p from 140p.
“The US Navy looks like a growth market, the deal adds capability for Serco, there are synergies from sharing the fixed overhead and the deal appears to be well priced (8x EBITA) and should be accretive to earnings,” the broker said in a note to clients.
“In addition, the UK becomes a smaller proportion of the group and given 80% of contracts are cost-plus, the risk profile is relatively low.”
RBC expects Serco's free cash flow (FCF) to improve markedly from £23mln 2019, to £83mln in 2020 and £103mln in 2021.
The broker said this reflects growth in the top line, margin improvements from the deal and the fall away of onerous contract provisions.
“This FCF should provide options for further mergers and acquisitions and to re-instigate the dividend,” it added.
RBC noted that Seco's management has worked hard to build a platform with the “right operational, back-office and risk management capabilities” and is now starting to benefit after the efforts of the past five years.
“The business is now in much better shape, and new contract and rebid momentum has been strong,” the broker said. “Positive organic growth and potential M&A over time should benefit margins further given the scalability of the platform that has now been created.”