With Rupert Soames at the helm, Serco shareholders can be sure of one thing: there will never be a shortage of metaphors. Having turned over a few stones, the new chief executive thinks Serco must shed several barnacles from its hull; while this is a bitter pill for shareholders, it’s better swallowed now. Or try the French version. It’s a case of “reculer pour mieux sauter”, said Soames – taking a step back to be better able to leap forward.
In any language, Serco is a right old mess. This was the fourth profits warning in a year. There was a £1.5bn hit to the balance sheet to cover asset write-downs and expected losses on big contracts. A £550m rights issue has been ordered for next March when the horrors have been fully audited. Bank of America Merrill Lynch and JP Morgan are on “standby” to underwrite the cash-call but are not today standing by a specific share price. Meanwhile, Serco has abolished its dividend. Faced with a one-third crash in the share price, investors’ response was probably more Anglo-Saxon: WTF?
The short answer is that Serco’s troubles run deeper than a few difficulties with electronic tags for non-existent prisoners. Former chief executive Christopher Hyman, it now seems, was too busy shouting about his and Serco’s supposed ethical superiority to follow basic rules of sound management.
Soames, it should be added, was too polite to kick Hyman personally. But he did identify two “strategic mis-steps” made by Serco. First, it diversified from its core markets, often via acquisitions. Second, it concentrated so much on winning new contracts that it failed to spot the risks it was taking on.
As an example of a duff contract, look at Serco’s work maintaining Australian patrol boats. Somehow the company seems to be on the hook for repair costs caused, in part, by bad design of the vessels in the first place. The liabilities on the remaining contract may run to £150m.
Soames’s bitter pill is the only one likely to address such fundamental ailments: Serco will concentrate on what it thinks it is good at. That translates as services to governments in areas such as justice and immigration, defence and transport. It’s goodbye to barnacles such as business processing for private companies. A useful side-effect is that Serco will be a smaller company and thus, in theory, easy to manage. Turnover will fall to £3bn-£3.5bn in 2016. That compares with £5bn last year.
According to the script, Serco will emerge in 2017 as a smaller and sharper operator. On the way, though, operating profits will fall as low as £100m, from £220m in the old days. But there’s no obvious alternative strategy and Soames, after 11 successful years at Aggreko, remains shareholders’ best hope of seeing some financial discipline injected into Serco. His overdose of metaphors is a big improvement on Hyman’s overload of vacuous feel-good boasts.
Banks’ bigger buffers
Is it a “watershed moment” in ending the problem of banks being too big to fail? That was the boast of the Bank of England governor, Mark Carney, wearing his international hat of chairman of the Financial Stability Board.
In a sense, he’s right. More than half a decade after the failure of Lehman Brothers and the state-sponsored rescue of Royal Bank of Scotland, financial regulators have finally stated how big capital buffers should be to avoid the need for taxpayers to write a large cheque in the next crisis. That is definitely progress.
The technical answer is that banks’ loss-absorbing capacity should be 16%-20% of assets, adjusted for risk. Throw in other buffers imposed nationally and the real range might be 21%-25%.
The thinking here is hard to dispute. In 2007-09, capital buffers were so low they were a joke. It is clearly sensible to force the likes of RBS, HSBC, Barclays and Standard Chartered – the UK banks affected by the new rules – to be able to absorb much bigger losses.
There is a price to pay in terms of banks’ higher funding costs, which will be passed on to customers, but so be it. The alternative was the current mad system whereby big banks enjoy, in effect, a state subsidy. That is bad for competition and stability, as well as taxpayers.
The difficulty lies in believing that, in a true crisis, governments would hold their nerve. For a crisis engulfing a single bank, it would not be hard to burn a few bondholders. But what if several global banks were on the brink at the same time? Would governments really allow bondholders’ losses to ricochet through the financial system and across borders? Or would national self-interest trump sensible coordination? It is impossible to say until the next crisis plays out.
So, yes, it is indeed a watershed moment for the regulators to have a plan for battle. By definition, though, financial crises occur out of the blue when regulators have been taken by surprise, or have been asleep. Judge the success of these bigger buffers only when they have been tested by events.
Revolutionary blow
Quindell is the company that wants to “revolutionise the insurance industry” with its handling of claims. It should stick to that ambition rather than revolutionising the way its directors deal in the company’s shares. Chairman Robert Terry and two other others last week entered into a “sale and repurchase” agreement with an outside financing house called Equities First. Some of the proceeds have been reinvested into Quindell shares – but not all, or at least not yet. As that detail became clear, Quindell’s shares fell 20%. What did Terry and co expect? If it requires two announcements to explain the detail, outsiders are bound to be baffled.
