Troubled outsourcing group Serco continues to slide on worries about its proposed £550m cash call.
Its shares are currently 16.6p or 9% lower at 162.4p as Credit Suisse moved its rating from neutral to underperform and slashed its price target from 325p to just 142p. It said “ a covenant breach scenario is the alternative [to the rights issue] based on management guidance.”
The company had already lost a third of its value last week after an unsheduled update including another profit warning and news of the rights issue. It is down another 24% this week, following Monday’s resignation of chairman Alastair Lyons. Serco is also looking to sell around £500m worth of businesses as new chief executive Rupert Soames attempts to turn around the struggling company, hit by contract problems, write-offs and investigations into its operations including allegedly overcharging on monitoring prisoners.
Credit Suisse said:
After the unveiling of significant onerous contract provisions and the risk of more to come, we see huge uncertainty around the operational cash flows of the business. Free cash flow is set to be negative in 2014 and 2015 and we believe there will be no dividend until 2016. Investment in risk management, systems, controls and business development is likely to retard medium-term margin recovery.
The unscheduled update on Serco’s strategy review, including contract and balance sheet reviews published on 10 November was extremely poor... Impairments and provisions amounting to £1.5bn identified so far, including around £350m of onerous contract provisions reflecting future cash calls on the business, are the current best estimate of the parlous state in which the company finds itself.
We do not propose to review in detail the update, since we have concluded that trying to dissect every number or qualifaction contained in the statement is unlikely to get us much closer to understanding what the future shape, size or economics of the business than the next person.
Our central assumption is that Serco seeks rights issue terms of 8 for 11, i.e. 8 new shares for every 11 held, equivalent to a 28% discount to the prevailing share price. Whereas a good rule of thumb for rights issues is a starting point of 40% (driven in part by the desire of underwriting banks to mitigate their risk), we believe the unusual situation at Serco, where the stock continues to lack a hard ante-rights reference point, means that a 40% discount might prove too aggressive. However, there is significant uncertainty in this regard.
Overall the market is in better health than Serco. The FTSE 100 is up 33.97 points at 6712.87, on hopes of further European Central Bank stimulus and recent positive US economic data, outweighing weakness in the eurozone and China. UK public finance figures were in line with expectations and also provided some support.
The leading index is on track for its fifth weekly rise and its best close since the end of September.
Oil shares have been lifted by talk of a possible production cut by Opec next week, with Royal Dutch Shell B shares rising 32p to £23.85.
Rolls-Royce has risen 5p to 849p after it won a $5bn order from Delta Airlines, as anticipated here.
But Royal Mail, in the wake of its recent results, is down 9.3p to 420.4p, with Credit Suisse issuing an underperform rating although the bank edged up its price target from 377p to 380p.
Among the mid-caps financial group Paragon has added 14p to 382.4p as UBS moved from neutral to buy and raised its target price from 374p to 410p. The bank said:
We think Paragon is entering an attractive phase on its growth path during which a step-up in balance sheet growth should boost the group’s return profile. In the last few years, the improvement in underlying business results and profitability has been masked by a rapid fall in leverage, which has capped the recovery in return on equity.
Going forward, we expect this to correct as the pace of asset growth catches up with growth in equity and the firm increases leverage through corporate bond issuance, leverage at the portfolio acquisition unit IDEM, and balance sheet optimisation of back-book securitisations. We see earnings per share growth averaging around 13% in the next three years, with return on equity improving to around 12%. We think Paragon offers a compelling medium-term structural growth story, and upgrade the stock to buy.
