The reputation of the outsourcing sector has taken another beating after news that the police have been called in to investigate alleged fraudulent behaviour by Serco (SRP) staff on a prisoner escort contract, misreporting data. The news, together with worse-than-expected margins in today's half-year results announcement, sends the shares crashing nearly 10% to 547p.

This is the second time that Serco has made the headlines for negative reasons, hot on the heels of July's electronic tagging probe that also involved G4S (GFS). It raises the risk that Serco will be blacklisted from future government contracts.

SERCO GROUP - Comparison Line Chart (Rebased to first) Investigations are already underway into Serco's contract portfolio with the government, so there are clearly major risks to the share price, even after today's fall. Westhouse Securities analyst Michael Donnelly doesn't believe 18% growth in AMEAA (Australasia, Middle East, Asia and Africa) and Global Services – the business process outsourcing operations – will be 'sufficient to offset the risks of further disclosures.'

We looked at the outsourcing sector in more detail last month. To find out which stock Donnelly picked as the only 'long-term winner', click here.

Liberum Capital reckons Serco's order book will start to fall in value. It highlights: 'Slowing of contract win-rate. Electronic monitoring not re-tendered. Northern Rail re-bid risk. DIAC volumes weakening. The National Physical Laboratory contract running down. Fiona Stanley hospital contract delays. AWE nuclear volume weakness.' Yet it says there's still 'lots to like' with the stock, including its improving free cashflow, strong growth in AMEAA and Global Services.

Investec has a 'sell' rating on the stock and reckons free cashflow is declining – contradicting Liberum's comments – noting that margins are under pressure from ongoing bid costs.

Issue Date: 29 Aug 2013