INVESTORS seeking an example of how a few public sector contracts can hamper a business need look no further than iSoft. As poorly patients go, the NHS sub-contractor has plenty of justification for bed space.
The company’s stock market fortunes blossomed after it won three of five regional software supply contracts in the NHS’s £6.2 billion IT modernisation programme. But, two years on, after programme delays, profit warnings and a change in accounting policy that effectively wiped out previous years’ profits, things aren’t looking so rosy.
Might it be reasonable to suggest that far from being a golden ticket to secured riches, taking on public sector work is a path to destruction of shareholder value?
Government spending on IT has given buoyancy to a sector that would otherwise have to survive on private sector demand that has, at times, been lacklustre in recent years. However, industry leaders this week said they expect a slowdown in spending on IT work by public sector bodies, after a busy few years of spending. Growth remains robust for now, but with stronger markets emerging outside the UK, should investors still be giving consideration to London-listed groups dependent on public sector work? The slide in iSoft’s fortunes over the past eight months, which has included a 90 per share price drop, can ultimately be attributed to its success in winning those NHS contracts. Delays to the NHS programme were to blame for pushing revenues for last year into future years, albeit in part because of iSoft’s poor time-keeping. The size of the NHS contracts also forced the group to reconsider the way it did its books, prompting the discovery of accounting irregularities that are now under investigation by the Financial Services Authority.
ISoft is not alone in having had problems with its NHS work. Accenture, the US computing group for which it is working, has already put aside $450 million (£240 million) to cover its losses on the scheme.
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Public sector contracts have a history of problems. In April, EDS, the American IT services group, agreed to pay up to £71.3 million in compensation to the UK Government, after systems it developed incorrectly granted payments worth £209 million to Inland Revenue claimants.
ISoft investors made the mistake of putting too much store by the Government’s backing of NHS contracts. The company’s shares rose to levels in 2004 and 2005 that seemed to assume that there would be perfect delivery, with no delays or problems. The shares traded at a level that left no room for manoeuvre. It was therefore with little surprise that January’s rescheduling of NHS work kick-started a plunge in iSoft’s share price.
The NHS’s National Programme for IT was novel in that it passed responsibility for delays and cost overruns to the contractors and sub- contractors. That may have been a boon for the Department of Health, but for contractors and sub-contractors it is certainly bad news.
The structure isn’t foolproof, with the NHS already admitting that some local health trusts have had to take on extra burdens for the implementation, largely on manpower costs.
Although there may be a broad slowdown in public sector spending ahead, companies operating in niche areas still seem to be confident of growth in demand for their core skills.
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Detica, which provides high-end IT consulting to the private and public sectors, reported a 50 per cent increase in revenues from government clients in the year to March this year, aided by “exceptional” demand for national intelligence-related work. The company uses data to detect fraud and has built a strong position with UK agencies. Underlying profits rose by 30 per cent to £11.8 million in the period. And, unlike many technology companies, it pays a dividend, albeit with an unexciting 0.8 per cent yield.
Detica has won consent to contract directly with the US Government, and the nature of its work poses fewer risks of the type seen with NHS contracts. The company deals directly with the government agency and contracts for shorter periods of time. On 24 times prospective earnings, Detica is valued above the industry average, but growth prospects justify it.
Civica has built a strong presence in the local government market, supplying 90 per cent of UK local authorities. The company, which develops software to process parking tickets and court cases, targets specific niche markets and then exploits that expertise across different geographies. Trading at 11 times prospective earnings, the shares are at a discount to the software sector, which trades at 15 times earnings.
ISoft’s public sector work may have played a role in its difficulties, but that is no reason to avoid other companies tapping the public sector pound.