For anyone concerned about British government spending – be that on prisons, defence or even London’s new bike hire scheme – the solution is simple. Invest in outsourcing service firms such as Serco, Capita, G4S or VT Group, and join in the profits. All four companies have substantially outperformed the FTSE All-Share Index over the past two years. With significant income derived from stable public sector contracts, their outlook continues to brighten.
A reduction in government spending generally means an increase in the outsourcing of public services. In each of the past three recessions, government spending as a percentage of output has tended to bottom out two to four years after the recession’s trough. This bodes well over the next few years for outsourcing firms that can provide services at a cheaper price. Indeed, Serco has won a record £4bn in contracts so far this year.
Nonetheless, the recession is reshaping the industry. Customers may be increasing their use of outsourcing but they are also reducing the number of providers they use, preferring companies that can offer full services. While this benefits large providers, smaller firms without a definable niche are being absorbed into a consolidating industry. Capita made no less than 12 acquisitions of small competitors during 2008.
The flip side of this market power is expensive valuations. Those with the highest public sector exposure such as Serco and Capita are trading above the broader market at between 13 and 16 times forward earnings. One of their main attractions is that they offer revenue visibility with about nine years remaining on existing contracts. These contracts may not make for exciting work but, as Paul Lester, chief executive of VT Group, says, “taking crap for less money” is proving largely recession-proof.