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Wheels coming off G4S recovery?

The latest reputational damage adds to weakening investor confidence in the outsourcer's recovery potential
August 22, 2018

The UK government has taken over the running of HMP Birmingham from security group G4S (GFS), in a move that will put further pressure on outsourced UK public services. The Ministry of Justice announced it would take over at the prison, replacing the leadership team and requiring G4S to bring in an additional 30 guards. The Ministry will run the prison for an initial six-month period, and possibly longer.

IC TIP: Hold at 251p

The shares fell on the morning of the announcement but quickly recovered. Indeed, the financial impact of the intervention is expected to mainly come from the additional staffing costs. UK prison standards have come under increased scrutiny in recent times, with prisons minister Rory Stewart pledging earlier this month he would quit if standards at 10 of the most challenging facilities did not improve in the next 12 months. Outsourcers run none of the prisons singled out by the minister, but G4S runs five facilities in the UK, as does rival Serco (SRP).

Despite a high level of press coverage, the government’s intervention is unlikely to have a lasting financial impact on G4S. The group’s care and justice division accounted for just 7 per cent of revenues during the first half and operates in both the UK and Australia. Ironically, the potential impact could fall more heavily on Serco, which is more exposed to the UK public sector, and could, therefore, suffer more if attitudes towards outsourcing sour further. The UK government accounted for 39 per cent of Serco’s revenues in the first half of the year, while government clients accounted for more than a fifth of G4S’s sales during the same period. Serco chief executive Rupert Soames recently spoke about the challenges facing outsourcing in the UK, noting that the market had been “somewhat dysfunctional for several years”.

However, even if failings at HMP Birmingham do not cause much financial damage to G4S, confidence in its longer-term prospects appears to have fallen. During the first half, underlying revenue growth was an anaemic 0.2 per cent, while a poor performance in its secure solutions business in the Middle East drove underlying pre-tax profits 3 per cent lower at average exchange rates. A decline in profitability also increased net debt as a proportion of adjusted cash profits to 2.7 times, above management's 2.5 target ratio.