Serco Group Loses Key Immigration Detention Contract

Investing.com — On Friday, Serco Group (LON:SRP) announced it was unsuccessful in renewing its longstanding immigration detention contract with the Australian government, which caused its shares to fall over 10%.

The contract, valued at £165 million annually, has contributed approximately £18 million (6% of Serco's EBITA) and has been crucial to the company's regional portfolio since 2009.

This contract will conclude by December 2024 and begin winding down in the 2025 fiscal year, leading to a gradual revenue decline as Serco transitions its responsibilities to a new provider over a period of up to 180 days.

Analysts at Jefferies estimate a potential £15 million (5% of group) hit to EBITA in FY25 and possibly a similar level in FY26, depending on offsets.

Losing this Australian contract is a significant setback, affecting both revenue and margin stability, as it had an estimated EBITA margin of 10.9%, much higher than Serco’s group average margin of around 5%.

Currently, there is no feedback on the reason for the loss, but the contract involves sensitive and complex operations, making it unlikely for Serco to have bid at a low price, which could imply the risk of being undercut by competitors.

Serco probably faced strong competition from new bidders willing to accept lower margins for this high-profile contract. Managing the contract’s challenging operational demands for over a decade highlights the financial risks associated with large, publicly funded contracts.

Additionally, Serco is grappling with rising labor costs in the UK. Changes to National Insurance contributions set to take effect in April 2025 are expected to increase direct labor costs by around £20 million annually, approximately 7% of Serco's total EBITA.

Jefferies noted that while there’s no pass-through written into customer contracts, negotiations and broader inflation adjustments could help partially mitigate these impacts over time.

Serco is exploring potential mitigations, including customer negotiations and inflation indexing, but these adjustments are unlikely to fully offset the new costs soon.

RBC Capital Markets analysts revised down their FY25/26 EBITA forecasts by 8%/9%. Despite this setback, they feel the company is still in a strong position with limited rebid risks, smoother organic growth prospects, and a solid balance sheet providing options.