What Serco must do to win City over

Serco has been a busy bee. After a series of scandals, a string of profits warnings and appointment of new CEO Rupert Soames in 2014, the accident-prone outsourcer has firmed up plans for a rights issue, completed its refinancing, published full-year results, scrapped the dividend and unveiled its full contract and strategy review.

Although first flagged in November, the rights issue launch has not been taken well. Serco shares had already plunged from 689p in summer 2013, but now languish at 181p, down three-quarter since then.

A one for one fully-underwritten cash call at 101p - a 51% discount to the previous day's close and big discount to the theoretical ex-rights price (TERP of 141p using a share price of 180p) - will raise £555 million for Serco, or £528 million after costs of which £450 million will be used to reduce net debt, currently £682 million, but with cash outflow of £150-200 million anticipated in 2015.

But this is just the start of a multi-year programme for Serco, says UBS.

"Serco needs to i) complete the divestment of some £560 million of revenues, ii) reinvest in business development to refill the bid pipeline, iii) complete a transformation of the finance function and improve business information, iv) adapt the cost structure to improve profitability, and to adjust to the fall in revenue," the broker reckons.

"From first impressions, financial disclosure looks thorough and the new accounting appears appropriately conservative. However, due to the significant impairments, provisions and exceptionals the picture is far from clear."

UBS points out that the £90 million guidance for trading profit in 2015 includes a £140 million release of onerous contract provisions, and significant tax assets in the UK will not be utilised until the UK profitability recovers.

And while the strategic plan for the long term is laid out, there is plenty of speculation about how long it will take to get there.

"In short: we think Serco can rebuild its business & reputation (we see neither the ambitions of 5-6% margins and 5-7% growth p.a. as out of kilter with industry average), but it is a long way off this today," writes analyst Rory McKenzie.

He makes no changes to estimates, predicting Serco will generate pre-tax profit of £67 million in 2015, down 13%, on revenue 14% lower at £4.1 billion. The 'neutral' rating and pre-rights issue target price of 165p remain, too.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.