Capita Share Discussion Threads

[kingston78] 27/2/2018 11:29

Many companies have intangible assets. Some of these are probably more “worthy” than others if I may describe it that way.

In any case, the asset (whether tangible or intangible) is meant to be used to generate income, profit and cash flow for the company. So long as the company performs well the asset in question is worth it, otherwise the asset will be impaired in addition to its normal amortisation and depreciation charge.

The problem when it comes to a cash crunch is that Intangible assets, by nature, cannot be converted into cash easily.

There is a balance to be struck between utilising cash for investment, dividend or retention for a rainy day. You will find that some company executives take too much risk and paying too much dividend when the company is unable to do so, especially when the dividend is paid out of borrowing. Many large companies including mining companies bought back their own shares at peak cycle when they had a lot of cash, and then divested businesses in a downturn and tapped shareholders for more capital at a lower share price. They have misjudged the cycles and misused the cash resources. People think that they can access to cheap finance easily and put investors’ money at risk. They would have been more prudent if they were running their own family business using their own capital.

[massimoj] 27/2/2018 10:50

Hi Fenners - well some of the intangibles will be things like IP and proprietary systems, which do convey an advantage I think, at least to some extent. Some of these are market leading and Capita also has a scale advantage which creates barriers to entry in relation to certain contracts. Capita also benefits from sticky customer relationships, as often systems and services are designed specifically for customers and that makes it hard for those customers to up and leave to someone else (although obviously that can happen).

You are right though - people are very important to a business like Capita, but I think there are other barriers to entry and competetive advantages.

[fenners66] 27/2/2018 10:44

massimoj - your point of this business is capital light also highlights a weakness - effectively you are saying the company needs it's people to run but apart from that has no significant barriers to entry ?

Or is anyone arguing that the intangible assets include proprietary software that conveys an advantage?

If it is the former then when things get a bit tough the employees can leave - not all will be on restrictive contracts....

[massimoj] 27/2/2018 09:58

Kingston - I think your analysis is good and worth doing, but if I may, I think you are missing the wood for the trees. Capita is not a business that employs tangible assets to earn cash flows; it is a 'capital light' business model.

Yes, the balance sheet is stocked full of intangibles, but imagine if Capita had never acquired a company and had originated each business line in house; in that case, even the goodwill would not be there, and very likely the NAV would be negligable or even negative. This is common with businesses with similar business models, and further, it is worth remembering that Capita has paid out almost all of its profits in dividends instead of retaining them. If it had retianed them instead, it would have a tonne of cash, the balance sheet would look a lot better, but the business would have not performed any better. Retaining earnings flatters the balance sheet but does not reflect any increased intrinsic value to the operating business.

I think one has to be careful not to apply a traditional form of balance sheet analysis (and one which would have been very applicable to say Carillion) to a business which really does not require tangible equity to generate cash flows. After all, you would not say that Alphabet's balance sheet looks terrible, but strip out the cash and do the analysis you have done on Capita, and I think you would probably end up with that conclusion.

[kingston78] 26/2/2018 23:45

Another adverse impact on Capita's financial statements is the adoption of IFRS 15, the new accounting standard on Revenue Recognition. This will recognise lower revenue in early years of a long term contract while it will recognise more upfront cost, rather than spread more evenly as before. The result is reduced profit.

The 2017 accounts will adopt IFRS 15, with the 2016 accounts re-stated to reflect this change. The 2016 accounts would have a reduced reported profit by £146 million, but more significantly the effect on the Balance Sheet would be dramatic. Instead of a net asset of £483 million it would have a net liability of £553 million, an adverse swing of £1 billion although this would not affect cash flow.

I therefore foresee a complete meltdown in Capita's balance sheet as at 31/12/2017 under IFRS 15, especially after substantial impairment, restructuring and provisions. The Balance sheet will be in a net deficit exceeding £1 billion, even after retaining a significant portion of Intangible assets. In other words, it is technically bankrupt in the accounting sense.

There will be a battle of the company against existing lenders who are nervous of further exposure. Equity finance is the only viable option with a very heavily discounted rights issue diluting existing investors' shareholdings. Be warned!!! This is purely my own analysis, so please do your own research.

[kingston78] 26/2/2018 22:06

One accounting trick that highly indebted companies do at the year end is to delay payment to their suppliers. Whilst the overall liability has not changed its net debt (cash less borrowings) has become smaller and will be favourable in the calculation of certain financial ratios. This is to mislead the public.

However, detailed analyses of interest payable during the financial year, with an estimated or published interest rates on the borrowings, will reveal that the average net debt during a financial year is actually higher than the year-end net debt. Such analysis over a few years will probably show that average net debt has increased year-on-year, as was the situation with Carillion.

Window dressing the accounts is not illegal but the auditors should do their jobs more diligently, especially on the "going concern" issue. Rarely do auditors qualify their audit report on listed companies, and yet many of them have failed. If auditors don't do their jobs properly what is the point of having auditors in the first place?

[cryptotrade] 26/2/2018 17:53

wait for the legal cases.

[paddyfool] 26/2/2018 15:06

The punch line is the rights issue did not have a price when the agreement was made. The underwriters will not be prepared to write any agreement at anywhere near todays price. The board will be in chaos as the decision to place a rights issue is now at best in doubt. If they go low the dilution will be horrific if they go high, and by that I mean a 10-25% discount to todays price, they run the risk of not getting it away and being slaughtered in the after market. and if its seen as too hard to get a rights issue what then? The non-execs are earning their money today, rather them than me.

[kingston78] 26/2/2018 15:04

The auditors are probably auditing the financial statements for the year ended 31/12/2017. In parallel, they would be working on the rights issue.

It will take more time to audit and sign off the annual accounts this year, so I assume that the rights issue document will either be signed off at the same time as the audited accounts or be produced separately and accompanied by unaudited figures. I expect the rights issue document be circulated in late March to mid April from my experience.

On a separate note, the balance sheet has deteriorated over the years. As at 31/12/2016 it had net assets of £483 million including intangible asset of £2,754 million. The position as at 31/12/2017 would have deteriorated to the extent that the net position would have become negative , including intangibles not impaired.

Let’s think about it. Would you value a mature but troubled company to the tune of £1.2 billion when it has a negative balance sheet? That is what investors are valuing it at the current share price. The share price is too high to sustain this valuation. I expect the share price to drop significantly once the rights issue document is circulated to investors.

[fenners66] 26/2/2018 14:24

How can they announce a fully underwritten rights issue with no terms and then........ silence.

It's not stacking up for me.

[paddyfool] 26/2/2018 13:03

So the Standby underwriting commitment will have terms, certainly a collar. The odds are that we are now around the boot laces and no where near the collar. So if this is the case should not there be an announcement? I am surprised that there has not been more comment on the type of underwriting that has been suggested. In itself it shows risk and weakness.

[fenners66] 26/2/2018 09:18

Paddy - well put especially liked the analogy of ripping out the bathroom and kitchen.

dex - with all the balance sheet intangibles its clear that the houses they bought would have been worth less than they were worth to Capita.
So your £400k house analogy was really a £300k house - but it was right next to your family say. If you want to sell it before you have paid off your 100% mortgage you will be in negative equity - as paddy said - you also ripped out the kitchen and bathroom - you were using next door's !

Now the only buyers know you need to sell fast and they are offering £200k ..... what do you do?

[paddyfool] 25/2/2018 19:19

I think we are saying they have radically overpaid. Your house may be illiquid but at least you could sell it eventually and you didn't pay the entire value of it in debt as you had a deposit. Capita made there acquisitions based on their share price. i.e. they paid x times profitability when their share prices was trading at 2x profitability. The share price is now trading at x/10. A lot of those acquisitions are looking very ugly right now on that measure alone (Debt on the balance sheet). There are also very few notable acquisitions which have turned out well. Hence the CEO saying he is going to get rid of some.
So in summary yes they did overpay and unlike your house they bought 100% of the business with debt. Unlike your house the businesses acquired will not rise in value of their own accord. They will have to grow to acquire more value and very few have. Worse than that when a large corporate buys a business they take advantage of synergies...this is code for taking out as much cost as possible from the overhead and more besides. This has the effect of making the purchase look great, the reality is the cost savings somehow never quite materialise as they should, but they do have the effect of destroying underlying value. i.e. you cannot now easily resell that business as you have removed IT, HR, Finance, management, premises and by accident a chunk of the talent which made it worth buying, so the initial hoped for, and paid for, growth evaporates. So similar to buying a house and ripping out the bathrooms, central heating and kitchen and expecting it to rise in value.
Ok so Ive overcooked the argument but the principles are there.

[dexdringle] 25/2/2018 18:28

We keep talking about the company having loaded up on debt to buy other companies. But, like anything else, if you borrow to buy it the thing you have bought is still worth what you paid for it. I borrow £250k to buy a house worth £400k. Oh my god, I now have debt of £250k thats awful. Oh, hang on, if I get into difficulties I just sell the house for £400k and clear the debt.

Or are we saying that Capita borrowed to buy worthless assets ? Surely that would be madness ??

[kingston78] 25/2/2018 14:21

My financial analyses show that if we were to strip out the Intangible Assets the Balance Sheet of Capita would have a deficit of £ 2,057 million in 2015 and a deficit of £2,271 million in 2016. This means that the entire market capitalisation of the company was supported by Goodwill on acquisition (the Intangible assets in question).
Meanwhile the company was issuing bonds to investors to get more cash to plug the cash flow requirement. The company continued to pay dividend to investors using borrowings. I doubt the quality of earnings to sustain a progressive dividend policy as well as continuing acquisitions to boost earnings per share using more borrowings. This was a house of cards waiting to collapse.

All the flowery words in the annual accounts from the former board of directors were to mislead investors. They talked about their strength of controlled acquisition etc. Anyone prudent accountant can see the weakness in the balance sheet with increased borrowings.

The current new CEO saw all of those problems and are undertaking drastic corrective action.

Bas news normally comes in three's. I expect further bad news once the finances and accounts have been scrutinised. Where have all the good accountants gone?

[pal44] 25/2/2018 10:52

agree ..Capita doesn't have high cash generating contracts and is short of cash.
hence to raise cash will do a firesale will it be enough to pull it up . Still not a buying opportunity i think .

[paddyfool] 23/2/2018 07:54

There comes a point where the level of the raising makes the fire sale inevitable. The numbers will no longer work.

[cryptotrade] 23/2/2018 07:54

How can anyone be a buyer in a company which created a false market. I guess that's why it's fallen to this price. It's interesting to see some larger companies struggling however part of this is the need to change, evolve , COOP, AA.It may well be their model is now wrong anyway. They may need to operate small units in the business, as Amazon do.

[kingston78] 22/2/2018 21:24

On 31/1/2018 Capita updated the market. It reported that its net debt as at 31/12/2017 was £1.15 billion. It was forecasting that during 2018 it would have cash outflow of £215 million on known commitments, and a further £260 million on others. That is a total of £1.6 billion net debt.

They expect the pension deficit be reduced from £381 million when revalued by actuary. However, they would contribute an additional £21 million in 2018 on top of normal contribution.

The above figures are frighteningly large, and they provide an insight into how Capita was being run into the ground by recklessly ambitious expansion. If you have read my previous posts you will agree with me that uncontrolled expansion based on debt finance will ruin any organisation.

The £700 million underwritten rights issue will not be enough because I doubt that Capita will get their disposal proceeds fast enough or high enough. Any bidders will pitch in at a low price. I expect that the size of the rights issue will be increased to £1 billion.

It is a long struggle from here.

[paddyfool] 22/2/2018 16:48

Capita now have the problem that they will struggle to win substantial new contracts and that the existing contracts will come under attack at renewal, to the extant they will have to price even more aggressively to retain their customers. This is what happened at Xchanging. The difference was that Xchanging had good margins on the existing contracts which threw of cash, and the contracts were very deep and difficult to get out of because there was a lot of IP involved. Also it had very little debt. Xchanging limped along for several years before being taken out. At no stage in the limp did it grow or win any major contracts. It was run as a cash cow waiting for someone to buy it for its insurance interests which they duly did.
Here it is different. Capita doesn't have high cash generating contracts and is short of cash. It has stated that it will have to raise a significant amount of cash through a rights issue some £700 million. This alone tells you , no screams, that the existing contractual arrangements are utterly rubbish and very low margin. Add to this the debt of £1 billion and you have a very sick business indeed. All this having disposed of the Crown jewels for a very good price.
When Capita bossed the market all things were possible, unfortunately the business is no longer boss and is very impaired in all ways. Worse than that it may have killed the very market it needed, government, through its ills.
I cannot see that this has any recovery prospects any time soon. In fact there is every chance that a fire sale may be the only answer. You have to wonder what price the capital raising will be at, and will the institutions be prepared to see lower than a 1-2-1 or lower issue against the residual break up value and getting someone to underwrite will be troublesome. Its hard to see anything but a massive discount to todays price and its hard to see the shareholders backing that. Remember when they talked about the capital raising the market cap was over twice what it is today. What looked feasible then doesn't look so now.