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The Capita Group Plc Half year results

The Capita Group Plc

Half year results for the 6 months to 30 June 2011

Capita, the UK’s leading business process outsourcing (“BPO”) and professional services company, has performed well in the first 6 months of 2011, securing &pound1.1bn of major new and extended contracts reflecting increasing demand for outsourcing across our markets and the excellent operational track record of the Group. Additionally, to date in 2011, we have invested &pound194m in 11 small to medium sized businesses which broaden our operational capability, market reach and scale, enabling us to add value to existing clients and enhance our propositions for new clients.

In the 6 months ended 30 June 2011, revenue increased by 3% to &pound1,400m (H1 2010: &pound1,361m). Underlying operating profit[1] rose by 8% to &pound193.0m (H1 2010: &pound178.4m) and underlying profit before taxation1 increased by 7% to &pound174m (H1 2010: &pound163.1m). Underlying earnings per share1 grew by 12% to 21.95p (H1 2010: 19.60p). Cash generated from operations was &pound179.6m (H1 2010: &pound216.3m). We have increased our interim dividend by 9% to 7.2p per share (2010: 6.6p).

Of the growth in revenues in the period, &pound134m was generated by both 2011 acquisitions and additional revenue from acquisitions completed in 2010. There was revenue attrition in 4 specific areas totalling &pound92m, consisting of 2 contracts (National Strategies and Home Access) which we previously announced were coming to an end and 2 business areas where major project spend was planned to reduce. This attrition was not fully counterbalanced in the period, mainly because growth in our resourcing and property consultancy businesses was more subdued than expected. However, Capita is now enjoying a healthy flow of new opportunities and the bid pipeline has been replenished to its previous record level of &pound4.7bn, providing us with a good platform for stronger progress in 2012.

Our focus on optimising our operational infrastructure and expanding the Group’s offshore capacity continues to drive margin progression, resulting in margins increasing to 13.8% (H1 2010: 13.1%). During the period, we have contained capital expenditure and retained an efficient capital structure.

Delivering shareholder value

To ensure that we continue to build long term value for shareholders, we focus on a number of key financial measures including:

&middot         Margin – our focus remains on generating a steadily improving operating margin. In H1 2011, operating margin (before acquired amortisation) was 13.8% (H1 2010: 13.1%). Our continued margin progression is due to our focus on operating at optimum efficiency across the Group, our ability to drive out benefits from our extensive scale, in particular through IT rationalisation, property consolidation and effective procurement, and the sophistication and added value of the services we deliver to clients.

&middot         Cash flow – &pound180m was generated by operations in the period (H1 2010: &pound216m), representing an underlying operating profit to cash conversion rate of 93% (H1 2010: 121%). Our underlying free cash flow was &pound97m (H1 2010: &pound140m). Operating cash flow has been impacted by additional working capital required for new and expanded contracts and for our Building Schools for the Future projects. These factors will continue to impact cash flow for the remainder of the year. Thereafter, cash flow is expected to revert to more usual levels.

We use surplus cash to add value in 3 main ways – through acquisitions, share buybacks and dividends. We deliver value to shareholders through steadily growing dividends, acquiring businesses which meet our strict criteria and are priced attractively, and undertaking share buybacks when attractive market opportunities arise. Weighing these 3 elements, our current balance is to focus more strongly than usual on the healthy pipeline of acquisition opportunities a decision which we believe will generate significant value to shareholders.

-          Acquisitions – acquisitions have consistently added value to our client propositions and been a key driver for enhancing value to our shareholders by both building platforms for future organic growth and by generating excellent returns on capital. Current market conditions are fuelling our pipeline of potential acquisitions and to date in 2011, we have invested &pound194m in 11 transactions. We expect to acquire further suitable businesses in the second half of the year alongside our focus on integrating our recently acquired companies into the Group.

-          Share buybacks – opportunistic share buybacks help us to maintain an efficient capital structure and minimise our long term cost of capital and we will continue to buy back shares if attractive opportunities arise. Shareholders renewed the Group’s authority to purchase up to 10% of issued share capital at our AGM in May 2011. No share buybacks were undertaken in H1 2011.

-          Interim dividend – the Board has declared an interim dividend of 7.2p per ordinary share (2010: 6.6p), representing an increase of 9%. The dividend will be payable on 12 October 2011 to shareholders on the register at the close of business on 2 September 2011.

&middot         Capital expenditure – we aim to contain capital expenditure at or below 4% of revenue. During the period, we met this objective with net capital expenditure at 2.8% (H1 2010: 2.8%) of revenue and anticipate maintaining these levels for the full year. 

&middot         Return on capital employed – we deploy our capital carefully and focus on driving a healthy return on capital. Over the last 12 months, the post tax return on average capital employed (including debt) was 18.8% (12 months to 30 June 2010: 20.2%). This compares to our estimated weighted average cost of capital which is 7.8%.

&middot         Balance sheet gearing – in January 2011, we issued &pound101m of 8&frac12 year private placement notes and in July 2011, we have issued a further &pound208m of 7 and 10 year private placement notes. The proceeds of the new issues were used to repay monies drawn down on the Group’s revolving credit facility. Following these issuances, we have &pound1,142m of private placement debt of which &pound123m matures between June 2012 and August 2015 and the remainder then gradually matures until 2021.

Generating profitable growth

We generate profitable growth by winning business from new and existing clients principally in the UK, Ireland and Continental Europe and supplement this by acquiring businesses that broaden our skill base and extend our market reach.

Organic growth 

Following a relatively subdued 2009 and 2010, we are seeing increasingly buoyant conditions for outsourcing in 2011, as demonstrated by the significant year on year increase in new contract awards and extensions. To date in 2011, we have secured 12 new contracts and extensions with an aggregate value of &pound1.1bn (H1 2010: 17 contracts totalling &pound523m). This includes life and pensions contracts with Zurich Financial Services Group and MetLife, a contract to administer vehicle tax and insurance evasion on road enforcement for the DVLA and a collaborative partnership with the London Borough of Lambeth:

-        MetLife: Selected to deliver an extended life and pensions administration contract worth approximately &pound149m over 10 years.  Capita will provide customer servicing, policy administration, claims activity and related IT support to underpin the long-term UK growth strategy of MetLife Europe Ltd 

 -    Teachers’ Pension Scheme: A 7 year contract worth &pound80m to administer the Teachers’ Pension Scheme (TPS), the second largest public sector pension scheme in England and Wales, with more than 1.6 million members. Capita has been administering TPS since 1996 and this will be our third consecutive contract 

 -        Zurich Financial Services Group: Extension of the current contract to deliver operational services for Zurich's UK life business operations (from 2015 to 2026) and to support the development of Zurich Global Life's European and international administration hubs for a 15 year period. The contract extension and expansion will generate approximately &pound570m in revenues to Capita. 

 -        Driver and Vehicle Licensing Agency (DVLA): Contract to provide a national Vehicle Excise Duty (VED) service that includes provision, at the DVLA's option, for a Continuous Insurance Enforcement (CIE) service. The five-year contract, with an option to extend for a further two years, has an estimated value of &pound100m. 

 -        LondonBorough of Lambeth: Appointed as preferred bidder to form a collaborative partnership to deliver a range of Council services including the existing revenue collection administered by Capita and additional services including management of the Council’s call centre operations, ICT support services and a benefits resilience service. For the core services, the contract is expected to be worth &pound60m over 10 years with the option to extend for a further five years. The commissioning programme also allows for the opportunity to widen the scope of the contract up to &pound300m.  

Contracts worth between &pound10m-&pound50m: We have also secured 7 contracts with an aggregate value of &pound118m. This includes delivery of a shared services contract for the London Boroughs of Bromley and Lewisham, IT outsourcing for English Heritage, revenues administration for the London Borough of Brent, managed resourcing services regarding contractors for EDF Energy, an agreement with the National Policing Improvement Agency (NPIA) to be one of 3 companies on the Digital Interviewing Framework, preferred supplier to deliver HR, payroll and recruitment services for up to 12 NHS trusts in Mersey. In addition, in July 2011 we have secured an extension to our existing contract with the Driving Standards Agency for the provision of a full range of information services throughout the DSA network.

Creating the fuel for organic growth

Following the 12 new contracts announced in H1 2011, we have rapidly replenished our bid pipeline which stands at &pound4.7bn today (February 2011: &pound4.7bn). This reflects the continued quality and quantity of business opportunities across our target markets. In the private sector, opportunities are particularly strong in the life and pensions and financial services markets. The most active public sector markets are local government and defence and we are also seeing opportunities emerge in the central government arena.

The pipeline, which is currently made up of 30 bids with an average contract duration of 9 years, only includes bid situations in which Capita is shortlisted to the last 4 or fewer bidders and caps the largest bids at &pound500m. There are 4 bids in our pipeline where the potential client has publicly announced that Capita is on the shortlist: administration of army recruitment for the MOD, support for Edinburgh City Council, the rebid to administer TV licensing for the BBC and a strategic partnership with NHS shared support services provider, Anglia Support Partnership (ASP).

Over the 5 years to 31 December 2015, we only have 2 material contracts (defined as having annual revenue in excess of 1% of 2010 turnover) due for rebid and these are both due in 2012 - the contract for TV licensing, where the re-bid process has commenced and we have been shortlisted, and the CRB contract. The National Strategies initiative ceased in March 2011 and the contract has therefore not been re-tendered. 

Underpinning the pipeline is an active prospect list of opportunities which are the fuel for the next tranche of potential outsourcing contracts, supported by a suspect list of early stage targets.

Stimulating growth through acquisition

The acquisition of small to medium sized companies that enhance our capabilities and take us into new and complementary areas has always played a key part in Capita’s business model. For example, our entry into the private sector in 2000 was via the purchase of IRG Plc, a share registration business, which we then expanded through organic growth and further acquisition creating the platform for our growth into the private sector and particularly the wider financial services market. From this initial entry point 11 years ago, our private sector annual revenues are now approaching &pound1.5bn and contribute 50% of the Group’s revenue, with leading positions established across a number of areas, including life & pensions, insurance and financial services.

Our more recent acquisitions continue to enhance our client propositions and provide platforms for further growth. For example:

&middot         We continue to expand our financial services offering and, in June 2009, acquired the European loan administration, asset management administration and commercial mortgage backed securities (CMBS) administration services of Capmark Financial Group Inc, creating Capita Asset Services. The business has subsequently grown organically, securing the largest ever outsourcing mandate in Europe from the National Asset Management Agency (& lsquo;NAMA’) in November 2009, and also by further bolt-on acquisitions. In February 2011, Capita acquired the securitised commercial loan business of Barclays Capital Mortgage Servicing Limited ('BCMS'), owned by Barclays Capital making Capita Asset Services Europe’s largest, independent, third-party commercial mortgage servicer, providing loan administration, facility agency, asset management and special servicing to the banking and securitisation markets.

&middot         We entered the business travel market in 2005 with the acquisition of Lonsdale Travel and expanded our capability with the acquisitions of Harry Weeks Travel & Leisure in 2007 and BSI in December 2010. Capita’s end-to-end business travel offering is now one of the top 5 travel businesses in the UK, allowing us to compete for clients across the public and private sectors where we are seeing significant demand. In particular, central government is looking to significantly drive down travel and subsistence costs for its workforce and we will be in a strong position to help achieve these aims.

We continue to see a healthy flow of acquisition opportunities that fit our growth strategy and are priced at attractive levels. To date in 2011, a total of &pound194m has been invested in 11 transactions across a number of our core capabilities and target markets, including customer services, health, consultancy and financial services, including:

-          Talis – provides management software and managed services to higher education markets and local authorities. The acquisition will add valuable new expertise and capabilities to Capita's existing products for the academic and public sector.

-          Barclays Capital Mortgage Servicing Limited (& lsquo;BCMS’) – a securitised commercial loan business that provides primary and special loan servicing for commercial real estate finance transactions. The acquired business is being integrated into Capita Asset Services, which is now Europe’s largest, independent, third-party commercial mortgage servicer.

-          Right Document Solutions – a provider of document consultancy and managed print services through long term contracts with a range of public and private sector clients. The acquisition builds upon Capita’s existing design, bulk print and document management capabilities and provides a good strategic fit with a number of our professional services businesses.

-          Tribal (health & government divisions) – The acquisition adds key new capabilities and scale to Capita's health and consulting businesses and brings established relationships across a wider spectrum of the health and government markets.

-          Call Centre Technology – a provider of voice telephony, applications and services for customer contact centres, adding valuable expertise and capabilities for new contracts and Capita's existing telephony services. CCT already supplies services to a number of our contracts and businesses that have recently been acquired by Capita, including First Assist and Capita Secure Information Systems.

-          Team 24 – a specialist healthcare recruitment company which adds depth and breadth of expertise to Capita's recruitment business and to the range of services it provides to the NHS and wider healthcare market.

-          Ventura– a customer contact specialist managing 50 million customer contacts each year for a range of additional private and public sector clients. Ventura was the third party customer services management arm of Next plc and is particularly strong in the private sector with clients including leading telecoms, utilities and retail companies. This acquisition provides us with greater scale and flexibility and enhances our customer services outsourcing capability and the potential to increase our private sector reach.[2][2]

We have a robust process for integrating acquisitions into the Group to generate value and will be concentrating on bedding down these new acquisitions in the second half of the year. We will continue to acquire further small to medium-sized businesses in H2 2011 if they fit our strict acquisition criteria and provide opportunities to enhance our propositions and create further value. 

Market update

Industry analysts value the overall UK BPO market at &pound117bn per annum with only &pound7.8bn actually outsourced by the end of 2010, reflecting the enormous potential for growth. We continue to be the market leader with a 23% market share in 2010. Below we have highlighted some of the key drivers for outsourcing in a number of our public and private sector markets.

Public sector: Following the Spending Review in October 2010 which addressed the potential for cost savings and efficiencies in the public sector, fiscal pressure continues to highlight the value that outsourcing can deliver. With an annual administration spend estimated at &pound16bn and 500,000 staff in administrative roles in 2008/2009, the Government is committed to reducing spend in this area by around &pound6bn a year by 2014-2015. Similarly in local government, where spending is to be cut by 7.1% per annum over the next 4 years, we are working with existing and new clients to see how we can support more efficient, quality service models.

The Government’s recent Open Public Services White Paper confirms the Government’s desire to reform public services to ensure equality of access to high-quality public services. It recognises that this reform will take time but that significant steps forward can be taken now. It also recognises the need to open these public services to a range of providers, engaging both large and smaller organisations from the private and third sectors to help them to achieve their aims. The Government is also encouraging and exploring a spectrum of engagement models, such as joint ventures, mutuals and other employee ownership and cooperative models.

We have an extensive track record of creating collaborative partnerships and working together with local organisations, charities and small businesses to deliver the right outcomes for our clients and the communities they serve. We are therefore well positioned to help create and participate in new models of delivering public services and to leverage our expertise, capability and infrastructure to support government at both a central and local level.

Some local authorities are already procuring in different ways to allow them to form partnerships capable of providing shared services for third party providers to the authority and to other local authorities and organisations to achieve considerable savings by working together to deliver common services and address local needs.

For example, our contract with the London Borough of Lambeth includes provision to significantly widen the scope of the contract and achieve further efficiencies by including other third party organisations. The collaborative partnership can grow the services delivered over the life of the contract from an initial value of &pound60m to a maximum value of &pound300m. Our pension administration business, Capita Hartshead, has recently been awarded the contract to act as the single provider to a Local Government Pension Scheme (LGPS) framework. The London Borough of Hammersmith & Fulham and the London Borough of Brent created the Framework Agreement and invited all 32 London boroughs to register & lsquo;an interest’ in consolidating their pension administration. 28 London boroughs are able to join the framework and with expected savings of more than &pound1m for the two founding councils over the 6 year contract term, other boroughs have indicated strong interest in joining the scheme in the near future. We expect to see more of this type of activity as local authorities look at innovative ways of cutting administration costs and protecting frontline services.

Private sector: Commercial organisations are also facing continued pressure to maintain their competitive position by driving down operational costs without compromising customer service. Organisations can clearly benefit from the higher productivity and enhanced operational capabilities and flexible capacity that an experienced outsourcing service partner can provide. Sales activity in the first half of 2011 has picked up considerably in the private sector and we expect to see decisions on bids start to flow through in the later part of   the year. We are particularly active in the UK life & pensions and wider financial services markets and also in Continental Europe where new and existing clients are exploring the alternative service delivery models. Several of our recent acquisitions bring with them high level relationships across a wide range of private sector organisations beyond our existing market reach and we are expanding these relationships. We are developing our nearshore and offshore capability to meet the increasing demand for flexible delivery models from private sector clients.

Developing our offshore/nearshore capability

Continental Europe: Capita's plans to create a multi-lingual shared services centre in Krakow, Poland, are well advanced. The business centre is scheduled to start delivering services to existing clients from Q4 2011 and will be fully operational from early 2012 ensuring that we are well positioned to respond to increasing demand from new clients in Europe. We have already opened temporary offices and have signed heads of terms to lease a 500 seat capacity shared services centre in Krakow city centre. The business centre’s primary language will be English however, multilingual services will be offered as required by our clients.

India: Capita’s business centres in India continue to thrive and deliver quality, efficient services to our UK clients. 1,300 new people are joining us in Pune as part of the recent acquisition of the Ventura operations from Next plc. We welcome them to Capita where they will continue to deliver services to former Ventura clients and assist us in growing the business. We will be reviewing our property portfolio in India to bring together our valuable workforces to share skills and expertise and optimise the use of resources and infrastructure.

Outlook: strong drivers for future growth

Against a backdrop of trading conditions which have continued to be challenging, the business has progressed in 2011 and we are now experiencing strong major contract sales performance and high levels of acquisition activity. We have secured contracts and renewals totalling &pound1.1bn in the first half of the year, more than double the value achieved in the first half of 2010. This reflects the increasingly strong demand for outsourcing across the public and private sectors after a 2 year period of subdued sales activity.

Following our recent contract wins, our bid pipeline has been rapidly replenished to its previous record level of &pound4.7bn of opportunities, with buoyant activity in the local government and life and pensions markets and growing activity across central government. After strong sales outcomes in the first half, we expect decisions on a number of bids in the bid pipeline in Q3 and Q4 this year.

Our pipeline of sales prospects, visibility of revenue from long term contracts and acquisition activity position us well for steady progress in 2011 and underpin strong growth prospects for 2012 and beyond

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