Come back Capita

In theory, the current age of austerity should be good news for big outsourcing companies such as Capita. After all, they're in business to save their customers money by running parts of their organisations. So outsourcing should be high on the agenda of the UK's public sector; simultaneously, outsourcers should be able to offer hard-pressed private-sector operators ways of becoming more efficient to stay competitive.

However, the reality is that the uncertainty caused by last year's change of government meant that outsourcing decisions were delayed, which resulted in disappointing trading for Capita. Its November trading update was a low point for a group that is usually lauded for its ability to hit the City's expectations, helped by the predictability of its revenues. It warned that pressures on public spending would "subdue" revenue growth more than anticipated and, as a result, the share price dipped below 650p.

Importantly, though, the tough 2010 seems to be no reflection on Capita's abilities. During the year it won one of every two contracts it bid for and, according to independent research firm IDC, its market share in the UK remains at 23 per cent. The long term also remains promising, with IDC estimating that only £7.8bn of a market possibly worth £117bn is currently outsourced.

While it would be premature to say Capita's market has turned, 2011 certainly holds more promise. There are already signs that contract wins are picking up following a particularly slow finish to 2010 - in the second half Capita only won £272m-worth of contracts, compared with £523m in the first half. Yet in the first seven weeks of this year it won five contracts worth £244m.

In February, Capita also reported a record bid pipeline worth £4.7bn, up £1bn from a year earlier. Bids are only included in the pipeline when Capita is at the short-list stage and, encouragingly, its list of bids yet to get to that stage was also at record levels. In addition, revenues this year should be helped by the fact that many of Capita's contracts are inflation-linked and the group only faces two re-bids for major contracts through to 2015.

All that said, it seems unlikely that 2011 will generate organic growth overall. Most City analysts expect the year to be flat. The hope is that, after a weak first half, the second half will show sufficient signs of improvement to give Capita's shareholders reason to think that the austerity-related boost is finally under way. With the Treasury leaning on central government to save £6bn from its £16bn administration costs and local government expected to make cuts of over 7 per cent a year for four years, outsourcing must have a major role in the cuts agenda.

Meanwhile, Capita has acquisitions, its own efficiency improvements and share buy-backs to boost its earnings growth. Bolt-on acquisitions are a constant for Capita, but, as the market has slowed, acquisition activity has picked up. In 2010, the group completed 12 deals worth £301m, compared with £178m in 2009; and, so far this year, it has announced another £86m worth. In the long run too much growth via acquisition might be a risk, but in the short term it keeps the momentum going.

Capita's profit margins should also be able to continue their gradual widening, thanks to the group's increasing scale and improved efficiency through low-cost operations in India. There are concerns that the government will negotiate harder on new contracts, but anecdotal evidence of this is still in short supply. Meanwhile, Capita's programme to buy back its own shares should provide a useful tailwind to earnings per share. In 2010 the group bought back 15.4m shares, which was equivalent to 2.5 per cent of the share capital.