Capita (LSE: CPI) is selling its educational software division and the stock market loves it. The share price of the business services firm has gained 21% over the last four days alone.
In addition, Capita provided a 45.9% return over the last month, in comparison with a negative 2.6% for the FTSE 250 Index.
However, go back to June 2015, and the value of returns changes considerably. Capita’s share price leaves the FTSE 250 behind having plummeted to a negative 90.6% return.
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On the face of it, Capita appears to e bottoming out. Could its latest sales announcement be a good reason to begin investing in the firm?
The recent history of the Capita share price
Over time, the FTSE weighs up the values of its constituents and the share prices react accordingly. This is as true of Capita as it is/was of Serco, Carillion, and other peers. When the latter went bust at the beginning of 2018, rumours were that Capita would too. Indeed, Capita’s share price tumbled as investors were fearful of its prospects.
However, despite being in a similar industry, the competitors were very different businesses. Capita didn’t hide its problems behind accounting fraud, for starters. It also had some valuable assets, such as its software businesses. Indeed, one fund manager valued the business around 200p-220p per share in 2018.
Nonetheless, it’s a difficult business to value because the firm has fingers in many pies. Some pies will be growing as others are contracting. This makes it hard to attract investors because we never really know what’s going on.
Consequently, when one outsourcing business goes bust, it’s easy to assume others will too. And so Capita’s share price continued to drop.
The decline was reinforced by the apparent industry model to focus on revenue growth, rather than profitability. This was a dangerous position to be in for an industry bidding on fixed-price contracts.
And so it proved to be. Capita’s share price fell further as earnings tumbled and profits were non-existent.
A possible future?
Enter turnaround specialist Jon Lewis and a new strategy to focus on hi-tech work, not low value, labour-intensive contracts. Capita also appears to be streamlining its discombobulated operations. The company recently sold Eclipse, its legal software business, for £56.5m. Education Software Solutions is planned to follow and is expected to sell for 10 times the value of Eclipse.
It’s also likely more divestments will be in the offing as management tries to reduce debt and bring the firm back to profitability, which sounds great in theory.
However, the sheer scale of this long-overdue overhaul should not be underestimated as Capita’s balance sheet is uninspiring. Using its 2019 reported earnings figures, the company’s net debt is 12.6 times gross earnings. And earnings before interest and tax (EBIT) are non-existent — they do not cover the Capita interest payments on its debt.
In other words, Capita paying off its debt from its operations is going to be an uphill struggle. Selling assets is currently the only way to do it. Without profitable operations in core business elements, Capita will simply not be able to strengthen its balance sheet in the long run.
The turnaround must start somewhere and divesting assets will help sustain it in the short-to-medium term. However, I want to see positive earnings from core operations — whatever they may be — before investing my money.
