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Updated 9/10/04, 9:15 A.M. PDT (adds "Not As Bad As It Seems")

Analysis of Capgemini's First Half 2004 Results

Stock Plummets on Unexpected Loss

North American Operations Drag on Revenues, Profits

PHOENIX, Sep 9 - Capgemini surprised investors and analysts with a 20 million loss in its just-reported first half 2004 financial release.  The fact that its chief financial officer, William Bitan, resigned, didn't help matters much, either.  The Capgemini stock plummeted about 13% to 19.53 in today's trading in response to both disclosures (see the chart).

Capgemini said the operating loss was a result in part of an 80 million charge for significant overruns on systems integration contracts signed in 2001 and 2002, as well the large upfront costs required to submit bids for contracts.  The company also attributed its loss to 52 million of restructuring charges. Capgemini said it adopted new restructuring measures in the second quarter, which include the closure or disposal of unprofitable non-core operations.

Capgemini also incurred a one-off charge of 30 million in the half as a result of its name change from Cap Gemini Ernst & Young. 

Weakness in its North American operations, where revenues declined by  29% and the loss was 32 million in the first half of 2004, was also cited by the company executives as a reason for disappointing results.

"Our ambition is for the United States as a whole to reach break-even in the second half of 2004, with the bulk of the difficulties in technology services," Capgemini's CEO Paul Hermelin said at today's Paris news conference, according to Reuters.  "(But) dealing with the American problem is not a matter of a few months; the aim is rather the start of next year."

On a more positive note, Capgemini said its order book has more than doubled compared to a year ago, to 12.7 billion from 6.1 billion, with 5.9 billion ($7.2 billion) of new contracts coming in the first half of 2004.

Profitability, meanwhile, would improve in the second half compared with the first, Capgemini said.  Capgemini's first-half operating margin was a negative 0.7% percent of revenue from a positive 2.7% a year earlier. Hermelin said he expected a positive operating margin of 2% to 3% in the second half.

Hermelin gave no targets for 2005, but aimed for further profitability improvements next year.  "The spiral has already reversed; all our businesses should show growth in the second half," he said, according to Reuters. "Our ambition for 2005 will be clearly to increase margin levels: the aim is to catch up to the margin levels of our competitors."

Not As Bad As It Seems

Actually, things are not nearly as bad at Capgemini as they seem judging by the drop of its stock.  Quite the contrary.  The surge in new contracts bodes well for the company's future revenues and earnings.  Even in the short term (third and fourth quarter), one can look to some immediate benefits from it.  The company expects a 9% "organic" revenue growth in the third quarter, followed by a 14% surge in the fourth.

What's especially encouraging is that Capgemini is poised to grow not just in the high-end, where it has won two of industry's biggest megadeals (Inland - Biggest Feather in Cap's Cap, Dec 2003, and TXU - Texas-size Home Run, May 2004), but also in the small and medium business market (SMB).  With the acquisition of Transciel, this market segment's revenue share has already doubled (from 8% to 16% of total - see the chart).  And it is showing the "highest operating profitability," according to Capgemini.

So it is in the SMB space that the key to future growth lies not just for Capgemini, but for the rest of its major competitors, too.  Some of them are still busy trying to squeeze blood out of a stone - i.e., grow rapidly in a shrinking high-end marketplace.  Others are cutting their noses off to spite themselves, such as EDS, whose CEO has just announced that he would cut another 15,000 to 20,000 jobs from its payroll (click here to read more about it).

Besides, about 132 million of the charges that Capgemini incurred in the second quarter that led to its unexpected loss are related to "house cleaning" - getting rid of unprofitable contracts.  You'd think the stock market would applaud that!?  To the extent that that's it now, and that there won't be any more similar surprises in the future, such "house cleaning" actually also bodes well for the quality of Capgemini's revenues and earnings in the future.  If in doubt, just check back with EDS for an example of how much worse things can get (e.g., with its Navy contract) if you do not clean house quickly and regularly.

Finally, all four of Capgemini's business segments have now bottomed out and are poised for growth, according to a chart from its presentation to analysts (see above).  And that's something that hasn't occurred in years (that the company is firing on all cylinders).  For a real world example of what happens when that happens, check out Accenture: Revving Up a Notch (June 2004) and Accenture: Burning the Track (Mar 2004).

In short, we would not be selling Capgemini short, both literally and figuratively.  Maybe some others are realizing that, too.  Capgemini's stock bounced back almost three points today (9/10/04) to close at 20.07.

Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2004: EDS to Cut Up to 20,000 More Jobs (Sep 2004); Capgemini Stock Plummets on Unexpected Loss (Sep 2004) HP Savaged by Wall Street (Aug 2004); Moody's Lowers the Boon on EDS (July 2004); HP: Delivering Value Horizontally (June 2004); Accenture: Revving Up a Notch (June 2004); Beware Your CFO! (May 2004)IBM: Changing of the Guard (May 2004); Capgemini: Texas-size Home Run (May 2004); Following the Money (May 2004);  EDS: On a Wink and a Prayer (Apr 2004); HPS Wins by a Nose! (Octathlon 2004); Accenture: Burning the Track (Mar 2004);  IGS: "Crown Jewel" Restored? (Mar 2004); HP: Still No Cigar (Feb 2004); Cap Gemini: Another, Smaller Loss (Feb 2004); CSC: Good Quarter Gets Boos (Feb 2004); EDS: "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); IT Industry: Whither Goeth It? (Jan 2004); Cronyism Is Alive and Well at EDS" (Jan 2004)

2003 Cap: Biggest Feather in Cap's Cap (Dec 2003); The 10-year Glitch (Mar 2003) 

A selection from prior years - Cap

Analysis of CGE&Y 2001 Results (Feb 21, 2002), Analysis of Cap Gemini Ernst & Young 2000 ... (2001),  CGG 1999 Preliminary (Mar 10, 2000),  CGG Annual Report 1998 (June 18, 1999),  CGG: The Most Improved (1998)

Or just click on and use appropriate  keywords.

Volume XX, Annex Newsflash 2004-17
September 9, 2004

Bob Djurdjevic, Editor
(c) Copyright 2004 by Annex Research, Inc. All rights reserved.
e-mail: annex@djurdjevic.com

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