Companies that supply services to the public sector are consolidating in the expectation that cash-strapped clients will turn to “one-stop shop” contractors – in spite of a government drive to encourage small businesses to bid for more work.
After Babcock International’s £1.4bn acquisition of VT Group last year, there has been a flurry of support services’ dealmaking, from Carillion’s purchase of Eaga to the takeover tussle between Interserve and Costain for Mouchel.
“Without the scale, you’re going to struggle,” says Steve Woolf, analyst at Numis Securities.
The recent tie-ups involve different sub-sectors; the activities range from maintaining RAF jets to enforcing the payment of parking fines for local authorities.
Yet each shares a key rationale: greater scale should allow the companies to bid for ever-larger contracts which they would otherwise struggle to meet.
For Interserve, a Mouchel combination would create an outsourcing powerhouse with operations ranging from benefits processing to property management.
“The contracts of the future will encompass all these things,” says Adrian Ringrose, Interserve chief executive. “It makes us a broader-based integrator – both blue and white collar services.”
Analysts say FTSE 250 waste management group Shanks, social housing maintenance company Mears and infrastructure services provider May Gurney are among the other potential takeover targets.
As well as consolidation between the already limited number of big service companies, the larger contractors are also snapping up smaller rivals.
Leaving private equity aside, corporate dealmaking in the UK support services sector totalled £5.2bn last year, according to DC Advisory Partners, with an average deal size of about £51m.
Capita, the back-office specialist, spent about £300m on small and medium-sized businesses in 2010 – its biggest ever annual acquisition spend.
Richard Marchant, the group’s local government director, says: “There’s going to be more demand for larger business process outsourcing deals and also shared-services deals – when one or more organisations get together and there’s up to four authorities involved. That’s about scale and building capacity.
“We are seeing a definite move to that.”
Several examples support the thesis. Capita boasts a 15-year, £242m “strategic partnership” with Swindon council handling several functions such as human resources and pay.
Serco has a £265m, 10-year contract with Glasgow, while Edinburgh has drawn up a shortlist of large suppliers including BT, Kier and Mitie to outsource services, worth up to £1.4bn over seven to 12 years.
The London borough of Barnet is considering outsourcing its entire back office to a single provider. “You’re going to see lots of that across London,” says Nick Walkley, chief executive. He accepts that only a limited number of companies have the capacity to deliver such a wide range of services. All is not lost for smaller suppliers, however.
David Cameron has pledged to reverse the state’s “institutional bias” against small business, and the coalition government says it “aspires” to award a quarter of government contracts to SMEs. Overall, only 16 per cent go to those with fewer than 250 staff, according to the Federation of Small Businesses.
Moreover, many prospective clients remain to be persuaded that “one-stop shops” offer the best value.
Joe Stock, procurement officer at Worcestershire county council, has seen many of the authority’s smaller suppliers acquired by the likes of Capita. Nevertheless, he estimates that SMEs still enjoy about 70 per cent of its annual £290m procurement budget.
Far from seeking to bundle the deals together, he says, the council has in the case of domiciliary care and cleaning carved up the contracts into 16 distinct geographic areas to encourage bids from local companies.
“We do it when we know we’re going to get added value or cheaper prices,” he says, adding that smaller operations often offer lower overheads, local knowledge and greater flexibility.
Moreover, the collapse into administration last year of Connaught, the former FTSE 250 social housing maintenance company that often undercut rivals on price, highlights the risks of relying on do-it-all service providers.
Even if large-scale partnerships offer better value in the long term, public bodies may turn to single service contracts that can be quicker and cheaper to procure, says John Tizard, director of the Centre for Public Service Partnerships.
Mr Marchant accepts that many authorities will conclude that large outsourcing is “not right for them”.
Some analysts suspect that consolidation is a defensive measure and that would-be predators are merely taking advantage of dented valuations. Recent results from Britain’s biggest outsourcing companies show the public spending cuts are taking their toll.
Pre-tax profits at Interserve fell 28 per cent to £64.1m, while profit warnings from Mouchel wiped as much as 79 per cent of its market capitalisation.
Elsewhere, Serco posted a 9 per cent improvement in annual sales – but nearly all of it came from its international operations. Capita endured its first organic revenue decline in at least a decade: excluding the contribution of acquisitions, sales fell about 5 per cent.
“A year ago Serco and Capita were saying how brilliant the environment was,” says Andy Smith at Charles Stanley.
“They’ve been backtracking since October. It’s tough for these guys.”
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