PHOENIX, Feb 24 – Capgemini’s 2004 revenues rose 9% in €uros (up 15% in U.S. dollars) to €6.3 billion ($8.3 billion), but big write-offs resulting from continued restructuring dropped €359 million ($474 million) of red ink to the bottom line.  Operating profit, fell to €58 million from €155 million in 2003.

The stock market evidently liked what it saw.  Undaunted by the company’s continuing losses, the Paris Bourse lifted the Capgemini shares by almost 8% to €28.30 following the release of its latest results (see the chart).  That’s because the operating income fell less than analysts had feared, and revenues and new contract sales were higher than expected.

“We are on a new profitability trend,” Nicolas Dufourcq, Capgemini’s CFO, told the analysts during a teleconference that followed the earnings release.  “It is not a hiccup (a one-time blip?).  It's something that will be continued in 2005.”

Capgemini’s recovery in Europe is gathering momentum, while North America continues to be its biggest enfant terrible (problem child).  The North American operations showed a loss of €32 million in the second half, the same amount as in the first, with the ramp-up costs of large contracts like TXU contributing to it.

Paul Hermelin, the CEO, told the conference call participants that, “in the second half (of 2004), we delivered on our commitments -- growth and a return to profitability, with a strong recovery in Europe ...”

Capgemini has a new man at the point leading the U.S. recovery efforts.  It is its new COO, Pierre Danon, whom Capgemini has just recruited from British Telecom where he ran very successfully its retail operations.  Danon will be the third top executive in less than 12 months to take a crack at fixing the leaky North American ship.

The CEO Hermelin is confident that his new man and the region’s recovery plan, codenamed “Booster,” will bear fruit.  And quickly.  “We started the U.S. (turnaround) plan, and I hope we can give you some positive news within two months,” he told the analysts.

How will the “Booster” reverse the consequences of the three “Bruiser” years that have dropped the U.S. revenue share from 40% to 22%?

Capgemini will refocus on a limited number of accounts in the U.S.; will be more selective in its investments; and will reduce the number of its office locations from 44 to 12, Hermelin said.  It will also offshore more services to Poland and India.

But Capgemini’s big challenge in the U.S. market has been and will be generating profitable new business, such as the TXU deal, and thus growing its revenue.  Reducing the number of engagements, consolidating offices, and shifting work to lower-cost countries – the key “Booster” steps - will hardly boost its U.S. revenues.

Strong European, SMB Results

Meanwhile, Capgemini’s European operations seem to be going great guns again.  Their operating income rose from €12 million in the first half of the year, to €110 million in the second half, and “is starting 2005 with renewed operational confidence,” the company said. 

Furthermore, European and Asia/Pacific revenues grew by 21% for the year, while North American business declined by 18%, despite the influx of new revenues from the TXU megadeal.

Within Europe, the two largest Capgemini countries, the U.K. and France, led the recovery with 53% and 48% respective revenues spurts (in euros).  The Benelux and Nordic countries also reported a strong double-digit rise.

But the fastest growth occurred in Capgemini’s small and medium business [SMB] market.  With the integration of the Transiciel business, acquired in late 2003, Capgemini has exploded in local professional services.  With a headcount of almost 14,000, this unit posted a revenue jump from about $580 million to $1.3 billion (a 6.6% organic growth rate).  This has doubled its share of Capgemini revenues from 8% to 16% in just one year.  More importantly, it has also increased its contribution to profits.

Outsourcing Growth Adds to Profit Woes, For Now…

Outsourcing is also gaining share of Capgemini’s business.  It now accounts for one-third of the total (up 21% over 2003 as reported in euros, and up 26% in U.S. dollars). 

At the end of 2004, the backlog stood in excess of €14 billion (an increase of 40% over the year).  This should contribute €3 billion to 2005 revenues, Capgemini said.  Of that total, the outsourcing contracts represent €11 billion, or nearly 80% of the total backlog.

Alas, the increase in outsourcing share is actually one reason for Capgemini’s profitability struggles.  The other is technology services.  The company’s two largest horizontal business segments have the lowest profit margins (technology services actually lost €46 million in 2004 on revenues of about €2.2 billion, while outsourcing made a €14 million operating profit on revenues of €2.1 billion).  By contrast, the SMB operation (“local professional services”) has much higher (7.5%) profit margins, but its 2004 revenue is only €1 billion.

The company’s net cash position improved from €266 million to €402 million at the end of 2004 - topping the €350 million Capgemini executives had predicted.  This included €98 million from asset sales.  But equity declined to €3 billion from €3.35 billion in 2003, due to the restructuring-related losses.

New contract sales were down slightly in 2004 compared to 2003, the company’s banner year highlighted by its Inland Revenue win in the U.K. (see “Biggest Feather in Cap’s Cap,” Dec 2003).  But at €10.5 billion ($13.8 billion), they are still quite respectable.

Outlook

The company is hoping that as outsourcing matures, and the big deals’ upfront costs begin to wane, they will correspondingly drop larger amounts to the bottom line.  The rapid growth in its SMB business will also have a beneficial profit effect.

“We are shooting for a (operating) margin of 3% or better if the U.S. restructuring can be accelerated,” Hermelin told the analysts.

That’s may not sound like much, but it beats €1 billion (over $1.3 billion) of red ink Capgemini has bled to the bottom line in the last three years.  And that qualifies the 3% profit a turnaround of major proportion, at least in our books, especially when accompanied with a double-digit (10%) growth at the top line.  Improving Capgemini’s sales and revenue record in the U.S. will be the company’s “wild card” in achieving that.  

Happy bargain hunting!

Bob Djurdjevic