Serco gets placing away but challenges remain

Embattled security group Serco (SRP) has completed a share placing to shore up its balance sheet following a material downgrade to profit expectations for the current financial year. The placing was first flagged in a profit warning last week that signalled challenging trading and sent the shares tumbling 15 per cent to 344p.

Serco placed almost 50m shares at a placing price of 320p, raising gross proceeds of around £160m. The new shares, which represented almost 10 per cent of the group's issued share capital prior to the placing, were sold to certain existing shareholders and new institutional investors. The placing, which was not open to members of the public, strengthens the group's balance sheet after a 28 per cent cut to expectations for adjusted operating profit in 2014 left it sailing close to the wind on its 3.5 times net-debt-to-ebitda banking covenant.

The strengthened balance sheet gives breathing space while the group undertakes a strategic review spearheaded by new chief executive Rupert Soames - previously the highly regarded boss of Aggreko. Serco expects to present the results of the strategic review when it reports its 2014 full-year results.

Credit Suisse says...

Neutral. We cut our earnings per share forecast for 2014 by 25 per cent and for 2015 by 7 per cent (to 17.98p and 22.15p, respectively) to reflect the extra margin headwinds and dilutive equity placing. We currently see the investment case as balanced. The arrival of a formidable CEO, guidance that includes a contingency buffer and a successful placing are clearly positive. But we see rebid risk and the potential for contract closures and divestments after the strategic review as key reasons for caution.

Investec says...

Sell. It is now clear why Rupert Soames has brought forward his start date. It will be important that he leads the charge on the rights issue given a lack of confidence in the current internal leadership team. The market will need to be convinced that this downgrade will be the last - not an easy task given 800-plus contracts. We have been long-term bears on this stock and see no reason to alter this stance until we get comfortable with the underlying margins and organic growth potential of the business. This warning and - finally - recognition that the balance sheet is strained will further constrain its ability to win new work.