Two days ago Serco released a note where it said that it had decided to stand down its bidding teams responsible for the rail opportunities in the Middle East. In other words, it was withdrawing from these major projects, which sent the stock down by almost 7%.
The projects in question involved the construction and management of the Riyadh Metro, the Doha Metro and the Lusail tram and had a combined value of aprox. GBP 2.5bn to Serco over a period of 20 years.
So, do these events invalidate in any sense the investment thesis? here's my take on it:
1. Even though the projects are worth GBP 140mn per annum, they only represent GBP 30mn of our 2019's expected Serco revenues as, for projection reasons, all pipeline revenue is weighted by a bid-to-win ratio of 20% (the historical ratio).
2. In terms of margin, Serco is just losing a mere GBP 1.5mn of its 2019 projected UTP of GBP 182mn, not much. More importantly, the company decided to reallocate the teams involved in the bidding to more profitable endeavors as the costs of waiting were getting large and probably outweighed the benefits of keeping their bids open.
3. Largely offsetting this lost is the recent unnoticed and on-the-cheap acquisition of the Health Facilities Management division of Carillion. The acquisition, made for GBP 50mn will provide Serco with contracts worth about GBP 90mn per annum of profitable revenue. Assuming a 5% margin, this assumes Serco paid a cheap PE multiple of only 9x.
Therefore, the overall effect of the Carillion deal and the Middle East withdrawal is actually an increase in projected revenues (from GBP 3.64bn to GBP 3.72bn) and profit (UTP from GBP 182mn to GBP 186mn)
For this reason, Serco's investment thesis remains intact and maintains in my view a 2019 price target of GBP 1.85-1.90 per share (85-90% return with respect to today's prices).
Disclosure: I am/we are long SECCF.