One of Capita’s (CPI) largest shareholders is tipping the troubled outsourcer to bounce back, claiming the business is worth at least two-thirds more than its current £2.14 billion market cap.
In the space of three years, Capita’s share price has slipped 90%, from a high of 1,320p to trade today at 135p. That’s thanks to a string of profit warnings, the first of which came in September 2016 when the firm traded at 990p.
“Three years ago, Capita was a company that could do no wrong,” says Alessandro Dicorrado, manager of the Investec Global Special Situations fund.
“When Serco and G4S were having their problems, everybody was saying ‘just invest in Capita’ and it was at £13. Now it’s at £1.30, so one-tenth, and people say don’t touch it with a bargepole.”
A cloud has hung over the outsourcing sector ever since Carillion’s demise in mid-January. Capita didn’t help itself by, just a fortnight later, issuing a second profit warning, the announcement of a £700 million rights issue and dividend suspension.
We pointed to the number of high-profile fund managers that had exposure to the stock at the time, including Neil Woodford and Mark Barnett. However, perhaps the one who was most annoyed by events was Dicorrado.
He initiated a position in Capita on 30 January and told Morningstar.co.uk that it was almost a perfect investment for his team. “Our ideal investment is when a company suffers a large, but non-fatal blow,” he says.
“People will focus on the large part of it and not on the fact that it’s not fatal. We thought Capita wouldn’t die and we thought that the price was right.”
However, less than 24 hours after Dicorrado bought shares in Capita, his investment had halved. But that didn’t deter him, and he ended up buying 10% of the company in the ensuing couple of days. After participating in the rights issue in May, the stock is now the largest holding in the fund.
Capita Could Have Significant Upside
The first thing Dicorrado points out is that there are big differences between the situations at Capita and Carillion. “The thing with Capita was that Carillion had just gone bust and people were saying it’s the same thing. Actually, the two businesses are completely different,” he explains.
“In Carillion, there was almost the allegation that you could make of accounting fraud, where management really hid the problems. Capita had some problems, but you could see from the cash flow statement that there was an underlying business there.”
In fact, Dicorrado reckons there are parts of the company – in particular its software business – that are quite valuable. On his low growth rate estimates, the business is worth between 200p and 220p – possible upside of 62%.
“If I’m honest, we haven’t quite understood exactly the dynamics of the industry because part of the outsourcing industry is in contraction and part is in growth and how Capita is exposed is not entirely easy to tell,” he admits.
“We think it’s fair to say it’s low growth, but it’s possible that this is quite a high growth business. If it is, then there is significant upside and you can make multiple times your money.”
Management will be a key part of the investment case. Under previous leadership, the company had become a mess. “They were operating under a different paradigm and they were very slow to adjust,” adds Dicorrado.
“The company was incentivised on revenue growth but not on profitability. When you’re in a contracting business that’s bidding on fixed-price contracts that’s incredibly dangerous.”
New boss Jon Lewis, who joined in December, is known as a turnaround specialist. Dicorrado holds off praising Lewis too much, but says he “seems to be on the good side of sensible”. Chief financial officer Nick Greatorex is also “very good”.
“Sometimes, all that you need is for a sensible person to come in. He doesn’t need to be great; just sensible. All you need is a fresh pair of eyes. What they’ve done so far is sensible.”
