Government downplays fears over outsourcing and Capita profit warning

SUMMARY:

Oliver Dowden, Parliamentary Secretary at the Cabinet Office, has said that he doesn’t believe Capita is in any way comparable to Carillion.

The government has sought to downplay concerns that Capita could soon follow a similar fate to recently collapsed Carillion, after it issued a profit warning last week. Parliamentary Secretary, Oliver Dowden, who was recently digital responsibilities at the Cabinet Office, told MPs in a recent debate that the two firms should not be compared.

Carillion went into liquidation last month following a recent profit warning, raising concerns about hundreds of public sector contracts it managed. The government has had to step in to take control of these contracts, many of which have since been handed over to Capita.

However, just last week Capita’s shares plunged by more than 50% after it issued a shock profit warning to the market. Understandably, concerns have been raised about the company’s future and its public sector contracts, given the Carillion mess.

Dowden told MPs that the government understood that this is a matter of significant interest, but sough to assure that “this company is in a very different situation”. He said:

To be clear, this announcement was primarily a balance sheet strengthening exercise, not purely a profit warning. As has been widely reported, the company has significant cash reserves on its balance sheet. We do not believe that Capita is in any way in a comparable position to Carillion. Furthermore, Capita has a very different business model, and if the House will allow me, I will give an update on that.

The issues that led to the insolvency of Carillion will come out in due course, but our current assessment is that they primarily flowed from difficulties in construction contracts, including those overseas. By contrast, Capita is primarily a services business, and 92% of its revenues come from within the UK.

Dowden said that the government regularly monitors the financial stability of all of its strategic suppliers (although this didn’t stop it from handing contracts to Carillion after its profit warning last year), and said that the measures announced by Capita would strengthen its balance sheet, reduce its pension deficit and invest in core elements of the business. The Parliamentary Secretary added:

Arguably, those are exactly the measures that could have prevented Carillion from getting into the difficulties it did.

As I have said, my officials met senior Capita executives yesterday to discuss the impact of the announcement. We continue to work closely with the company to monitor the execution of its plan and to ensure the continued delivery of public services.

We continue to engage with all our strategic suppliers and make continuing assessments of our contingency plans, where necessary. It would not be appropriate for me to comment in any further detail on the specifics of those contingency plans, given their commercial sensitivity.

The future role of outsourcing

The collapse of Carillion has sparked debate amongst MPs about the future role of outsourcing, a model that grew significantly in popularity during the 1990s. Government departments outsourced delivery to private sector companies, largely driven by cost saving measures.

Whilst not all contracts have been bad, there have been a string of high profile failures in recent decades and the government’s ability to effectively manage deals has seen many major hits to the public purse. In addition, it is widely thought that outsourcing resulted in a decline in civil service expertise and skills, as well as reduced innovation in Whitehall – given that deals were often signed for 5 years or more.

Shadow Cabinet Office Minister, John Trickett, voiced concerns during the recent debate that Capita was given 154 government contracts last year and in recent weeks Carillion contracts were re-brokered to Capita – despite the company being in trouble. He said:

Share values were plummeting and profit warnings were being issued. There was short selling on the stock market and allegations against Capita of fraud in the handling of public contracts. Yesterday, Capita’s total value on the exchange was barely much more than its total debt. The company is in serious trouble. It is a familiar tale of woe, with strong echoes of Carillion.

Opposition MP, Rachel Reeves, echoed concerns and said that the similarities between Carillion and Capita was worrying. She said:

I cannot help but conclude that the Government’s thinking on this is both muddled and complacent. He has told us that the situations at Capita and Carillion are completely different, but let us look in more detail at ​the circumstances of both companies: both have debts of more than £1 billion and pensions deficits in the hundreds of millions; both paid out dividends of more than £1 billion in the past five years; both rely on the public purse for half of their contracts; both were audited by KPMG; and both grew through acquisition and not through organic growth. It seems there are more similarities than differences between these two companies.

However, the government is refusing to believe that outsourcing is the cause of the problem and Dowden was adamant that Capita wasn’t going to become a similar problem for public service delivery.

Dowden added that the government is working to effectively scrutinize public sector outsourcing contracts, by firstly looking at the publish results of companies and using third parties to understand and verify them. And secondly, by continuing to engage with companies on a one-on-one basis through the Cabinet Office, to understand their financial position.

He said that there is “nothing wrong, per se, with engaging with the private sector for the delivery of services”, but that the government must “ensure that there is rigour in the contracts”. Dowden admitted that many contracts in the past have not been properly negotiated and have not delivered value for the public sector, and that “they will continue to burden us for many decades to come”, but that this “is not an invalidation of the model; it is about problems with specific contractual negotiations”. Dowden added:

The fact that Capita has embarked on this course of restructuring means that it is effectively choosing to switch resources away from the continued payment of dividends and towards pension funds. That should give pensioners confidence in respect of that pension fund. He also asked about jobs, and again, the restructuring can give confidence about the continuing delivery of those jobs.

A profit warning does not mean that a company is imminently going to collapse. A profit warning is a warning to the markets that its results will not be in line with what it had previously thought. If every time that a company issued a profit warning, we as a Government said that we would cease to contract with them, there would be very few companies we could contract with. I will not name leading companies, because I do not want to influence their market value, but I could name a huge list of FTSE 100 companies that routinely issue profit warnings. That does not mean that they are about to disappear.

If we were to choose overnight, in the face of one profit warning, to stop contracting with that company, there would be a significant risk of the delivery of public services falling over. As I have said, the objective of the Government is the continued delivery of public services, and we have continued to pay the cleaners, continued to have the dinners served and continued to ensure that what the people out there in the country care about, which is that their public services are delivered, continues to be delivered.

Image credit - Image sourced via Capita website

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