The past couple of years have not been a happy time for the large outsourced service providers who support the public sector in the UK and increasingly beyond.
We might trace the beginning of the problems to the scandal around prisoner tagging which engulfed Serco and G4S back in 2013. At the beginning of that year, Serco’s share price was about 500p. Today it is at 112p. G4S, which also had problems around the London Olympics, has come through the period much better, it should be said, but perhaps that proves the point, as the firm has a higher proportion of private sector business than Serco or Capita.
Indeed, it has become clear that the problems are much wider than the tagging events, in terms of both the causes and the firms affected now. Capita, the giant of the outsourcing industry, saw its value crash by around a third virtually overnight last September on the back of poor results and a profits warning that took investors by surprise.
One reason for this is the squeeze on public expenditure generally. It has taken a while to really bite, but following the financial crash of 2008-9 and various crises in public finances around Europe, providers are no longer seeing an ever increasing pot of money being made available to them. As Capita said in their statement last year, “revenue from new major sales in the second half of this year is likely to be lower than expected, due to continued delays in decision making and lower conversion of our pipeline”.
Read into that what you will in terms of causes, but slower decision-making may well be an indicator of lower budgets and cost pressures. Combine that with what you might see as more cynicism or realism about what outsourcing firms can really do for government, and these factors have certainly depressed the outlook for such firms.
There are also issues with the accounting practices in some of these businesses. Mitie is another firm that has built its business in the main on government contracts in areas such as buildings management, cleaning and security. In an outspoken opinion piece for The Times last week, respected equity fund manager Tim Steer claimed that the Financial Reporting Council, which should regulate firms’ accounting, was aware of potentially “significant problems” with Mitie’s accounting as far back as May 2015 but failed to act.
“Where was the Financial Reporting Council? As early as May 2015, the regulator was aware of the perceived significant problems in Mitie’s accounts, but did nothing. It was happy, it seems, that the company’s accounting policy on mobilisation costs, accrued income and goodwill (all policies to inflate assets and profits) were tickety-boo”.
There is an interesting question here for public sector buyers as well. Contracting authorities generally want to check on the financial health of firms bidding for work, certainly for longer term, large and sensitive contracts. But if the Financial Reporting Council can’t see (or don’t care) that a firm’s accounts are perhaps inaccurate (it looks like Mitie’s profits may have been overstated by as much as 40%), then how is the humble procurement manager in a local government or health organisation supposed to unravel and understand these complex matters?
And this does all have impact on the public sector; Mitie has basically had to give away its healthcare division, which must have some impact on clients, including public sector bodies.
Maybe there should be a new category of exclusion from bidding, along with not paying your taxes, corrupt practices and so on – perhaps if your accounts are found to be dodgy, you should be barred from bidding for pubic contracts for two years? But of course that might just drive firms like Mitie out of business altogether, which is not really good news for anyone.
The other point to note is that some of the pressure on this type of firm may be coming from better performance by contracting authorities and buyers. If the public sector is getting smarter at contracting and contract management – holding firms to account on performance, for instance – we might expect to see some effect on margins. We’re not convinced this is the main reason for what has happened to share prices in the sector, but it may well play a part.