An open letter to Capita shareholders
Dear Capita shareholders,
How are you all today? Everyone happy with their investment? I expect so, after all it has been a bumper year for Capita so far. The 2012 results looked like a pretty solid performance, underlying revenues up 14% compared to the previous year, profits and dividends up 10%, all good news – mostly. Of course, if you’d looked beyond the headline figures and delved into the small print of the results statement you might have noticed the following ‘…Our margins were slightly lower than the previous period (52 bpts) due to: the initial implementation costs of major new contracts; the set up costs of expanding our international service delivery network in Poland and South Africa; and the underperformance of our General Insurance and Property Services divisions and 2 contracts - the courts’ interpretation services contract and the DVLA Vehicle Excise Duty service contract…’
If you wanted to find out just how badly the Courts’ interpretation services contract was performing, you had to wait until August 7th to find out. This is when Capita Translation and Interpreting (CTI) – wholly owned by Capita but still reporting as a separate company – revealed its 2012 results, and what a sorry tale they tell. Thanks to the Courts’ contract, turnover increased from £6.8m to £21.1m, but operating losses ballooned from £1.6m to £15m. Before you ask, that isn’t a typo, it does actually say £15 million. How is that possible, you might wonder? How is it that a giant like Capita finds itself with such a money-pit of a contract?
The reason is, of course, that you inherited the contract when you bought a company called Applied Language Solutions (ALS) back in December 2011, a deal which cost Capita £7.5m. Don’t forget to add that to the running total of losses. At this point I could give you the whole history of ALS and its founder and former owner Gavin Wheeldon, but you can search on the ‘net' if you wish to know more. I’ll just summarise with a couple of quotes, which will pretty much tell you everything you need to know. The first quote is from the man himself:
‘…I was ringing up and pretending I was this huge translation company when really it was just me in the back bedroom with a phone and PC. I won the contract and then thought: oh my God, how on earth do I deliver this?..’
This is what his mother had to say about him:
‘..My nickname for Gavin was our small Arthur Daley, my dad always said if he didn’t end up behind bars he’d end up making a fortune!...’
How is it that the Courts’ Interpreting contract is proving to such a loss-maker? The answer to that is quite simple; it was never intended to be profitable. Think about it. You’re the owner of a small enterprise which has shown spectacular growth since you started it up, but somewhat annoyingly fails to make any profits. Indeed, it is accumulating a sizeable mountain of debt just to keep going. In order to off-load what minister Francis Maude MP was to later describe as ‘..a failing company..’ you need to make your company more attractive to potential buyers, and what could be more attractive than landing a big juicy government contract? To this end, you put in a bid for the contract where you promise to deliver everything the customer is asking for, with all the bells and whistles, and at a price which undercuts all of the competition by a substantial margin. Having won the contract, you find someone to buy your company and you walk off into the sunset with your millions, and leave the poor suckers that bought the business to find out they’ve bought a complete dud. In this instance, you can replace ‘poor suckers’ with ‘Capita shareholders’.
What are the sorts of really dumb things that Mr Wheeldon promised ALS would deliver? For a start, he offered to pick up much of the travel costs that Interpreters incur when they travel to an assignment, and not pass any of that cost on to the customer.
Under the system that prevailed before the contract, the Courts would pay for travel time and other expenses, just as they did (and continue to do) for all other categories of expert witnesses. After all, if you have to travel a substantial distance, it just wouldn’t be worth doing the job if you had to cover your own expenses, especially parking, bearing in mind that most Courts are located in city centres where parking is often at a premium.
Why Mr Wheeldon thought that travelling costs could be absorbed into his gross margin is anyone’s guess, but it does lead on to the next fantasy contract deliverable, which was to significantly increase the numbers of Interpreters available to satisfy demand. Taken at face value, this would reduce the need to pay travel expenses as it would be easier to find an interpreter that lives locally. Indeed, one of the KPIs in the contract was that 95% of assignments would be fulfilled by someone within a 25 mile radius, and yet in August 2012, for example, the actual figure was just 34%. Put it another, whereas the business plan assumed that in only about 5% of assignments there would be significant travel expenses to be paid, the actual figure is about 66%, more than 13 times greater. I think you can see where are a lot of your losses are being swallowed up.
I expect Capita shareholders come from all walks of life, from individuals who fancy a punt on the stock-market, to the fund managers that manage huge portfolios of investments on behalf of pension funds. Whatever your background, I expect most of you know a little about the fundamentals of economics, the laws of supply and demand, price elasticity, that sort of thing, GCSE level economics. Well, when it came to the Language services contract, ALS and the Ministry of Justice put conventional wisdom to one side and turned the rules of the free market on their head. They decided that the best way to get more Interpreters to enter the market was – you guessed it – to slash the pay rates. The consequences of this folly are plain to see: the number of Interpreters prepared to work for Capita is probably around half the numbers that were doing the job before the contract was rolled out, which leads on to the third big whammy. As Capita doesn’t have people prepared to work for it, many of the assignments are being sub-contracted out to other agencies, some of whom will be bidding to win the contract from Capita when it’s up for renewal in 2016.
Taking all of these factors into account, it’s plain to see why this contract means nothing but pain for Capita. It’s hardly surprising that Mr Wheeldon started touting his business for sale before the ink on the courts’ contract was barely dry. Mr Wheeldon and other senior managers of ALS actually stayed on at the company – on the Capita payroll - until July 2012, when it was agreed to ‘part company’. You may wish to consider what the Capita board had to say about them in written evidence to the parliamentary Justice Select Committee:
‘….Capita has also now replaced all of the ALS senior management team that were involved with the contract as, in my and my board colleagues’ opinion, there was insufficient experience and capability to handle and address the issues being faced by service users and the Ministry in its capacity as the commissioning public authority. We were not satisfied with ALS management’s attitude to business process adherence, implementation planning, audit management and service delivery..’
Read that passage and decide for yourself if that sounds like a group of people that are enthusiastic and determined to make the contract work, or are they just marking time, planning their next business ventures, instead of getting on with the job Capita is paying them to do?
As a shareholder, you must wonder who within Capita did all the due diligence before deciding to buy ALS. After all, when you’re losing over £1m per month, ALS would have been bankrupted within a matter of weeks. Capita could have waited until then to step in and pick up the pieces, no doubt the Ministry of Justice would have been so grateful they’d have probably paid Capita to do it, and Capita would be in an excellent bargaining position to re-negotiate the contract. In all fairness, maybe Capita decided it didn’t need to do much in the way of due diligence, assuming that the Ministry would have done all that before they placed the contract with ALS. How wrong they were.
For years to come, the procurement of the Language Services Contract with ALS will be the definitive, text-book case study of how not to place a government out-sourcing contract. It was not for nothing that the Public Accounts Committee report into the contract identified the Ministry of Justice as an ‘unintelligent customer’. I think the committee was being a little too polite. On the spectrum of competence, I’d like to know where ‘unintelligence’ ends and stupidity begins.
The big question now for Capita shareholders is this: are you happy to continue sustaining these losses, or are you going to do something about it? There is a remedy available, which is to pull out of the contract. There are no early termination penalties, it could happen as early as tomorrow if you want it that way. There is a recent precedent, when NHS Direct decided to pull out of delivering the 111 emergency call service, citing the contracts as being ‘financially unsustainable’. Hugely embarrassing for NHS Direct, but at least they had the courage to act early, and stop throwing good money after bad.
At present, both Capita and the MoJ are putting on a brave face, claiming they are investing in the business and that things are improving. Well, they may call it investment, but really it’s just plain old spending money to subsidise the service. As for improvements, you need look no further than the service credits imposed on Capita for failing to meet the key contract fulfilment rate. November 2012 - £1202; December 2012 - £854; January 2013 - £3070; February 2013 - £3164; March 2013 - £3651; April 2013 - £4119.
You cannot help but notice the inexorable upward trend, clear evidence that contract performance is on a downwards slide, not to mention that bad publicity Capita receives from all the press stories about collapsed trials, delayed trials, case adjournments etc. You might be able to brush off such criticism if Capita was making a decent profit on the contract, but to take massive losses sound more like masochism than shrewd investment.
The Ministry of Justice is in no hurry to terminate the contract. Indeed, why should they when they are receiving a service – albeit a substandard one – at well below cost price. It allows them to claim they are making substantial savings, but the truth is that the costs have simply been transferred from being a burden on the taxpayer to a burden on Capita shareholders. As a UK taxpayer I suppose I should feel grateful for your collective benevolence. It’s gratifying that after all the taxes you already pay to HM Treasury in the way of income tax, corporation tax, tax on dividends, stamp duty etc, you still feel the need to go the extra mile and provide a direct subsidy as well. It would have saved a lot of disruption if the government had left the old interpreter booking system alone and simply imposed a windfall tax on Capita to help it shore up the public finances.
What is puzzling is why Capita itself doesn’t pull out of the contract. One can only think that the senior management that decided to buy ALS don't want to admit they got it disastrously wrong, in case it makes them look stupid. Perhaps they believe that if they keep quiet about it, no one will notice the losses when compared to the profits other parts of the company are making. Perhaps they’re content to take the money they could be paying out as dividends and use it instead to prop up a failing business, in the forlorn hope that something will turn up.
I can’t imagine what that something might be. There is little scope for growing the business, as demand for legal interpreters is largely determined by the volume of criminal activity. Demand was already declining before the contract took effect, assisted in part by government policy. Many offences which would have once required being hauled up before a magistrate are now routinely dealt with by police cautions. Local government minister Eric Pickles has been vocal in his opposition to providing any interpretation or translation services to foreign nationals, taking the view that anyone who wants to live in the UK should speak English. The Metropolitan police service – which spends about £5m/year on translation and interpreting – has no intention of migrating over to using Capita’s service. It already has its own tried and tested system which works perfectly well, and has observed the grief that other forces have experienced at the hands of Capita.
In conclusion, I would ask all Capita shareholders to consider whether it is in their personal interests to sit back and watch their money being poured down the drain. If you are persuaded that it makes sense to cut your losses now, then your only hope is to put pressure on the company to pull out of the contract at the earliest opportunity. It means writing off the money paid in buying ALS and subsidising the contract over the last 18 months, which must amount to around £30m by now, but if you do nothing, you’re likely to continue losing another £10m/year (at least) for the foreseeable future.