Interserve - Final results, acquisition and placing

Further to my trading suggestion last week. Interserve have announced final results today. Turnover looked light at £2192.6 million +12% v £2339 million (F) but they do have good revenue visibility with a record future workload of £6.4 billion and 75% of this year consensus revenue already secured. There was £2.5 billion of new business won in the year, including work with the BBC, University of Sussex, HMRC, The Royal Navy, Ministry of Defence, DWP, Magnox, Jaguar Land Rover, the Lusail Tower in Qatar and the Emirates Engine Maintenance Centre in Dubai. 
Earnings came in at 47.7 pence +5.3% v 46.1 pence (F), dividend 21.5 pence +4.9% v 21.3 pence (F) with a 14.7p final (2.5% yield on final at 600 pence), so headline numbers look fine at first glance. They have moved to a small debt position of £38.6 million v £25.8 million cash last year. In their statement Chief Executive Adrian Ringrose said:

"In our UK Support Services business we delivered our medium term objective of finishing the year with margins of five per cent. Our Construction division remained resilient and Equipment Services delivered strong results, while continuing to expand into new markets."

The other surprise with these figures and the main talking point is the proposed acquisition of Initial Facilities for a cash consideration of £250 million funded by debt and an equity placing of 9.99 per cent of issued share capital. Initial Facilities comprises the facilities services businesses of the Rentokil Initial plc group with operations in the UK, Ireland and Spain, with the UK and Ireland representing 92.2 per cent of revenue in the year ended 31 December 2013.  It provides a comprehensive range of facilities services from specialist single services, including cleaning, catering, security, mechanical and electrical building maintenance, energy management and statutory compliance, to fully integrated TFM. Initial Facilities has a strong record in serving a broad customer base within the private sector, incorporating services to many professional service businesses, national retailers, transport operators and a variety of industrial businesses, including the London Underground which currently represents approximately £50 million of revenue per annum. Initial Facilities has over 22,000 employees in the UK and Ireland and approximately 3,000 in Spain. For the year ended 31 December 2013, Initial Facilities reported an operating profit of £8.8 million, a profit before taxation of £8.4 million and gross assets of £229.6 million. So the price looks quite high in relation to the operating profits with an EBIT/EV Yield of 3.5%, but not far off the gross assets being acquired. However, they say it will be earnings enhancing and there should be synergies which they quantify at £5 million for the enlarged group.

Extracts from what they had to say about the acquisition are:

 "The combination will position Interserve as one of the largest providers (top three by turnover) of facilities management services in the UK and drive future growth, the acquisition is expected to be significantly earnings enhancing in the first full year. We have confidence in the continued growth potential of the business, which is reflected by our proposed acquisition of Initial Facilities. The acquisition of such a complementary business allows us to deliver further against our growth strategy.The breadth and fit of the services we will now be able to offer, added to the advantages of increased scale and potential synergies, will create a compelling proposition, leaving us well placed for future growth. We look forward to bringing the enhanced capabilities of the enlarged Group to a wider addressable market of both new and existing customers, whilst providing more opportunity for our expanded employee base."
 
The placing looks like it will raise around £70 to £75 million depending what level it is done at. This will part fund the £250 million cost of the Initial acquisition with the balance being funded through new and existing debt facilities. The Placing is not conditional upon completion of the Acquisition. In the event that the Acquisition does not complete, Interserve will retain the net proceeds of the Placing for potential investment opportunities and general corporate purposes. Slightly annoying that this will give the shorts an easy opportunity to close their positions at an advantageous price, make me wonder if the price action was driven by a leak of this deal?

Any way this looks like a good deal as it furthers their strategy of moving away from a reliance on low margin volatile construction towards more stable and predictable service and facilities management type work. This is explained in the following extract from the announcement today:

Transaction highlights:

·      Strengthened market position:  The enhanced support services activities that will result from the Acquisition will position Interserve as one of the largest providers (top three by revenue) of support services activities in the UK.  This will enhance Interserve's ability to offer its customers a range of services from Total Facilities Management ("TFM") on a national basis to more specialist single services either on a local or national basis.  Nonetheless, the Company as enlarged by the acquisition of Initial Facilities (the "Enlarged Group") will have a market share of below five per cent, hence providing significant opportunity for further revenue growth within the £70 billion UK facilities management market, of which £42 billion was outsourced  in the UK in 2012 (Source: Credo, 2013).

·      Greater breadth of services and capabilities: Initial Facilities possesses additional capability in its fire and water related maintenance services as well as a more defined energy management proposition which would be available to the whole customer base of the Enlarged Group.  Enhancing the portfolio of services will enable the Enlarged Group to self-deliver certain services that are currently subcontracted and also broaden the customer proposition.

·      Greater breadth of customers:  Initial Facilities, with its greater proportion of contracts in the private sector, complements the current prominent position that Interserve has within the public sector. The Board believes that approximately 85 per cent. of Initial Facilities is generated from the private sector, with the public sector representing the 15 per cent. The outsourced market for facilities services in the private sector is currently estimated to be nearly twice that of the public sector (£25.2bn vs £13.7bn, source: Credo, 2013) and Interserve's experience and credentials within this sector create a significant opportunity for the Enlarged Group.

The Enlarged Group's Support Services Activities would have a pro forma split of turnover of 48 per cent public sector and 52 per cent private sector.  This balanced portfolio, coupled with the smaller average size of contracts within the private sector will help ensure that the Enlarged Group will not be overly exposed to any one sector or customer contract.

·      Synergy opportunities:  The additional scale that comes with acquiring Initial Facilities will provide the Enlarged Group with further opportunity to leverage operational efficiencies as well as providing cost saving opportunities within areas such as corporate support and operational management functions.  The board of Interserve also believes that the Enlarged Group will have the ability to access revenue opportunities which are not otherwise currently available to either Interserve or Initial Facilities.

·      Additional management capability: Both Interserve and Initial Facilities have an excellent reputation in the marketplace.  A broader pool of management talent will be a significant asset to the Enlarged Group as it continues to develop over time.

Conclusion & Summary
Overall a good set of numbers slightly ahead of forecasts on a cursory inspection. The acquisition, while unexpected seems to be a good one which they say will lead to earnings enhancement - will have to wait and see where the earning move to but should be some upgrades to come then. The shares have responded well this morning and hit 600 pence first thing - so happy to keep on running with this one given the relatively low rating and upgrades to come and potential for a re-rating.