Capita: What does the company actually do? And is it another Carillion in the making?

Can it be turned around? And should we expect other outsourcing firms to follow it into trouble?

The contractor Capita on Wednesday issued a profits warning, cancelled its dividend and said it would request up to £700m in extra funds from investors. The share price plunged by 47.5 per cent in response.

The news follows the traumatic collapse into liquidation of another big outsourcing firm, Carillion, earlier this month.

So what does Capita actually do? Can its fortunes be turned around? Or is it another Carillion in the making?

And should we brace for other outsourcing firms to follow it into trouble?

What does Capita do?

Like Carillion, it’s a major provider of outsourced services to the public sector.

But whereas Carillion’s specialism was the “blue collar” construction and maintenance of buildings, Capita’s focus is “white collar” back office IT projects and administration.

Two of its most high-profile contracts are collecting the BBC licence fee from households and running the London Congestion Charge. It also looks after the NHS’s administration services.

Work by the research group Tussell suggests that the firm won contracts from 226 different public sector buyers over the last two years alone, with around half of these coming from local governments.

Capita secured more than twice as many contracts as its next biggest rival, Mitie, over that period, emphasising the degree to which the public sector depends on the firm.

So it only does public sector work?

No. The 2016 annual report said 53 per cent of Capita’s revenue came from the private sector. This includes work for pension funds, retailers and telecoms companies.

The company employs around 73,000 people, three quarters of them in the UK, and the rest in Europe, India and South Africa.

In the six months to June 2017 Capita reported total revenues of £2.1bn, roughly the same as the year earlier. However, reported profits were only £28m, down 26 per cent on a year earlier. Free cash flow fell 9 per cent to £182m.

Weakening results and profit warnings had forced the departure of previous chief executive of three years, Andy Parker, in March last year.

The Capita share price peaked at £13 in July 2015. On Wednesday it was trading at just £1.82. That has taken the market capitalisation of the firm from above £8.6bn to just £1.2bn.

What’s the latest thing that’s gone wrong?

In its announcement to the stock market on Tuesday the new chief executive, Jonathan Lewis, did not hold back.

He said Capita was spread over too many markets, had underinvested and that there had been “too much emphasis on acquisitions to drive growth”. He also mentioned “weakness in new sales”.

“Capita is too complex, it is driven by a short-term focus and lacks operational discipline and financial flexibility,” was Mr Lewis’s unsparing conclusion.

On top of this, Mr Lewis said the firm still had too much debt, at £1.15bn, and that this urgently needed to be brought down through selling assets.

“Not exactly solid foundations,” responded Mike van Dulken, head of Research at Accendo Markets.

Other analysts and traders were similarly spooked (especially with the Carillion experience fresh in their mind) hence the brutal share price sell off.

So is Capita the new Carillion?

Some City of London analysts welcomed the drastic action by Mr Lewis to shore up Capita’s balance sheet, suggesting this is this kind of “kitchen sinking” that Carillion ought to have done.

Some highlighted that Capita’s cash reserves are around £1.2bn, which should, in theory, give it leeway to get its house in order. Carillion ultimately failed because its banks refused to extend their loans to the firm.

Yet though Capita’s cash position is stronger than the £390m that Carillion was reporting in its most recent report it was not lost on investors that Carillion burned through that cash extraordinarily rapidly, so that it had just £29m in the bank by the time it finally sank into liquidation.

The deficit in Capita’s defined benefit pension scheme is also apparently smaller than Carillion’s. Mr Lewis told the stock market that the deficit was expected to be “significantly below” the £381m reported last June (versus Carillion’s roughly £600m shortfall) and that the firm would pump an additional £21m into the scheme this year.

The Prime Minister’s spokesman said the Government was monitoring the health of Capita and did not think it was in “a comparable position” to Carillion.

But the reference by Mr Lewis to acquisitions being used to drive growth at Capita and the slowdown in contract renewals is ominous because that appears to be the story of Carillion’s downfall.

Michael Donnelly of the stockbroker Panmure Gordon, who has been warning about the fragility of Capita for two years, estimates that £469m of its public sector contracts are up for retender this year.

If it cannot hold on to those contracts, and the revenues from them, it will be in serious trouble.

Could other outsourcing companies be in trouble too?

Some of the big players in the outsourcing sector are certainly under similar pressure in the stock markets.

The share price of Serco is down 30 per cent over the past three years. Mitie is down 36 per cent over that time. Interserve is down 81 per cent. Both fell further on Wednesday.

Analysts say these firms have been underbidding for public sector contracts in recent years, effectively overstretching themselves financially to win new work.

However, other outsourcers are doing better in the stock market. G4S’s share price is flat late 2014, Sodexo is 27 per cent higher and ISS up 33 per cent.

The broad point about outsourcing firms like Capita is that it is inherently difficult for outsiders to estimate their value accurately since their worth is largely based on complex and opaque contracts for the future delivery of services.

If managements are overly aggressive in their valuations of these contracts and the amount of profit they expect to make from them it’s not simple for outsiders to identify that hubris.

The National Audit Office argued in 2013 that there ought to be more public transparency over the sector’s books given the public sector’s inordinate reliance on them.

In response to the Carillion debacle and the latest crisis for Capita, Labour is pressing for the law to be changed to make private contractors subject to Freedom of Information laws.