Babcock
Two years ago, Babcock International finally persuaded the FTSE classification authorities that it should sit in the “aerospace and defence” sector rather than in “support services”.
Fair enough, given its deep entwinement with the Ministry of Defence and its civil fleet of emergency helicopters. In reality, Babcock was fed up with being bracketed with all the losers in support services: Serco, Capita, G4S, Mitie, Interserve, Kier Group, and, the biggest loser of them all, Carillion.
This week, shares in Babcock fell below £2 for the first time since 2005. The company, which boasts an order book of £17 billion, has seen its stock market value dwindle to a little over £1 billion.
This is a company that was in the FTSE 100 three years ago. It is now at the bottom of the top 300 London-listed stocks. The shares have lost 25 per cent since a trading update last week and have nearly halved in the past two months. The stock was above £6 a year ago.
What is spooking investors is whether— and the irony is not lost — Babcock is heading the way of its old cohort in support services: admissions that onerous contracts haven’t been properly accounted for, the spectre of large writedowns, issues with cash, and the need for a kitchen-sink restructuring and a painfully diluting fundraiser.
In short, the fear is that Babcock is on the trajectory to a multi-year rescue job that the likes of Serco, Capita, G4S, Mitie, Interserve and Kier went through some years ago and from which they are yet to recover — and in the case of Carillion never did.
The back story
Babcock has become as crucial a contractor for the MoD as BAE and Rolls-Royce. It operates the Devonport naval dockyard, maintains and helps build the submarine fleet at Faslane and Barrow-in-Furness, and builds Royal Navy warships at Rosyth.
It undertakes engineering support and flying training for the RAF. Babcock is also the training contractor to the Royal Navy and Royal Marines, although it is to lose this work to Capita, of all people. It also trains engineers and performs maintenance for the Army.
The majority of its £4.8 billion annual income comes from the British taxpayer. It employs 34,000 people.
The present Babcock is the creation of the late Peter Rogers, a larger-than-life deal-maker who was chief executive from 2003 to 2016. He took an engineering company and turned it into a public sector contractor with successive big acquisitions: £350 million for Devonport, £1.3 billion for VT Group — the former Vosper Thornycroft — and £1.6 billion for Avincis, the old Bond helicopters group.
Corporate governance
There has long been an issue of trust, with some investors growing weary of poor communications and unexpected “nasties” buried deep in the accounts.
The blame for that fractious relationship with the City was laid at the door of Mike Turner, a combative former chief executive of BAE, who had been on the Babcock board for 20 years and its chairman for ten before his departure in 2019.
Babcock had been raising governance eyebrows for some time, not least in a 2016 shareholder revolt over Mr Rogers’ payoff on retirement.
After doubt was cast last week by Babcock’s new management on past accounting policies, the spotlight is now shining on how or why PWC has been hiding in plain sight as the company’s auditor for the past 19 years. It is that sort of cosy relationship that became a big issue at Carillion and its 19-year auditor KPMG. It is understood Babcock is due to ditch PWC soon.
The current crisis
David Lockwood was brought in as chief executive in September. His sidekick David Mellors joined Babcock shortly afterwards as finance director. Their last tour of duty was shaking up Cobham, the troubled aerospace group, which was then sold to private equity in 2019. Mr Lockwood immediately launched a strategic review of Babock’s portfolio of peripheral businesses and Mr Mellors has launched an accounting review.
The messages are worrying. There is a “cultural issue” over the company’s relationship with cash. Babcock is too “federated”, that is, its divisions operate in silos. There will be asset and income writedowns.
All this comes on top of the impact of Covid-19, which has brought nine-month profits down by more than a third to £202 million. Net debt is up by nearly a third at £1.2 billion. Ten weeks before the end of its financial year, management confesses it has no idea what the outcome will be.
What happens next?
The downward drift in the share price comes with investors left hanging for at least three months, as the board does not expect to share news on sell-offs, shake-ups and accounting impacts until its full-year results in May.
If Mr Lockwood’s history at Cobham is any guide, the language around Babcock’s previous errors will be blunt and fruity.
Unlike Cobham, Babcock shareholders cannot wait around for a rescue takeover because, as a national security risk, government is unlikely allow a change in ownership. The time for a merger with Serco, much mooted two summers ago, seems to have passed.
The company declined to comment further on its trading update of last week but reported that someone sees value in the shares: the chief executive, finance director and chairwoman Ruth Cairnie spent nearly £180,000 between them today buying shares at a little under £2 each.
