Analysis of Capgemini's' 4Q07 business results (Feb 14, 2008)

SCOTTSDALE, Feb 14 – Capgemini delivered a great Valentine's Day present to its shareholders - a 10 point-surge in the stock price. The one-day rally followed the company's release of the fourth quarter and full year 2007 results this morning. And what was it that the Paris Bourse investors cheered the most about the results?

It all added up to a four-act Valentine's Day opera that was sweet music to Capgemini investors' and shareholders' ears

. And the upbeat tone of the company's fourth quarter release was more than a welcome finale to 2007, given the stock slide off in recent months off of its 12-month highs of nearly $60, reached last spring (see the right chart).

"The 2007 was quite a successful year... and our people should be proud of their achievements," said Paul Hermelin, Capgemini's CEO, in an interview with Euro Business Media channel. Looking ahead, he added that, "the entire sector has been struck with the pessimism of all investors. I think this is a little bit early because, today we don’t see signs of slowdown."

Both Hermelin and Capgemini's chief of strategy, Pierre-Yves Cros, who spoke to industry analysts about the earnings release, stressed the 7.4% operating margin as one of the key achievements in 2007. Indeed, this represents a 1.6 point jump from the profit level the year before. Which was more than double that in 2005. So clearly, the company is on a strong upward profitability path.

One reason for the improved profitability is the 40% revenue growth over the last three years. Another reason are Capgemini's offshoring efforts. The company currently has over 17,000 people in India and more than 2,200 in Poland, with its work force in China, Morocco and Argentina also expanding. About 24% of the company's work in 2007 was offshored as compared to only 13% the year before (see the chart). The company expects this trend to continue in 2008.

Horizontal Segments: Local Professional Services (Sogeti), Capgemini's euphemistic name for

its SMB operation that focuses on midsize and smaller clients, continued to be the most profitable horizontal unit with an operating margin of 12%. Alas, its share of 2007 revenue remained 16.2%, as it was the year before (up 9.5% over the year earlier in constant currency). Which means that another way of continuing to improve the profit margins would be for Capgemini to invest in and get more aggressive with the SMB part of its business. Answering a question during the analyst teleconference, Capgemini's Cros said he expects this business segment indeed to grow faster in 2008.

Consulting is the company's second most profitable activity with operating margin of 10.5%. And yet its growth in 2007 was even slower (up only 4.5%). But the 9.6% revenue increase in the second half suggests an accelerating momentum for this operation going into 2008.

Technology was the fastest growing part of Capgemini in 2007, surging by 11% last year while also recording a very good operating margin of 8.9%.

Finally, Outsourcing grew by 7.8% in 2007, with operating margins of 4.7%. This is likely to improve in 2008 and beyond, Capgemini executives said, as they fee they have now put some of their "problem deals" behind them by renegotiating those contracts (like Schneider in France, for example).

Geographies: Both North America and Europe reported strong growth in the fourth

quarter and for the full year. In Europe, Nordic countries were a standout. Southern Europe and Benelux countries also turned in double-digit revenue growth. Germany and Central Europe was lagging behind with only a 3.9% revenue growth, mostly due to a decline in outsourcing business, the company said in a statement.

The 2006 K

anbay acquisition boosted the North American share of Capgemini's revenues to about 20%. Overall, this region has grown at 9.4% in constant currency and on an organic basis. In U.S. dollars, however, the North American revenues were up 40% over 2006 to $2.4 billion, while the operating margin improved from 5.4% to 6.5%.

Thanks a drop in revenues of the huge U.K. HMRC (the British tax authority) megadeal, the revenue of the company's largest geographic segment rose only 4.4% in 2007. But the U.K. Consulting and Technology sectors grew in double digits, contributing to a healthy 6.8% operating margin.

Capgemini's stellar new contract sales in the 2002-2004 time frame was an important factor in the subsequent strong revenue growth. But what bodes well for the future revenues is that the new bookings have been improving in the last three years.

In 2007, for example, they came in just shy of €10 billion ($14.5 billion), the company's best sales performance since 2004 (see the chart). Included in the fourth quarter total of €3.7 billion was also €1.6 billion-worth of contract extensions of the U.K. megadeal (HMRC). So all appears well even in the part of the portfolio that slowed down the U.K. growth last year.

Elsewhere around the world, the company said the demand for consulting and IT services was sustained throughout 2007 and in early 2008. The global crisis in the banking sector has not had any repercussions on Capgemini's business so far, the company said in a statement. Bookings are in line with forecasts and sales results for the fourth quarter have meant that the company "has started 2008 in good shape for growth," Capgemini added.

But the company warned that "it is not inconceivable that the difficulties of the banking sector will end up spreading to the whole economy and reach our own disciplines."

Outlook

Nevertheless, Capgemini estimates that it will be able to grow its 2008 revenues organically between 2% and 5%. The company is also confident in its ability to improve its operating margin to 8.5% (vs. 7.4% in 2007).

"This Group has become far more resilient, far more agile, and with ‘I-cubed’ we are increasing our resilience and we are increasing further our agility," the CEO Hermelin said in an interview. "So personally, I think we are going to demonstrate, even if the market is a little less buoyant, that this Group is winning — is winning market share — and will show a very solid profitability track record."

So there you have it - a cautiously optimistic forecast for 2008 after a strong finish in 2007. No wonder Paris Bourse investors and traders liked their Valentine's Day gift.

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Annex Bulletin 2008-05 February 14, 2008

Updated 2/14/08, 10:30PM