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IT SERVICES
Analysis
of Cap Gemini Ernst & Young’s 2001 Business Results
It Could Have Been Worse
PHOENIX, Feb. 21 - “It could have been worse,” was probably the best “good news” summary of Cap Gemini Ernst & Young’s (CGEY) just-announced 2001 financial results. At least that’s the impression one gets from the company’s latest release. It included a boastful-sounding statement that CGEY “succeeded in remaining profitable in 2001 in what was an extremely difficult market.”
That didn’t seem to
impress the Paris Bourse investors very much, however.
They dumped the CGEY stock in record numbers today (Feb. 21),
pushing the volume to over 2.9 million shares, almost four times the daily
average since a year ago. By
the time the carnage mercifully stopped, the CGEY stock was down 3.5% to €74
($64), after being as low as €72 earlier in the day.
Since reaching the peak of €294 in March 2000, the CGEY stock has now lost 75% of its value, as the company’s market capitalization dropped from about $35 billion to about $8 billion. Yet, even at these deflated levels, the CGEY shares are well above the market cap back in 1997, when the resurgence of this IT services vendor started (see the charts and “Cap: The Most Improved,” Annex Bulletin 98-17, Apr. 7, 1998).
So what spooked the
investors today? A 65% drop
in net profit, for starters. At
€152 million ($130 million), CGEY’s net margin was only 1.8% last
year. But it beats red ink,
the company executives seem to imply.
It
does. Just. But not everywhere. In
CGEY’s second largest geographic region, for example (the U.K.), the
company lost money. As it did
in Asia/Pacific (see the “Operating Profit” chart).
On
the plus side, CGEY’s revenues continue to grow despite the “extremely
difficult market.” They
were up 18% in U.S. dollars, (21%
in €uros). But when adjusted on a proforma basis for the Ernst &
Young acquisition, an apples-to-apples 2001 growth actually turns into a
2.5% annual decline in U.S. dollars (up 0.3% in €uros).
So
the third largest European IT services vendor will have to do better than
just be marginally profitable, or be treading water in terms of growth, if
it is to maintain the aura of a company on the mend and on the rise, an
image that its four-year resurgence had earned.
Cost
Cuts…
Paul Hermelin, the new
CEO who took over the top management post last December, seems to
understand that. CGEY has
already cut its work force by about 3,000, paring down its total
employment to about 56,500 by the end of 2001. This and other cost reductions could help save about €800
million ($695 million) per year, according to CGEY’s estimates released
last December, when the latest round of layoffs was announced.
But
slashing costs and expenses without growing sales won’t be enough.
That was apparent even in the second half of 2001.
After a respectable growth (+15%) in new contract sales during the
first six months of the year, the bottom seemed to fall out in the second
half. The new contract sales
shrank by 13% - from $5.2 billion to $3.9 billion (from €6.0 billion to
€4.5 billion). So resuming
its sales growth has to be the priority No. 1 for 2002.
…Followed
by Sales Surge?
The
company seems to understand that, too.
Having taken the initial cuts in 2001, the company “will now
concentrate its efforts on improving sales performance,” CGEY said in a
statement. Which also
means reaching deeper down into the marketplace, and trying to do business
with smaller companies to whom the largest IT services providers in Europe
have not been really paying much attention till now.
By forming a new 5,000-employee strong Sogeti unit in mid-January, with a mission of offering “local professional services,” according to Berend Brix, Sogeti’s new CEO, CGEY signaled it is prepared to put its money where its mouth was back in December. Sogeti’s staff will be drawn from CGEY’s operations in the U.S., France, the Netherlands, Belgium, Switzerland and Germany.
Small IT projects will represent about 30% of Sogeti’s activities which in 2001, when the new unit operated within CGEY, contributed about €550 million ($478 million) to the company’s sales. Hermelin said that Cap Gemini did not intend to spin off Sogeti or sell its shares on the stock market.
“Sogeti's model is high [staff] utilization and a lower [price] markup, vs. the extreme example of consulting, which is lower utilization and higher markup,” Brix told the Wall Street Journal in January (see the WSJ, Jan. 16).
Sogeti officials said that they will recruit additional employees in 2002 and likely broaden their presence to as many as four more countries. They declined to offer any sales estimates for 2002.
Focusing on smaller companies is also a strategy that this writer recommended to the EDS chairman and CEO back in April 1999, when Dick Brown had less than three months at the helm of EDS (see (see Annex Bulletin 99-20, 6/26/1999).
It worked. Here’s an excerpt from the Annex Bulletin on EDS’s 2000 results, “EDS Delivers on Its Promises,” published over a year ago (Feb. 7, 2001):
“But as Brown pointed out three months
ago, perhaps the best news for EDS shareholders is that much of the new
business is coming from new, smaller customers in which there was little
or no competition (see Annex
Bulletin 2000-26, Nov. 3, 2000).
Byrne Mulroney, an EDS executive in charge
of partner relationships, said in a telephone interview this week that a
year ago, the company created an indirect channels organization “to take
our experience and management capability and enable channel partners to be
successful.”
This
organization has been addressing the fast growing segments of the market
that EDS has not traditionally served, leveraging EDS’s strengths in the
back end, and our partners’ strengths in the front end routes to new
markets, Mulroney explained.
Some of the EDS new sales growth figures,
especially during the second half of last year, are directly attributable
to this new strategy.”
So the suggested strategy worked. And when something works, clone it! At least that’s what successful businesses do. Which means that CGEY’s new sales tack - focusing on smaller businesses - has good chances of success, too.
That is especially true in Europe, which is not only a bigger market than the U.S. (350 million vs. 280 million people), but there are A LOT MORE smaller and medium size companies on the Old Continent than in the good old U.S. The success that IBM enjoyed in Europe with its entry and midrange products, for example, attest to it (see Annex Bulletin 96-32, “Renaissance II,” June 1996).
Summary
CGEY’s greatest management issue for 2002 has to be generating sales growth. The opportunities are clearly there, as the record results by some of CGEY competitors show (EDS, IBM, Accenture…).
Furthermore, given that all of these competitors seem to be dealing with the same “problem sectors” (telecoms and financial services), and the same growth industries (government, energy, utilities…), CGEY’s main challenge seems to be improving its sales execution, not searching for a “silver bullet.”
Perhaps one reason the CGEY stock dropped so precipitously today was a warning that it issued: “The real turnaround cannot be expected before the middle of this year,” CGEY said in a statement.
Of course, that’s also what the CGEY competitors have been telling their shareholders. But investors tend to ignore such warnings when they are issued on the heels of record sales and profits. And they tend to magnify them after disappointing results.
Happy bargain hunting!
Bob
Djurdjevic
