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   Confidential Annex Research Client Edition

IT SERVICES

Analysis of Cap Gemini Ernst & Young’s 2002 Results

The Ten-year Glitch

Declining Profits Turns to Losses Amid Cutbacks and Restructuring

WESTERN AUSTRALIA, Mar 3 - Cap Gemini Ernst & Young (CGE&Y) seems to be afflicted with a 10-year glitch.  Every decade or so, the company bleeds “red ink.” 

The last time around the management was forced into scratching a “red ink” (gl)itch was in the 1992-1993 period.  Just as in 2002, declining profits had turned into losses (on the heels of the Gulf War and the ensuing 1991 recession - see the chart).

When CGE&Y released its latest 2002 business results on Feb 28, they contained a loss of €514 million ($549 million) on revenues of €7 billion ($7.5 billion).  Thanks to vagaries of foreign currency translations, however, i.e., the weakening of the U.S. dollar, the 2002 revenue amount was down 16% in €uros from the comparable 2001 figure, but up 3% in U.S. dollars. 

No such “miracles” were at work in terms of net profits, or losses, as it turns out.  The main reason for the hefty loss was a €463 million restructuring charge.  Of that total, €359 million was related to 5,455 that were slashed in 2002.  The remainder (€104 million) was spent on “office space rationalization” (read - reduction).

Mostly as a result of the net loss, the CGE&Y equity declined from €4.3 billion in 2001 to €3.5 billion in at the end of 2002.  The CGE&Y market capitalization also dropped sharply (see the charts).

Despite its significant woes last year, however, CGE&Y was actually a profitable company in 2002, at least from an operational standpoint.  Its operating profit had shrunk from €703 million in 2000 and €423 million in 2001 to only €114 million in last year.  But at least it was a profit, rather than a loss.  The corresponding operating margins declined from 10% in 2000, to 5% in 2001 and 2% in 2002.

Geographies…

Of the four major CGE&Y geographic segments, France turned in the best performance (meaning, France shrank the least - by 9% from 2001).  North America and UK/Ireland revenues declined 16% and 13% respectively, with the British Isles “distinguishing” themselves additionally with a €24 million operating loss (North America recorded a €42 million operating profit).

The worst business results, however, came from the smallest CGE&Y region - Asia/Pacific.  The revenues in this area of the world dropped by 31% to €140 million, also producing a €12 million loss to boot.  The new A/P management that CGE&Y installed in 2002, with whom we met during our recent visit to Sydney, were optimistic that they can turn things around this year.  Time will tell…

The best European region was Central Europe, the only CGE&Y area that actually produced revenue growth last year (+3%).  If only it were a little bigger… Alas, Central Europe contributed only €466 million to the company’s total 2002 revenues, thus barely making a dent in the overall declining trends.

Furthermore, Central Europe’s growth came at a price, and undesirable one at that.  The area lost money in 2002, as is often the case with relative start-ups.  Its operating loss was €3 million.

Industry Segments

As most major IT services providers have been reporting, ever since 9/11, global competitors have been operating in a global war economy.  As a result, the government sector has been booming while private enterprises languished.  

CGE&Y was no exception.  Its public service and health care industry segment thrived in 2002 (up 37% to 26% of total revenues), while most of the others shrank.  The only exception was the “life sciences” sector that also grew (by 7%) to 7% of global revenues.

Among the biggest losers in 2002 were the “telecom and media” and “manufacturing” segments, whose revenues declined by 37% and 26% respectively.

Horizontal Segments

Outsourcing was the only CGE&Y horizontal business segment to show discernible growth in 2002.  It grew by more than 30% to over $2 billion, or 27% of total revenues.  

The “project consulting” (including systems integration) dropped from 72% of the total revenues in 2001 to 67%, while Sogeti, a newly formed entity in early 2002 (see Analysis of CGE&Y 2001 Results, Feb 21, 2002), declined from 7% to 6% of the total.

Summary & Outlook

Last year was clearly a period the CGE&Y management and shareholders would rather forget.  But if you listen to their expectations in the future, it was also the year that prepared them for weathering the continued tough economic environment in 2003.

No, do not expect any “silver bullets,” such as switching to “duct tape” production, or quick fixes and sudden strategy changes.  The CGE&Y management sounded ready to slug it out in the trenches while holding their basic course.  Which means trying to improve the “front end efficiency” (presumably the sales productivity?), while increasing the service delivery productivity “through a more systemic and better coordinated use of network development centers.”

If things go according to plan, we can expect continued modest declines in revenue during the first half of 2003, with “stabilization” taking place in the second half.  At the bottom line, CGE&Y is hoping to return to about a 5% operating margin that it enjoyed in 2001.  

Don’t we live in interesting times? (which happens to be an old Chinese curse - “may you live in interesting times”).  With the present and the past being so awful, going “back to the future” while scratching the 10-year (gl)itch seems an appealing proposition. 

Happy bargain hunting!

Volume XIX, No. 2003-05
March 3, 2003

Editor: Bob Djurdjevic
Published by Annex Research
e-mail: annex@djurdjevic.com

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