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VT is set for a major refocus, and finance director Phillip Harrison is determined to make it work

by Timon Day

I quiz VT Group’s finance director Philip Harrison on the rationale for doing everything from building schools in London to procuring aircraft for the Royal Air Force (RAF).

By his response Harrison has clearly answered this question before: ‘We will paint buildings if you want us to but will sub-contract out low value-added jobs and concentrate on higher value-added work surrounding the customer as best we can.’

And never letting the customer go? I ask. ‘And never letting them go. We are not in a parasitic relationship but a symbiotic one. We want to ensure that the customer grows and gets what he wants. Our job is to get best value and share some of the gain, we are in with the customer for ten to 25 years. It must be a win-win relationship so we have to make it work.’

VT’s customer base includes large public companies such as BAE Systems, Rolls-Royce and Lockheed Martin. But 95% of its business is derived from governments, mostly the UK and US. I suggest that VT just wants to line its pockets, making money for shareholders without saving governments much.

Harrison, hits back: ‘We have just been named Ministry of Defence contractor of the year by value for money and helping the MoD meet its targets. The MoD has woken up to commercial realities in the past few years of good supplier and customer relationships.’

Changing times

Famous for its 147-year history of building warships for the UK government, VT has a different agenda today. So, while plans are under way to merge its state-of-the-art shipyard at Portsmouth with BAE’s Glasgow facilities, VT watchers believe the company will exit from this business as soon as possible.

VT will own 45% of the resulting BVT Surface Fleet, with BAE owning 55%, but BAE has the option to buy out VT after three years. Analysts think VT will be keen to sell to release cash to fulfil its ambition of becoming Europe’s leading engineering-based support services business and shift away from aerospace and defence to support services.

The bespectacled and good-humoured Harrison thinks VT should be equally rated with facilities companies such as Serco and Capita. Its shares are on a forward PE rating of around 15 compared with the near 20-times commanded by Serco and Capita: ‘It is time for people to realise we have got our momentum as well, after five years of success in building support services businesses.’

I ask Harrison to elaborate on strategy. ‘We don’t want to operate like other support services businesses that do everything from clerical and insurance work to IT systems,’ he explains. ‘Our focus is on how to deploy our engineering skills to solve critical problems for the customer. We do a variety of white-collar and blue-collar work.’

Harrison admits that VT might sell its shareholdings in the Lewisham and Greenwich private finance initiative (PFI) deals as well as 500 schools in Surrey, Reading and Waltham Forest – though not for several years.

It is hard to see the logic of renewing and refurbishing and maintaining hundreds of schools as it is low margin and does not really meet VT’s aim of moving up the value chain. It wants to be a long-term partner that is critical to the success of its client, and offer a completely managed service.

Harrison is enthusiastic about VT’s success in winning dozens of contracts training engineers for the Royal Navy, British Energy, Network Rail, and more recently Volkswagen and Subaru. Here one can see VT’s strong engineering bent being put to good use. Many more contracts are in the pipeline as VT throws resources at building its education and skills arm into a major part of the business, following the 47% profit jump to £5.6 million last year.

The company got the government-owned British Nuclear Group Project Services for £45 million a few months ago. This business makes a profit of £6 million, which should be many times this amount within a decade as the government starts to spend over £1 billion a year decommissioning old nuclear reactors. Critically, new ones must be designed for much cheaper and easier dismantling than the 20 reactors built during the past 50 years.

‘Our skills will be needed not only to decommission old reactors but also to design the decommissioning process in new build,’ says Harrison. ‘The likelihood is, new plants will be built on old sites, so it will all happen at the same time. We expect a ramp up in profits in two to three years’ time. The government expects decommissioning to cost £75 billion.’

Riding US expansion

To backtrack, VT gains 60% of its sales and profits from defence contracts of one shape or the other. This will not change much over the next decade. While UK defence spending might not change much, experts reckon US spending will rise over 10% to $700 billion, excluding Iran, over the next five to ten years as America is determined to remain the world’s top power in the face of a resurgent China.

VT looks after 1,200 helicopters for the US Army alone, and is pitching for dozens of new contracts. Soon it will be a $1 billion business helped by more acquisitions. VT was awarded US Army contractor of the year. Working with other companies such as BAE, Rolls-Royce and Lockheed, VT has achieved myriad partnerships that are mutually profitable.

The next big baby is the UK Search & Rescue Helicopter replacement of current RAF, Royal Navy and Maritime Coastguard helicopters. The contract will start in 2012 and last 30 years, with a value of £4 billion. VT has linked up with Lockheed and British International Helicopters but it will take another two years for a deal to be signed.

After that VT hopes to win with partner(s) a British Army fleet management deal to source and maintain more than 100,000 trucks, armoured cars and tanks. This will take three to four years to hammer out. The MoD might end up a virtual entity, I suggest. Harrison disagrees. ‘The MoD must always retain its key logistics and front-line operational roles. We can play in home bases, which we can make as efficient and effective for armed forces as possible.’

Even so, there is plenty more MoD outsourcing to aim at over the next decade or two. But the UK and Europe is chicken feed compared with the US, which will continue to account for well over half global defence spending for the next 20 years. While defence will provide core profits, as VT and its partners become embedded in government procurement, maintenance and training, the company will venture more into local government and EU government work, explains Harrison. ‘There are plenty of government-related services in which to grow our business, diversify and spread risk,’ he says.

Waste management is seen as a huge growth opportunity. The drive towards processing waste and extracting value rather than sending it to landfill sites plays to VT’s strengths. This market also harnesses VT’s other attributes including project management skills, PFI and systems integration experience. Local councils probably need to invest more than £10 billion in modern waste management facilities over the next decade or so. VT made a breakthrough a few months ago when it was named preferred bidder for a Wakefield Council waste treatment plant.

This is worth £700 million over 25 years. VT plans a mechanical biological treatment facility. It is pitching for four other contracts, such as the one at Hooton Park near Merseyside.

‘If one part of government cuts its spending another part is rising,’ says Harrison. This means VT should be an ultra-defensive play in uncertain economic times. Its order book has shot up from £3.7 billion to £6 billion this year. Nearly £1.2 billion of this work will be delivered next year and over £1 billion the year after, and the same again in 2011. Harrison is extremely confident of maintaining the momentum, pointing to the company’s strong management culture and excellent working relationships with both local and national government and trades unions.

It may take a few years for VT to be equally rated with facilities companies such as Serco and Capita. First the market has to be convinced VT is of the same ilk, with strong repeat revenue and a clearer rationale. On the other hand, if VT can continue growing its profits by more than 20% a year it won’t take much longer for the penny to drop and its shares to jump.

Would I buy shares in VT? YES

30 second VT Group

• Created in 1966 from merger of Vosper and Thorneycroft shipbuilding companies

• Five divisions: communications, education, services, support services and shipbuilding

• Won orders worth £6 billion this year

• Hopes to win another £10 billion orders over next two to three years

• Might sell warships arm to joint partner BAE Systems and switch to support services listing

• Share price up close on 15% in last 12 months