G4S: Back on track

On the eve of London 2012, G4S, the UK-based security company, announced that it was unable to provide sufficient security staff for the Games, requiring the army to be drafted in at the last minute and causing 17% to be wiped from the company's value and serious reputational damage.

Sandwiched between an aborted takeover of Danish outsourcer ISS the previous autumn and a SFO investigation into electronic tagging that led to a temporary ban on it bidding for government contracts the following year, the high-profile blunder, which CEO Nick Buckles admitted at a parliamentary committee hearing to be a "humiliating shambles" would cost the company nearly £90 million and Buckles his job. It also marked the end of a period of unrelenting growth – between formation in 2004 and 2011 G4S spent £1.5bn acquiring over 70 companies, doubling its share price – and the start of a transformational phase that would put it onto SKAGEN's value-focused investment radar.

G4S share price Sep 2011 - Sep 2016

Scandinavian roots to emerging market dominance

The company's Scandinavian roots go back 100 years but today's G4S was born in 2004 when UK-based Securicor merged with Group 4 Falck of Denmark and today it employs over 620,000 people, making it the third largest listed private-sector employer in the world behind Walmart and Hon Hai. Security services, which include everything from CCTV and intruder alarms to land mine clearance and diplomat protection, make up 86% of its revenues. These, in addition to cash solutions, e.g. transportation and ATM management which constitute 14% of sales, are provided to individuals, corporates and governments across 110 countries with over a third of revenues generated by emerging markets where G4S has an unrivalled position.

Its rapid expansion, often into increasingly risky geographies and practices, brought with it a lack of focus on internal controls and a new management team was installed in 2013 to turnaround the group's fortunes. Under the new CEO Ashley Almanza, who joined as CFO from BG Group and was promoted within a month, G4S has sought to instil greater discipline by exiting loss-making or high-risk contracts, selling underperforming assets and expanding into higher margin consultancy services. While the operational benefits from restructuring have been apparent – G4S has again been awarded UK government contracts – the financial hangover from a decade of aggressive debt-fuelled expansion has been harder to shake-off.

Despite a £348m rights issue in 2013, many investors believed that the company would require additional capital. This uncertainty weighed on the G4S share price and saw it exit the FTSE 100 last year for the first time since 2007. We didn't share this view (see end of article) and SKAGEN Global used the attractive valuation to first invest in August 2015 and then increase our position when a further rise in the level of debt spooked investors at the beginning of 2016. Our confidence in the company's restructuring plan was soon rewarded when rating agency S&P affirmed its investment grade status. There were further signs in the company's recent interim results that our investment thesis is starting to materialise and from the subsequent 20% share price rise it would seem that the market's confidence in G4S is being restored.

Environmental, Social and Governance progress

In addition to the financial progress being made – half year revenues and margins increased while financial leverage fell – the company is making significant strides to improve the sustainability and ethical impact of its operations. G4S had previously been involved in several controversies ranging from concerns over low wages to human rights abuses. Helped by its disposal programme which has seen the company shed several of its more reputationally risky assets and other positive corporate actions, the company appears to finally be addressing its own risk management.

We take ESG factors very seriously and their screening is embedded into our investment process for both new and existing holdings. In light of its controversies over the past decade, G4S was the largest among 18 company engagements we conducted last year and our efforts to promote better disclosure of their conduct remain ongoing. However, it is our view that the new management team at G4S takes the issues seriously and are committed to further improvements.

Inevitably for a company of such scale, the turnaround has taken some time but we believe it is on track and the operational and financial outlook for G4S is increasingly positive. Our conviction is reflected in its top ten position in the fund, while we are now the company's seventh largest shareholder alongside blue-chip investors such as Blackrock, Invesco and Woodford.

Given G4S's valuation – it still trades at a significant discount to peers and we predict 65% further upside despite the recent gains – we hope that the company's recent momentum should propel it onto the radars of other investors, particularly if its performance continues to progress as we expect. The company now looks fit for purpose and in an increasingly uncertain and complex world it is likely that demand for its security and risk management solutions will only grow. If its ESG policies continue to improve as we hope, we could see G4S approach Olympic condition and our own contrarian stance and patience should be further rewarded.

G4S and a summary of our 'Three Us'

Unpopular: Not only was G4S unpopular with the wider public following its series of corporate fiascos but also among the investment community with 60% of analysts rating the stock Sell or Hold.

Under-researched: The market failed to appreciate the scale of G4S's operational underperformance and the potential for margin improvement post-restructuring. We also believe technological advances will boost industry profitability and consolidation.

Undervalued: G4S trades at a discount to rivals which limits downside and offers huge upside if the company's turnaround continues to be successful.

Read more about SKAGEN Funds' investment philosophy.