By Jason Booth, 10/12/16
Last week, I wrote about Mitie Group, (OTCPK:MITFY) a UK management services company, whose shares I felt were oversold due to overblown Brexit fears, and worthy of a strong recovery. So far, it looks like a good call, with Mitie up around 8% since publication.
So I was flattered when a reader asked if I had views on another, much larger British management services company, Capita PLC, (OTCPK:CTAGY). Bloomberg News had just run a story highlighting both companies as close competitors being hurt by Brexit. Following the same logic, was Capita's current share price collapse also overblown, giving investors a chance to buy a much bigger company at bargain prices? The simplest answer is: no.
Both Capita and Mitie shares have fallen sharply:
Deal-Driven Growth Strategy
Despite being put in the same basket by the media and most investors, the two companies are fundamentally different in their trade, expansion strategy and valuation. Mitie has grown organically as a conservatively managed company with limited exposure to the EU in terms of revenue. Capita, on the other hand, appears at first review as a deal-driven, well-leveraged company with a major interest and ambitions in the EU, while still boasting unjustifiably high multiples.
But Capita looks overvalues vs. Mitie:
Capita's Went Long on Europe
In 2015, Capita made its largest ever acquisition with the purchase of customer management business, avocis, headquartered in Switzerland. Today, Capita Europe (established in 2015) has 16 offices in Switzerland, Germany, Poland, Austria and the Czech Republic. Capita Europe now accounts for 10% of employees and revenue of Capita PLC.
It marked the high point of a multi-year buying spree by Capita. Based on a review of the company's own announcements, Capita has spent over half a billion pounds on acquisitions since 2013. The uncertainty over Brexit is simply highlighting the problems that come with integrating more than 75,000 employees at than 350 sites in multiple nations.
As one analyst told Bloomberg: "Some of its difficulties "are longer-term chickens coming home to roost, which clearly the Brexit issues may have accelerated," adding "Is the strategy unraveling of acquisition-led growth?"
Waiting for the Next Shoe to Drop
Expansion has come at a price. Capita's net debt reached £1,901M in June 2016, up from £1,203M at the end of 2013. There are questions that remain unanswered. Did they borrow money in Euro or other currencies to buy companies in Pounds since 2013? And all of Capita's deals were transacted on a cash free/debt free basis. While simplifying the acquisition process by streamlining valuations, CF/DF deals can also make it harder to identify risk factors, such as currency fluctuations, pension liabilities and debt obligations. The upshot is that the Brexit fallout, especially currency volatility, may cause unforeseen problems with Capita's balance sheet down the road.
Despite the uncertainty and falling over 50%, Capita's shares still boast a rich P/E of 46. Thus, it's not surprising that some analysts are expecting zero upside for Capita's shares. According to reports, Jefferies International slashed its target price from £1,340.00 to £815.00. Exane BNP Paribas is maintaining a hold on Capita Group at £950.00. I would not disagree with them.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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