Why Shares In Serco Group plc Plunged 30% Today

Shares of outsourcing company Serco (LSE: SRP) plunged by as much as 30% this morning, after the company announced that it was planning to undertake a £550m rights issue along with £1.5bn of impairment charges.

Additionally, management revealed that the group was lowering its forecast for adjusted operating profit this year by £20m, to £130m-140m. The outlook for 2015 was also lowered.

Today’s news, which was described as a “bitter pill” by Serco’s chief executive Rupert Soames, follows the conclusion of a strategic review by the company and is the latest in what has become an almost constant stream of bad news for the troubled outsourcer.

The review identified of £1.5bn impairments, about half of which is related to goodwill and intangibles. Unfortunately, as Serco’s balance sheet is written down, it’s expected that the company will be pushed into a breach of its debt-to-profit covenant on a private placement loan.

Serco plans to hold talks with its lenders to amend the conditions and the £550m rights issue, pencilled in for the first quarter of 2015, is designed to shore up the balance sheet. 

A bitter pill

After falling by a third this morning, Serco’s market capitalisation currently stands at around £1.2bn and the company’s last set of accounts reveal total assets of £2.8bn and shareholder equity of £1.2bn. These figures really put Serco’s £1.5bn impairment into perspective and explain why investors have rushed to dump their shares. 

Indeed, wiping £1.5bn of assets off Serco’s balance sheet will mean that shareholder equity turns negative, which is never a good sign. That being said, the £550m rights issue will go some way to shoring up the company’s balance sheet, although it remains to be seen if this cash call will be enough. 

In particular, after shoring up its balance sheet, Serco still has to regain the trust of its customers, as the group’s reputation has taken a battering over the past few years.

Nevertheless, the group has now admitted many of its past mistakes and Serco’s full strategic review, which will be revealed alongside full-year results, notes that the company:

” … Serco lost some of its focus and diluted its operational expertise…it [the group] has concentrated too much on winning new business and has failed to manage effectively the fact that over recent years there have been significant advances in public sector contracting, particularly in the UK, with new models that transfer substantially more risk to suppliers. As a consequence, we now have a number of contracts which are making large losses, and others which are in sectors where we are sub-scale …”

Further, management has come to the conclusion that Serco’s systems and controls are not suitable for a company of Serco’s size. A lack of spending on company infrastructure over the years has held the group back. 

Not attractive 

Even after today’s declines Serco is not an attractive investment to me. Based on current City forecasts, the company is trading at a forward P/E of around 13. However, these forecasts have not been adjusted to take into account Serco’s lower profit forecast for this year and the dilution that will occur as a result of the company’s rights issue. 

What’s more, Serco still has a lot to prove before investors can start to trust the company again.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.