Serco charges dent profits

Serco chief executive Rupert Soames, hired to lead the group's recovery in February last year, has much more work to do. The outsourcer was hit with £1.3bn of contract provisions and asset impairments last year, driving an operating loss of £1.3bn. Around £558m of this relates to expected future contract losses between 2015 and 2024. Its UK Central Government division suffered most, with profits falling more than 300 per cent to a £243m loss. The loss of its electronic monitoring contract and the end of its Colnbrook Immigration Removal Centre deal dragged on the division's performance. Its order book also took a hit, down £1bn on the previous year to £12.6bn.

Serco took a misstep common to government outsourcers. An overly-aggressively attitude towards bidding for government contracts has meant the group has been weighed down by provisions it has had to make for loss-making contracts. Notably, its contract to provide accommodation for UK asylum seekers led to a £155m charge. A scarcity of accommodation, plus a greater number of asylum seekers than expected, meant the group has had to resort to housing individuals in hotels until dedicated housing becomes available. This has resulted in the group making a loss for each asylum seeker it accommodates.

Mr Soames told the Financial Times earlier this month that the group would need to curb its aggressive bidding for government contracts. He said the group needed "to get better at saying no" to certain contracts, refraining from signing deals unless they can be shown to be profitable. Julian Cater, analyst at Numis, said Serco's issues with its UK government contracts would have been magnified in comparison to elsewhere. "The UK government, recognising the other providers were chasing growth, asked them to sign up to basically more and more onerous terms," Mr Cater said.

Revenues for Serco's Asia Pacific division also took a knock last year following tighter immigration policies by the Australian government. This reduced the volume of people in Serco's care and saw turnover on its largest contract, on behalf of the country's immigration services, fall by a third. Overall the division made a £202m loss, compared with a £78m profit in 2013.

In April last year Serco announced it would be carrying out a strategic review. This involves slimming down the group and selling off non-core businesses, such as its environmental service and leisure business in the UK and Great Southern Rail business in Australia. The group intends to focus on public sector contracts in its five core sectors, including defence and justice and immigration. Management believes a low level of private sector penetration and the critical nature of public services gives plenty of headroom for growth.

In order to put the business on a firmer footing Serco also announced a £555m rights issue, which is expected to bring leverage down to around 2 times cash profits before tax. The group also reached agreements its with lending banks and US private placement noteholders to refinance its existing credit facilities. This will be subject to completion of the rights issue and it is estimated will reduce the company's gross indebtedness by £450m.