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Why I won’t touch Capita with a bargepole after today’s news

Today, troubled outsourcer Capita (LSE: CPI) published further details of its long-awaited £700m rights issue

To shore up the balance sheet, management is looking to raise £701m, or £662m after fees to advisers, from shareholders. This will enable the group to pay down some of its £1.2bn net debt (there’s also a £407m pension deficit to deal with), fund its restructuring and invest in new technology. 

The three-for-two rights issue will see the firm issue one million new shares at 70p each, a discount of 34% to the theoretical price that the shares should trade at after the rights issue.

Neil Woodford’s Investec and Woodford Investment Management will be the most significant contributors to the fundraising as they are Capita’s largest investors with a 15% stake. 

Uncertainty removed? 

City analysts have been waiting for further details on Capita’s rights issue, and now that the company has put out more information, some of the uncertainty over its future has been removed. However, despite this clarity, I’m still not interested in the shares. 

I believe that Capita is only at the start of a long process of restructuring. According to the company’s full-year 2017 figures, management expects underlying pre-tax profits of between £270m and £300m for the year ending 31 December 2018, before restructuring costs. This figure is more than 20% below the underlying profit of £383m reported for 2017. The enterprise reported a £513.1m annual loss on revenues of £4.2bn for the year to the end of December. 

Management does not expect the firm to return to growth until 2020 as the group works through its existing cache of contracts. 

To help fund the turnaround, management has also decided to eliminate Capita’s dividend distribution until it is “generating sufficient sustainable free cash flow,” which could take several years. 

Plenty of work to do

Add all of the above together, and I believe that while Capita’s outlook has improved now that it has announced a rights issue, it will be several years before the business is back on track and growing again. With this being the case, it seems to me as if investors face several more years of uncertainty and, perhaps more importantly, no income while they wait for the turnaround. 

There is also no certainty that Capita will be able to turn itself around successfully over the next few years. New CEO, Jonathan Lewis has set out to fix the company’s “short-term focus” as well as its lack of “operational discipline and financial flexibility,” which sounds impressive, but I would like to see results before investing. 

Indeed, the whole outsourcing sector is currently struggling as rising costs are eroding razor-thin profit margins on contracts signed years ago. It will be some time before these legacy issues run off and the industry can return to growth. 

So overall, for the time being, I would avoid Capita. There are plenty of other investments out there with a brighter outlook. 

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.