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Serco's Soames doesn't have all the answers

Back then, many investors somewhat counter-intuitively believed outsourcers would benefit from an age of public-sector austerity, as governments would look to them to cut costs. In reality, austerity has put pressure on fees and made mandarins more circumspect about signing deals.

Serco's update this month told a classic story of corporate rise, over-reach and fall. After outlining £1.5bn of likely balance sheet write-downs and provisions, new chief executive Rupert Soames identified two "strategic missteps" taken by his predecessor Chris Hyman under chairman Alastair Lyons, who this week admitted "ultimate responsibility" and resigned.

First, Serco reacted to slowing growth and increased competition in its core markets by diversifying into new areas that required different skills - notably business process outsourcing (BPO). Mr Soames now wants to refocus the group on its original skill set of providing services to governments in five core sectors: justice and immigration, defence, transport, citizen services and healthcare. It will sell most of its BPO businesses, which will require writing down "a large proportion" of the £500m of associated goodwill. Mumbai back-office provider Intelnet will probably fetch less than the £385m it cost in 2011, for example.

The second misstep was to bid too aggressively for new business. "There have been significant advances in public sector contracting, particularly in the UK, with new models that transfer substantially more risk to suppliers," explained Mr Saomes. Good for tax-payers, bad for outsourcers.

The company now has a number of loss-making contracts, the single largest being a deal to maintain patrol boats for the Australian navy that need a lot more work than initially thought. The much-criticised contract to look after UK asylum seekers - a government committee accused Serco and peer G4S (GFS) of providing "squalid rundown" housing - is also proving hugely expensive. It looks like Serco will need to make about £450m of so-called 'onerous contract provisions' to account for the unexpected losses. The final number will be made public when the company reports its full-year results in March.

These missteps were made worse by poor management oversight, added Mr Soames: "Serco's infrastructure has not kept pace with its growing scale, breadth and complexity." This magnified the chances of cost overruns, risk being signed into new contracts and public-relations disasters such as this year's scandal over the electronic tagging of dead offenders. The new boss has completely overhauled internal management processes.

So what are shareholders to do? One reading is that Mr Soames has lumped all the group's problems together - a so-called 'kitchen sink' job - in order to focus on progression in future updates. A generous parallel might be drawn with G4S, whose shares are up nearly 30 per cent since the group made headlines for bungling the Olympics security contract in mid 2012.

But that parallel is deceptive. G4S came under fire for operational competence, but nobody questioned its business strategy, which is focused on a single sector - security - mainly in the private sector. Serco's problems clearly extend far beyond one PR disaster. A more ominous parallel could be drawn with the banks. Public-sector contracts have something in common with loans: if they go well, they provide a wonderfully reliable income stream; but if they go badly, they tear through capital, demanding huge write-downs. Mr Soames' description of Serco's hunger for growth at any price is reminiscent of the banks' attitude to lending during the 2003-2007 boom.

At the very earliest, I'd wait until the £550m rights issue next year before buying back into Serco. Even then, I have doubts about Mr Soames's vision for corporate repair. One of the group's biggest problems is its dependence on very large government clients it cannot afford to alienate. This dependence surely explains why it has made "limited progress on additional cost recovery with our customer", as management put its failure to renegotiate the Australian naval contract. Mr Soames offers no way round this problem - in fact, his refocused Serco would be more reliant than ever on just a few government clients. The boss needs to explain how this can possibly make good business sense.