Serco Group (LSE:SRP) Q3 2026 Earnings Call

0:00 Good afternoon, ladies and gentlemen, and welcome to CIRCO event. Currently, all participants are in listen-only mode. Later, we will conduct a question and answer session. If you would like to ask a question, just press star followed by the number one on your telephone keypad. I would like to remind all participants that this call is being recorded. I want to hand it over to Anthony Kirby, Group Chief Executive, to open the presentation. Please go ahead.

0:26 Good morning, everyone, and thank you for joining us. We're hosting our call this morning from Washington, D.C., so good morning from a very early America. I'm Anthony Kirby. I'm Group Chief Executive of Serco, and I'm joined today by Mark Reid, our Chief Financial Officer, and Barbara Suplee, our excellent CEO of North America. Today, I'm pleased to announce our intention to acquire Kinetics U.S. business, which we will refer to as QQ U.S. This acquisition gives us greater scale and capability in two areas that we've consistently identified as strategic priorities for Serco. One, North America, and two, defence. But rather than go straight into the details of the transaction, I'd like to start by putting into context of the wider Group strategy this acquisition that we've shared with you previously.

1:22 Mark and I, supported by the Executive Committee and the Board, have a very clear ambition for Serco, which is to become more customer focused and a faster growing business, delivering safer, sustainable, profitable growth. We've talked consistently about focusing Serco on markets where we see the most attractive structural growth, where we have strong customer relationships, deep capabilities, and importantly, where we believe we have a right to win. We remain focused on defence, justice and immigration, and citizen services, and on the geographical markets where we see the strongest opportunities for growth. North America defence remains our most attractive market. The US is the largest government services market in the world, where we already have a pipeline of opportunities of more than £7 billion.

2:14 We've built our position organically through winning new work and expanding but we've also supplemented this growth with carefully selected acquisitions where they've given us new expertise, scale or customer access. You've seen us do that through several acquisitions since 2018 and most recently with a successful integration of MT&S. QQUS is the next step in that journey and is a clear fit with our strategy. So at its simplest, Q2US is a defence business and a national security business delivering mission-critical services and technology-enabled solutions. Its capabilities support some of the US government's most critical missions, including integrating satellite constellations for secure communications and missile tracking, operating airborne radar surveillance of the US borders, and providing robotics and naval control systems.

3:17 It combines specialist services with engineering, technology and production capability. QQ-US has more than 800 specialist employees supporting around 100 programs with no major rebates due before 2028. Its customers include some of the most important organizations across US defense and national security, including the military, space force and the three-letter agencies. and in terms of strategic alignment, QQUS fits naturally with our three mutually reinforcing priorities of growth, competitiveness and operational excellence. On growth, QQUS operates in areas of strong government demand as evidenced by this year's book to bill of more than 150%.

4:10 On competitiveness, the current US management team has made significant progress restructuring and refocusing the business, including exiting non-core activities. But QQUS remains sub-scale in a market where scale really does matter. So becoming part of Serco's North American platform will make QQUS more competitive and better positioned to grow. And on operational excellence, The business has a high quality contract book, stabilised operations and strong customer performance scores. So we're acquiring a good business on a much stronger footing than it was but there is still more to do and we recognise it has more potential for growth.

4:55 So with that context let me take you briefly through the headline terms of the transaction. We've agreed a cash consideration of $292 million, comprising $237 million for the operating business and $55 million for the tax benefit associated with the transaction. We've taken a prudent view in valuing that tax benefit. Our current CERCO forecast is for QQUS to generate around $370 million of revenue and $21 million of underlying operating profit. on a full year basis in 2027. We also expect to deliver at least 3 million of net run rate synergies. Putting those elements together gives us a 2027 underlying operating profit multiple of around 9.9 times. We think that's an attractive valuation for a technology enabled US defence business of this kind. Completion is expected in the first quarter of 2027 subject to the required approvals.

5:58 Mark will provide a bit more colour on the financial case shortly. But first, let me explain why we think this is such a good Bolton acquisition for Serco. In many respects, the model here is familiar. It builds on the approach we took with MT&S, adding scale and complementary capabilities in a market we know well, where we see attractive long-term structural growth. There are four principal reasons although the first three are very closely connected. So let me take all four. First, priority mix. QQUS increases our scale in North American defence exactly where we said we want to grow. Second, capability. It strengthens us in areas of strong and growing government demand while adding more specialist technology, design and prototyping experience.

6:49 And those first two points feed directly into the third which is greater growth and competitiveness. Bringing QQUS into Serco gives the business greater scale and a more efficient cost space while significantly strengthening our position with customers including Space Force, the Army and the Navy. And combining the expertise, customer relationships and the pipelines of two businesses should give us more opportunities to compete and win. And that brings me to the fourth reason, the financial returns. The transaction also fits with how we've consistently said we'll allocate capital and we remain incredibly disciplined when it comes to acquisitions. Even more so now we have a frugal and fabulous CFO.

7:35 These four elements are mutually reinforcing. We're increasing our exposure to a market we like, strengthening our position in that market and creating more opportunities for growth while maintaining the financial discipline that you've come to expect from us. So just let me take each of those in turn. First, portfolio mix. The direction of travel here is very clear. Before MT&S, and including our share of joint ventures, defence represented around 38% of group revenue. With QQUS, that will move us to around 46%. And we see a similar shift in North America, which moves from 25% of group revenue before MT&S to around 33% following this acquisition.

8:23 Our North America business will now have around $2.5 billion of annual revenue and contribute around half of the Group's profit. So QQUS further increases our exposure to two of the most attractive markets, North America and defence. The second reason is capability and I think this slide tells an important story about the evolution of Serco in North America. Back in 2017 our North American business generated around 900 million of revenue. Since then we've built the platform through a combination of strong organic growth and targeted acquisitions. BTP added satellite communications and radar engineering. The naval systems business unit strengthened our design systems and engineering lifecycle support capabilities.

9:15 WBB added high-end engineering and technical services. And most recently, MT&S strengthened our position in mission training and satellite ground communication networks. Each acquisition has moved us up the value chain, adding deeper expertise and more technology-led offerings. And importantly, the acquisitions have complemented strong organic growth. We've demonstrated that we can bring specialist businesses into Serco, retaining their talent, expertise and customer relationships and help them grow as part of a much larger North American business. The combination of organic growth and selective acquisitions has created the broad defence platform that we have today and QQUS strengthens that platform further.

10:08 I'm now going to hand over to Barbara to bring to light what QQUS actually does and why these capabilities are important to Serco North America. Barbara.

10:18 Thanks Anthony. Just briefly by way of introduction, I have spent more than 30 years working in or alongside many of the organizations that QQUS serves today. Before Serco, I led a multi-billion dollar portfolio supporting customers across the Army, Navy and Marine Corps. Earlier in my career, I also served within the U.S. intelligence community and as a U.S. Navy intelligence specialist. That gives me a real appreciation of what QQUS adds to the North American business we're building. This slide will be familiar to those of you who have followed our previous results announcements. Serco already has a broad defense platform.

11:03 QQUS strengthens four areas in particular. Program and acquisition support, design and delivery, operations and technology, data and digital. In some of those areas, QQUS gives us additional scale and much greater depth and capabilities we already have. In others, it brings specialist expertise and technologies that broaden what we can offer our customers. And that's important because our customers increasingly need partners that can bring together technology, Engineering Expertise and Operational Delivery to solve more complex mission requirements. Rather than take you through every area on the slide, let me bring a couple of those to life through two examples of the work QQUS is doing today.

11:50 The first is the Proliferated Warfighter Space Architecture where QQUS works with the Space Development Agency. This is a $224 million program supporting the development and delivery of the US military's next generation satellite architecture. Its engineers help the US government determine the capability it needs, support acquisition, integrate systems supplied by multiple organizations, and help make the overall constellation operate as one. QQUS's role spans the life cycle from acquisition through launch and into operations. That architecture support areas including missile warning and tracking, Communications, and sensor to shooter connectivity.

12:36 It's complicated, highly technical work, and is a good illustration of the type of specialist capability QQUS brings to Serco. Space is already an area we have real experience. Serco has a long history supporting space missions in Europe, and MTNS strengthened our satellite capabilities in North America. QQUS takes us a step further, adding greater scale and depth in response to strong customer demand. The second example is TARS, the Tethered Aerostat Radar System. These are large tethered aerostats carrying radar and sensors high above key U.S. borders, providing persistent surveillance. QQUS operates and sustains eight sites under its contract with the U.S.

13:21 Customs and Border Protection. But QQUS isn't simply operating the equipment, it also helps modernize the sensors Integrate the data, automate the system combining engineering, software, advanced sensing, and the operational delivery. The system tracks activity across air, land, and maritime domains, supporting border security and counter-nuclear missions. Together, they show the breadth of specialist expertise QQUS brings. And that brings me to the wider opportunity we see from putting QQUS and Serco together.

13:57 There are three areas I'd highlight.

13:59 First, scale and efficiency. Bringing the two businesses together creates a North American platform of around $2.5 billion of annual revenue. QQUS will benefit from Serco's existing scale, infrastructure, and lower cost base in North America. We've already identified cost synergies from the tribes of action, but for me, the most important point is what it does for competitiveness. In the U.S. market, scale matters. A lower cost base and a larger platform give QQUS greater flexibility when competing for work while protecting returns. That should make the business more competitive and better positioned to grow. Second, customer relationships. QQUS strengthens our relationship with the Space Force while deepening our position with the Navy and Army and bringing complementary technology and solutions expertise to Serco. At the same time, Serco brings deep relationships across wider US defense market and a strong track record of delivery for our customers.

15:02 So there's a genuine two-way opportunity here. QQUS brings expertise in customer relationships that strengthens Serco and Serco gives QQUS a broader platform from which to grow. And lastly, pipeline. Across Serco, we already have more than 7 billion pounds of defense work in our pipeline. QQS brings around 40 further opportunities. We'll review and qualify those opportunities in the normal way, but they give the combined business a broader opportunity set from day one. This isn't simply about putting two businesses together. It's about creating a larger, more efficient, and more competitive North American business with stronger customer relationships and a broader opportunity set from which to grow.

15:48 And over time, we expect the wider group to benefit too. through access to new expertise, ideas, and technologies that we can learn from and apply more broadly across CERCO where appropriate. With that, I'll hand over to Mark to take you through why the transaction also makes compelling financial sense.

16:07 Mark? Thanks, Barbara. You've heard from Anthony and Barbara why QQS makes strategic sense. Let me give you the CFO perspective, because ultimately the transaction has to stand up on the numbers. Since joining Serco at the beginning of the year, Anthony and I have been working to strengthen our M&A pipeline and how we assess opportunities. Our discipline has not changed. Each business has to fit and the numbers need to work and this deal meets both tests. We're paying $292 million including around $55 million of tax benefit, so effectively $237 million for the operating business. Our current forecast is for QQES to generate around $370 million of revenue and $21 million of underlying operating profit in 2027.

16:56 We've identified around $8 million of growth synergies by 2028, which nets to around $3 million of benefits to Serco, reflecting the cost-plus nature of parts of the portfolio. Taken together, this gives us a 2027 profit multiple of around 9.9 times including the synergies. For business with this exposure to the U.S. defense market and these capabilities we think that's an attractive entry point. The transaction is expected to be EPS accretive in the first full year and we expect ROIC to meet our WAP by year three and exceed it after there. From a balance sheet perspective, we expect the transaction to increase leverage by around 0.6x, leaving us comfortably within our stated 1-2x target range.

17:46 And we'll fund acquisition entirely from existing cash and committed facilities. More broadly, we've talked consistently about being disciplined in how we allocate your capital. That means investing organically, paying a growing dividend, making acquisitions where they meet our strategic and financial criteria, and returning surplus capital to shareholders. QQUS fits squarely within that framework. And importantly, the acquisition doesn't change our existing £150 million 2026 share buyback, which we will continue as planned. That builds on a strong track record of returning capital to our shareholders. Between 2021 and the end of 2026, we'll have returned more than £750 million through dividends and share buybacks, while also investing organic and acquisitive growth.

18:33 And with that, Anthony, I'll hand back to you to close.

18:37 Mark, thanks. So let me finish where I started, if I may. We think QQUS represents a compelling acquisition for Serco. It's directly aligned with our strategy, increasing our exposure to North America and defence, while adding technology-led capabilities in areas where we see attractive long-term demand. It builds on a model we've successfully deployed before. Combining our scale, customer relationships and operating platform with specialist businesses that strengthen our position and create further opportunities for growth. And as Mark has just explained, we're doing it with a financial discipline that you've rightly and deservedly come to expect from us while continuing to deliver attractive returns to shareholders.

19:26 QQUS brings Serco new expertise, new customers and new opportunities. and Serco Bridge QQUS, the scale and platform to compete more effectively and grow, as Barbara demonstrated. That's why we're excited about this acquisition and we're looking forward to welcoming QQUS colleagues to Serco and supporting their growth as part of a larger organisation. And with that, I'll now hand over to Mark to facilitate any questions that you may have. Thank you. Ladies and gentlemen, we will now begin the question and answer session. To ask a question on the phone line, please signal by pressing star 1 on your telephone keypad. We will pause for a moment to assemble the queue.

20:15 We'll take our first question from Christopher Bambury with both hands. Christopher, please go ahead.

20:22 Good morning. Yes, I'm just looking at the Connecticut XJS revenue fell material between 24 and 26 despite strong headline contract awards and the partner healthy pipeline. In terms of your DD, what we identified as the causes of those decline and what's been genuinely fixed rather than simply cyclical or timing related. Thank you.

20:43 Okay, thanks very much for the question, Chris. Look, we think we're acquiring a good business that's already on a much more positive trajectory. QQUS has got an excellent core set of mission-critical contracts. The current leadership team, I will just point out, has made significant progress in stabilising that operational performance. and I've undergone some substantial restructuring. The customer relationships are strong, performance ratings are excellent and there is really good order momentum. I think in the third half around 150% have booked a bill as I mentioned earlier. I think the opportunity for us is to bring QQUS which is relatively still sub-scale in a US market context into our platform where we Thank you.

22:13 Your next question comes from the line of David Brockton with Doishi Numis. David, please go ahead.

22:20 Good morning. Can I ask two questions, please? Firstly, just in respect of the margins, I appreciate there's been a good effort within the kinetic business to improve the margins, but is there any reason why they would be structurally lower than the Serco North American business on a sort of medium-term perspective? and the synergy number there looks low particularly relative to when you did WBB and I guess related to that is that because all of the restructuring and heavy lifting has been done? And then the second question just in respect of the tax asset, can I understand whether you can use that tax asset against Serco's wider US taxable profits or is that primarily for use against the kinetic US business only? Thank you.

23:06 David, let me take the cash one first. So yes, we can use it against Serco North America's taxable profits. I think that's straightforward and we believe it's a good asset. In terms of the overall margin, I think the business is different, slightly different in terms of composition. Well, we've got great experience in being able to manage margin in North America. And so we do see the ability of the business to move margin up over the medium term. And so, yeah, that is part of our best case. But again, we think it's going to be possible as we get into the business and progress it.

23:50 Thank you. Sorry, just one follow-up. Just on the three-year ROIC hurdle, are you including the full consideration for that, or is that just a consideration for the operating business?

23:59 Yes. That's just a consideration. That's it. Okay.

24:03 Okay. Your next question comes from the line of Arthur Toslav with Citi. Arthur, please go ahead.

24:15 Good morning, everybody. Quick one for me, folks. The question I had was just around, there seems to be quite significant differences in the financial outlook for FY27 between your statement and what is in the Kinetic statement. So they've obviously talked about, you know, 385 million of revenue at a 7% margin in the US. You're obviously talking 370 million of revenue and 21 million of operating profits. That would be a margin starting with a five. So I guess my question is kind of what drives those differences and could you be accused of being a bit conservative here?

25:02 Thank you.

25:04 Let me take that. So look, again, you know, we've spent a lot of time doing diligence as you'd expect us to do. And, you know, we've taken a view and we, you know, we fully believe that's a quite an appropriate view for Cerco. And so, look, as I said, we'll come back in due course as we close and we start running this business and give you our outlook as we always do. But, you know, it happens, David, right? People take different views and, you know, we've taken a prudent approach as we normally do.

25:35 Yeah, I think that's a good point that Mark's just made there. We need to get this business in onto our platforms. We clearly see a margin for 2027, but inevitably with all of our previous acquisitions, we expect that to be the base case as opposed to the overall outcome as we move forward.

26:00 Yeah, understood. That's very helpful. Thank you very much. Your next question comes from the line of Michael Donnelly within Fastbike. Michael, please go ahead.

26:15 Thank you. Good morning. Can you hear me?

26:17 Yep. Yeah. Two for me, one for Anthony and one for Barbara, please. Anthony, in Kinetics May prelim, Steve Wadey said that geopolitical uncertainty benefited defence hardware. Now, I'd be interested in your read on that observation at a very high level. And then, Barbara, can you help us understand how much of Kinetic's revenue is tied to Space Force's prolific warfighter space architecture program? And how does the recompete calendar look for that specific program over the next three years or so? Thank you.

26:53 Okay, well, why don't I go first? I think this is a market question that maybe you're referring to the Steve was talking to this morning look we obviously take a a circle lens when we look at all of these opportunities and as Mark said we are prudent in how we look at these how we evaluate what the growth potential is both in terms of the top and the bottom line but look we have two years to delight our customers particularly on the PWSA contract and prepare adequately for re-completes. Re-completes plus also we can leverage Serco's past performance from our re-competes.

27:40 and those contracts as we move forward which Barbara will touch on shortly are very clearly focused on mission critical deliverables. I think the level of services versus hardware in the QQUS business is heavily weighted towards services rather than hardware and technology. But look, this is a good business that we think by combining both together, where we have the one plus one equaling three, a conundrum that we often have with acquisitions is something that we're very focused on as we move forward. It's a good business. It's been transformed to a level at which, through our due diligence, So Barbara, would you be able to touch on Michael's second question, please?

28:39 Yes, thank you. As Anthony mentioned, the re-compete for this is not until 2028 for the PWSA program. So we feel very confident that we will be able to continue to deliver those capabilities and be very well positioned for their pre-compete. And I'm sorry, I missed the first part of your question for me.

29:10 It was how significant PWSA was in the revenue base for Kinetic North America.

29:18 Yes, it is about 25% of the overall QQUS program portfolio.

29:29 That's great. Thank you, Papa. Thanks, Mark. There are no further questions. I'll wait and hand back to Sorry Clothing for a closing remark.

29:43 Thank you all very, very much for your time. Really appreciate it. Thank you very much for the insightful questions. You know exactly where we are if you have anything that comes out following this update and we stand ready to answer any further questions as we move forward. But thank you all very much. Have a very good and safe day and we will speak to you soon. That concludes today's call. You may now disconnect.