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Is It Time To Sell Serco Group plc?

Troubled outsourcing company Serco Group (LSE: SRP) is in the news once again today, as uncertainty surrounds the troubled group’s cash call, which was announced at the end of last week. 

In particular, Serco pre-announced last week that it intends to launch a fully underwritten £550m equity issue in March, when it completes a strategic review. However, investors have become concerned about the level of dilution now required to achieve this level of funding. 

Indeed, Serco’s shares have slumped by around 40%, to a ten-year low, since the rights issue was announced. This implies that the company will have to issue more shares than it originally intended, in order to achieve the level of funding required. 

And there’s little chance that the size of the rights issue will be scaled back. After announcing £1.5bn of impairment charges alongside the rights issue last week, Serco’s balance sheet is in need of a sudden cash infusion. So the company needs a hefty cash infusion to shore up its creaking balance sheet.

Plenty of uncertainty

It’s not just the potential dilution that’s concerning investors. There are now plenty of question marks hanging over Serco’s ability to compete effectively in the global market place. 

Over the past month, problems have continued to emerge with the group’s handling of contracts awarded to it over the past few years. These problems include a deal to accommodate asylum seekers, running healthcare services in Suffolk and maintaining the Royal Maritime Auxiliary fleet.

As the company struggles, City analysts believe that Serco’s free cash flow will be negative during 2014 and 2015; bad news for a company that’s already running out of cash. 

What’s more, City analysts believe that at the current share price, in order for Serco to raise enough cash to bolster its balance sheet, the potential dilution will reduce 2016 earnings per share to only 6p. 

In other words, according to current City forecasts, at present levels Serco is currently trading at a 2016 P/E of 27.2. This is an exceptionally high multiple for a company that struggling to turn itself around. 

Nevertheless, these figures are only estimates. It’s still not clear how many rights Serco will have to issue to raise all the cash it needs. 

Slimming down 

Despite the uncertainty surrounding Serco’s future, the company is trying to change its image: the group has brought on a new CEO, Rupert Soames, and chairman Alastair Lyons — who has been chairman of the company since 2010 — resigned earlier this week.

Further, Serco plans to sell off a host of businesses and it is hoped that a good business will emerge from the ashes when the turnaround is complete.

Still, there’s no denying that Serco has plenty of work to do before its recovery is complete and for the time being, I would sit on the sidelines. 

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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.