Tag

consolidation

Consequences For Customers From Current Services Industry Disruption | Sherpas in Blue Shirts

By | Blog

The services industry is in disruption, pivoting from highly profitable but mature labor arbitrage factories to a rapidly growing, immature new market based on automation and software-defined market with digital platforms generating value. Most large companies have outsourced numerous IT and business process functions and now depend on the supply chain of services. However, I’m forecasting a services industry consolidation and substantial change in the supply base. Enterprises should seriously consider the impact and risks this market consolidation means for their business.

Read more in my blog on Forbes

Ascender’s Acquisition of NGA’s ANZ Business: Consolidation in a Maturing Market | Sherpas in Blue Shirts

By | Blog, Mergers & Acquisitions

On 31 January 2017, Australia-based Ascender and NGA Human Resources announced that Ascender had acquired NGA’s Australia and New Zealand business. Part of the agreement is a partnership between the two companies to deliver payroll and HR services solutions for the ANZ region, ensuring a seamless solution for NGA HR’s global payroll and HR clients. The deal makes Ascender one of the largest HR and Payroll providers in the ANZ and APAC region.

What are the implications of the deal?

For NGA:

  • Global deals with ANZ components will continue unaffected, as Ascender will serve as a partner provider in the region with no disruption to existing operations
  • NGA will aim to use a partnership-based approach for multi-country deals originating in the ANZ region. It will no longer be active in the single country payroll market in ANZ.

For Ascender:

  • Its single country capability and reach in the ANZ region will get a boost with the addition of NGA’s services delivery and technology capabilities, specifically the Preceda and PS Enterprise HCM platforms
  • It will have access to a new set of clients in ANZ, with an opportunity to sell into other regions of APAC through the newly acquired client portfolio. This could potentially increase its multi country payroll outsourcing (MCPO) market penetration in the APAC region.

Of course, as with any deal of this type, there are numerous things those in the region should watch out for.

First, NGA and Ascender will be looking to forge a partnership in a way that is beneficial to both parties beyond the immediate operational need. The scope and extent of this new partnership will evolve and take shape as the dust settles. It remains to be seen what form it will take, especially in light of Ascender’s recent entry into the Europe-based Payroll Services Alliance, wherein eight major payroll service companies have bundled their services into a unified offering that consists of strong local expertise and services, supplemented by coordination and integration at an international level.

As far as technology is concerned, with NGA’s PS Enterprise and Preceda HCM platforms coming into Ascender’s fold as part of the acquisition, Ascender will likely seek to integrate the different system capabilities under one brand over time. As with a lot of private equity-backed acquisitions, since the focus will be on improving margins, we are likely to see more investment in consolidating and improving technology, driving automation, and increasing self-service functionality.

Although the APAC market continues to experience relatively high growth rates – 7-9% in single country payroll outsourcing and 23-25% in MCPO – the region is fairly complex, and each country requires a distinct strategy to ensure sustainable growth. For instance, while India requires a heavily price-sensitive services sales approach, a technology-driven approach works better in Australia.

With the APAC region requiring a great deal of management attention and local presence to drive continued success, global providers’ APAC arms tend to be private equity acquisition targets. Indeed, while Western economy-based global players don’t necessarily have the focus to negotiate the uniqueness of the APAC region’s HR services and payroll requirements, private equity can certainly help bring that focus to the table. For example, Ascender is backed by a private equity-led consortium, and just two years ago, private equity firm Everstone Capital bought out Aon Hewitt’s APAC business, (renamed Excelity Global).

While not all will be private equity-driven, we do anticipate more acquisitions and consolidation in this space in the APAC region as the market matures, particularly in geographic markets that are fragmented, with no clear leader in sight.

Capita Goes for Accelerated Growth with Xchanging Bid | Sherpas in Blue Shirts

By | Blog

This week we heard that Capita and Xchanging had agreed on the terms of a recommended cash offer of 160 pence per share. The offer values Xchanging at approximately £412m. If it goes ahead, the acquisition would be Capita’s largest ever; it is 260% bigger than its previous largest acquisition, that of avocis for £157m in February 2015.

Capita’s newly found appetite for larger acquisitions marks a noticeable change in approach between the current CEO, Andy Parker, and his predecessor, Paul Pindar. While Pindar went for niche acquisitions, Parker is going for accelerated inorganic growth.

If this bid goes through, it will impact Capita’s business in the following ways:

  • Significant leg-up in Insurance BPO: Xchanging is something of a jewel in the insurance sector due to its golden relationship with Lloyds of London as well as insurance sector specific technologies such as Xuber. Insurance services accounts for the larger part of revenue at circa 60%. For some time now Capita has been talking about growth in the insurance sector, setting the scene for more of its M&A activity. It has previously stated, “Where premium growth remains modest, (insurance) firms are focused on improving operational efficiency and organisational flexibility, areas Capita is well placed to help them address.” Before it made the offer for Xchanging, Capita had expanded its insurance capabilities through the acquisition of SouthWestern. This brought it 700 skilled, multi-lingual FTEs at two sites, Krakow and Lodz, providing services to insurance, finance and legal administration, and customer management across Northern Europe. Another relevant and recent acquisition was that of tricontes in 2014. The £6.2m acquisition of the Munich-based company in June 2014 brought Capita specialist contact centre services for various sectors including the insurance sector in Germany.

  • Bigger play in the private sector business: The split between Capita’s public and private sector business has always stayed roughly around 50:50 with annual variations of plus or minus 5%. In 2014 Capita’s private sector business was £2273.6 and accounted for 52% of revenues. With revenues of £406.8m in 2014, Xchanging could boost Capita’s private sector business by as much as 18% – a significant growth.

  • Entry into potentially lucrative BPO segments: Xchanging has good capabilities in the fast growing Procurement Outsourcing (PO) and Capital Markets BPO. Our analysis shows that both market segments are growing upwards of 10% CAGR. Further, these are specialized BPO segments and hence less prone to commoditization. However, to fully capitalize on the potential, Capita would have to address recent issues with Xchanging’s PO business.

  • Geographic diversification: This acquisition would help Capita expand its market presence beyond the UK. Some of the key countries where it could help Capita are Italy, Germany, and the U.S. While the scale may not be big, it can provide Capita a base upon which to build its international business. Further, continental Europe is a specialized market, which may not be the easiest to penetrate for an external service provider. Xchanging, with its multiple contracts in Germany, can help Capita in its entry in that geography.

  • Greater global sourcing leverage: Capita has around 5,000-6,000 FTEs in offshore location. This acquisition offers the potential of increasing this number by 20-25% primarily in India.

Clearly, this acquisition can help accelerate Capita’ growth and capabilities in multiple ways. However, as with any acquisition, successful integration will be key to harness the potential including effectively addressing recent issues.

Capita is not the only service provider to be eying growth in the insurance sector. With this bid, Capita’s acquisitive culture is set to give it an edge over the others.

For our previous coverage of Capita’s growth strategy see “Capita’s German Gambit.” 

Teva Buys Allergan’s Generics Business to Consolidate Pole Position | Sherpas in Blue Shirts

By | Blog, Healthcare & Life Sciences

On July 27, Israel-based Teva Pharmaceutical announced the acquisition of Allergan’s generics business unit for US$40.5 billion in cash and stock, consolidating its position as the leader in off-brand drugs. The deal which becomes the latest in a wave of high-profile consolidation in the pharmaceutical industry, combines Teva, the world’s largest generics drug company with its third largest competitor. The acquisition gives Teva enhanced scale in the intensely competitive generics market (over 20% market share) with cost savings potential due to product overlaps and economies of scale (through operating synergies of nearly US$1.4 billion) as it looks to cope with end of patent expirations. The deals comes at a time when the entire healthcare and life sciences continuum is witnessing rapid consolidation moves including large payers teaming up.

Core Competence – the New Life Sciences M&A Mantra

The deal is another indication in a long line of recent transactions as life sciences firms undergo a realignment of strategic focus and choose to concentrate on business of core competence. Following the big bang “acquire all” days of Big Pharma, pharmaceutical firms have realized that they need to reorient strategic goals and narrow down their focus to specific service lines and markets. This was the principal driving factor in the seminal Novartis-GSK asset swap announced in April 2014, which typified the new normal.

For Teva, this wraps up an increasingly messy four-month long pursuit of another generics rival, Mylan. The company withdrew its latest US$40.1 billion hostile offer to acquire Mylan as the deal prospects became bleak. Mylan itself is busy chasing rival OTC drugs company, Perrigo, which has so far snubbed Mylan’s attempts. The deal also has interesting implications for Allergan. The company has been at the center of major M&A activity in the last two years. This sale allows it to pay off debt from the US$70.5 billion integration with Actavis in 2014. That deal also signaled the end of one of the intense takeover struggles as Actavis beat Valeant Pharmaceuticals for Allergan. The sale to Teva allows Allergan to focus on building its branded drugs business. It could also mount an effort to purchase large peers such as Amgen or AbbVie.

Implications for Service Providers

As with any major consolidation exercise, the primary beneficiaries will be service providers with exposure to both merging entities and account-level relationships as they help with the integration initiatives. A natural consequence of such an exercise is the tendency to go for vendor rationalization as enterprises look to trim the sourcing pie. Demonstrating value across the life sciences value chain will emerge as a crucial differentiator in retaining presence across accounts. Given the diversified operational footprint of pharma firms, global presence becomes an important qualifying criteria for large scale deals, especially when it comes to areas such as infrastructure management. As the spotlight shifts on pockets of core competence, mapping enterprise-specific business outcomes and challenges to technology/process solutions will be key in getting management buy-in for forthcoming sourcing initiatives. The following image illustrates the current exposure of key service providers across major life sciences firms. As you can see, these mergers will lead to overlapping accounts for several services providers.

Account exposure across life sciences firms

The Road Ahead

Life sciences buyers stand at interesting crossroads right now. They seek technological preparedness to tackle multi-faceted challenges arising out of stifling R&D efficiency, dwindling margins, increasing M&A/restructuring, and evolving customer profile. Blockbuster-drugs-led growth has paved way for more pragmatic business models in this new reality. While the digital Kool-Aid continues to sweep the landscape, life sciences firms tend to struggle with digital enablement due to factors such as fragmented service provider landscape and non-standardized internal structures. How they navigate this challenge while digitizing operations will be crucial. Our recent report on IT Outsourcing in the Life Sciences Industry focuses on how global life sciences organizations need to enable their systems for digital enablement through a well-thought out services integration strategy. Pharma is in a continually evolving state of flux and these changes are only going to intensify. Service providers need to up their game to ride this wave.

Q1 2015 in Services Industry Reveals Heightened Tensions | Sherpas in Blue Shirts

By | Blog

In reviewing the DeepDive Equity Research report for Q1, it’s clear that this year’s first quarter was a bit of a disaster for the services industry. Contrary to industry expectations at the beginning of the year, the report evidences that growth is decelerating. What happened to the expectations?

This report heralds what I’ve been blogging about for more than a year – the services industry has been rapidly moving to a mature state and is now at an inflection point. The results: slower growth, pressure on pricing and margins plus accelerated industry consolidation. In the Q1 report, Rod Bourgeois, founder and head of research and consulting at DeepDive Equity Research, presents analysis of the quarter’s results for 15 leading service providers.

The report (“IT Services: Whoa! What Happened in Q1 Results of 15 Services Firms”) is well worth reading. It reveals that nine of the 15 providers posted bad earnings results, two had mixed results and two were incomplete. Only two providers posted good earnings results. Only two – and these results are despite the accelerated GDP and more favorable economies in North America and the UK.

A caveat: as Rod points out, one quarter doesn’t make a trend. But it is troubling. And it certainly fits with my thesis of a rapidly maturing market.

What are the implications?

First, this means that the underlying growth assumptions on which the labor arbitrage market is based are no longer valid. Second, tensions around pricing and margins will heighten.

The challenge for providers is growth. The winning strategy will require moving from an industrialized arbitrage focus to one of differentiation and achieving a leadership position in new growth areas.

But the buying enterprises also have a challenge in a maturing market: don’t get trapped by vendor lock-in.


Photo credit: Flickr

Health Net – Centene Merger Leaves a (Slightly) Bitter Pill for Cognizant | Sherpas in Blue Shirts

By | Blog

On July 2, managed healthcare companies Centene and Health Net announced a merger in a cash-and-stock deal valued at US$6.8 billion, becoming the latest deal in an intensifying wave of consolidation in healthcare. The agreement has been approved by both companies’ Board of Directors and is expected to close in early 2016. The deal combines the two companies, with the joint entity having more than 10 million members and an estimated US$37 billion in revenue this year. The large-scale reform of US healthcare (instigated by the Affordable Care Act) was never expected to be a smooth and genteel affair. One of the immediate impacts was provider consolidation as health systems (which had endemic cost and profitability issues) looked for scale, efficiency, and lean cost structures. A similar trend was also expected in the payer space, but the rollout of the Health Insurance Exchanges (HIX), which operationalized last year, delayed the eventual M&A frenzy. Last month, America’s numero uno insurer, UnitedHealth Group (UHG), approached the number three, Aetna. The latter responded by buying number four, Humana, for $37 billion on July 3, capping a seminal week for mega mergers in health insurance. Humana was earlier reported to be close to a similar deal with Cigna. The second largest, Anthem, is in the midst of a messy takeover attempt as it relentlessly pursues the number five, Cigna (which rejected an initial US$47.5 billion bid). We covered the potential impact of the potential UHG-Aetna and Anthem-Cigna deals on IT services in a blog soon after the first rumors started floating.

Collateral damage – the Cognizant story

The announcement comes at an extremely inopportune time for Cognizant. The company had announced (with much fanfare) a marquee seven-year US$2.7 billion deal with Health Net last August. The engagement was unique in multiple ways. Along with Accenture’s Rio Tinto deal, it is the flag bearer of a bold new deal construct, which epitomizes the fundamental tenets of the As-a-Service economy and widely expected to herald the era of a consumption-based IT services model. Under the terms of the seven-year master services agreement (MSA), Cognizant was to provide a wide gamut of services to Health Net across consulting, technology, and administrative areas spanning claims management, membership and benefits configuration, customer contact center services, information technology, QA, appeals & grievances, and medical management support. Cognizant was to be held responsible for meeting specific SLA targets for improving the quality, effectiveness, and efficiency of multiple operating metrics. These included claims processing and routing times, customer contact center response times, and contact center customer satisfaction targets. In effect, a fairly wide ranging set of services with ambitious KPIs for accountability and governance.

The planned implementation was scheduled to begin in mid-2015. Given the Centene-Health Net deal, the implementation is being deferred, while the deal is completed pending the merger review and approval process. As a result, Cognizant does not expect any contribution (previously pegged at about US$100 million in H2 CY2015) from the deal, which the company can easily absorb without tempering its ambitious revenue guidance for the current financial year. Additionally, it also foresees that if the merger is completed, the existing MSA is not likely to be implemented, which (if it materializes) will be a major setback. Cognizant will still remain a strategic technology/operations partner to Health Net (under a prior contract) through 2020 with a total contract value (TCV) of about US$520 million. Cognizant has also negotiated the right to license certain Health Net IP for use in its solutions and “As-a-Service”platforms, which is not expected to be impacted by the proposed merger.

Looking ahead, despite the short-term loss of US$100 million incremental revenue, Cognizant’s CFO Karen McLoughlin has reaffirmed 2015 guidance as strength in other areas of the business are expected to offset the lost revenue. 2015 revenue is expected to be at least US$12.24 billion with non-GAAP EPS at least US$2.93. Overall, the contract was expected to be margin dilutive in the early years and in generally only “margin neutral over the long run.

Lessons for the services world 

As overall macroeconomic confidence is on the upswing and various industry drivers come into play, the M&A activity is only bound to intensify. This has a profound implication for service providers who are deeply entrenched in such large enterprises and need to be prepared to come out on top of any eventuality. One potential impact of such M&A is the tendency for the combined entity to rationalize its vendor portfolio – choosing to stick to a short list of key strategic vendors by trimming the sourcing pie. The selection criteria for vendors then boils down to specific value-differentiators, maturity of service portfolio, senior management relationships, competitive positioning, and account-level exposure. Technology/operations budgets also tend to shrink as enterprises leverage economy of scale and target operational efficiency.

The following image illustrates the current exposure of key service providers across UHG, Aetna, Anthem, and Cigna. As is evident, these mergers tend to benefit larger service providers that are typically well entrenched across the combining firms. However, a few, may find their portfolios at-risk given competitive underpinnings, sourcing maturity, and enterprise penetration.

Account-level exposure of key service providers

Net-net, we don’t expect Cognizant to be unduly impacted by the proposed merger given the current state of affairs and its leading position in the healthcare and life sciences landscape (poised to reach US$4 billion in annual revenue in the next 18 months). The opportunity at hand is not under threat but there will be significant shifts and redistribution between vendors. The healthcare market is poised to witness increased turbulence (we believe this is just a teaser of things to come) and service providers need to realign and reposition themselves to utilize this opportunity. Let the games begin!

UHG-Aetna and Anthem-Cigna Merger Rumor Mills May Give IT Service Providers Goose Bumps | Sherpas in Blue Shirts

By | Blog

Rumor mills are buzzing over the potential acquisition approaches made by suitors United Health and Anthem for Aetna and Cigna, respectively. The Affordable Care Act (ACA) and the growing focus on consolidation to drive health insurance premium/cost rationalization have led to these tactical maneuvers. While the equity analysts and investment banks have already started to split hairs on the potential implications for capital markets and stocks, our focus here is on the implications these mergers may have on the IT/BPO services market.

These four companies – Aetna, Anthem, Cigna, and UnitedHealth – are star accounts for some of the largest IT service providers that focus on the payer industry. Some service providers have so much revenue exposure to these accounts that their healthcare revenues can take a hit of over 200 basis points, simply as a consequence of IT budget realignments or vendor consolidation.

Impact on IT services

These potential mergers may lead to the following key transformational IT implications:

  • Systems and applications integration: Merging organizations reduce redundancy by retiring transactional systems and applications, and opting for integrated systems that can work across the merging entities. The biggest impact will likely be on claims, members, and product rationalization initiatives
  • Database and datawarehouse consolidation: This is one of the biggest imminent implications, as some of these organizations (especially Anthem) have gone through a decade long initiative to create an enterprise view of organizational data. Going through another round of database integration will be an imperative hard to push to a future date
  • Infrastructure rationalization: These are huge capital assets, and mergers often present an opportunity to divest some of these assets in favor of cloud-based (most likely private) services
  • Vendor rationalization: There are likely to be significant vendor redundancies, given that most of these organizations have mature vendor portfolios.

Implications for service providers

  • The most likely beneficiaries of these mergers will be service providers that have systems experience across both the acquiring and target entities, as this will help with any integration initiative
  • The second most likely beneficiaries will be service providers that are strongly entrenched in one of the entities and have indispensable systemic knowledge. However, given the potential hazard of these systems being retired as part of redundancy rationalization initiatives, these entrenchments can also be huge risks for these service providers
  • Competitive presence will also be a key differentiator. Service providers with smaller visibility into these accounts may find their portfolios being overtaken by competitors with wider system coverage and presence in these accounts. Organizations today do not fear putting all their eggs in one basket. In fact, they rely a lot on service partners that will not only share their risk but also be strong partners in their transitional initiatives.

The following image illustrates the current exposure of key service providers in these four entities. As you see, these mergers may be beneficial for most of these large service providers. However, a few, such as Infosys in UHG-Aetna, CGI in Anthem-Cigna, and IBM in both UHG-Aetna and Anthem-Cigna, may have at-risk portfolios given competitive underpinnings and systemic maturity of the acquirers.

We’ll be reporting our views on this story as it unfolds, so keep watching this space.

UHG Aetna Anthem Cigna Account-level Exposure of Key Service Providers

Virtustream Acquisition – EMC Spreads Its Hybrid Cloud Wings | Sherpas in Blue Shirts

By | Blog

EMC has taken a significant step forward in its hybrid cloud journey with the announcement of its acquisition of Virtustream in an all-cash transaction of US$1.2 billion. Founded in 2009, Virtustream is estimated to have clocked ~US$ 100 million in revenues last year through its cloud hosting services and management software (xStream) offerings – while cloud IaaS accounted for 60% of this revenue, the remaining 40% came from management software licenses.

The U.S.-based company will eventually become the managed cloud services division within the EMC Federation business. The transaction is expected to close by the third quarter of 2015 and be additive to EMC’s revenues starting 2016.

EMC is well known for its deep pockets. With about 70 acquisitions since 2003, the inorganic route is clearly not new to EMC (to put it mildly). The company has not shied away from flexing its muscles from time-to-time to build capabilities for its mainstay storage business and beyond.

EMC’s “Shift” to Cloud

The emergence of cloud has had a strong impact on EMC’s core storage business, which has been witnessing a sluggish demand over the past few years (the overall Information Storage division of EMC has witnessed a CAGR of ~3% over 2012-14). While EMC has rejigged its focus to cover new storage products, this “strategic tweak” in itself is not expected to arrest EMC’s plummeting revenue growth. Therefore, EMC has put its bet on the “next big thing” in the IT industry – hybrid cloud.

EMC’s association with VMWare and Pivotal has ensured that EMC is no newbie to the cloud; however, the real sign of intent from EMC came with the launch of its Enterprise Hybrid Cloud Solution last year. The launch also coincided with a triplet of cloud acquisitions – Cloudscaling (an OpenStack IaaS solution developer), Maginatics (a cloud-enabled storage provider), and Spanning (a cloud-based application data security provider).

So what does Virtustream bring to the table?

As EMC looks to make a mark in the enterprise cloud market, the Virtustream acquisition offers multiple benefits to EMC:

    1. Expansion of the Enterprise Hybrid Cloud Solution portfolio: EMC’s Enterprise Hybrid Cloud Solution is currently an on-premise private cloud offering that provides cloud-bursting options to VMware vCloud Air and other public cloud services. The addition of Virtustream’s xStream platform provides EMC with capabilities to manage both on-premise and off-premise deployments, thereby offering a truly hybrid cloud setup

      The xStream platform will be leveraged by EMC Federation service provider partners to deliver independent services based upon it

    2. Credible cloud managed services capabilities: Virtustream has witnessed credible success in serving large enterprises with complex cloud deployments and managed services requirements, through partnerships with industry-leading vendors such as SAP (which made a US$40 million investment in Virtustream in 2013), Oracle, and Microsoft. Virtustream has been certified by SAP to offer SAP HANA as-a-service. EMC can leverage Virtustream’s managed service capabilities/experience to serve its own existing clientele as well as prospects

    3. Datacenter footprint: Virtustream brings a credible revenue stream based on its datacenter footprint spanning locations such as the U.S., UK and the Netherlands (catering to key demand markets such as North America and Europe)

    4. Meaningful clientele: Virtustream brings a credible roster of clients including Coca-Cola, Domino Sugar, Heinz, Hess Corporation, and Kawasaki, which will get added to EMC’s kitty (to cross-sell its broader hybrid cloud and storage offerings).

The move to acquire Virtustream seems to be a logical one for EMC (although the revenue multiple of ~12X indicates some level of desperation on EMC’s part, given the ongoing stakeholder unrest). Also, given EMC’s traditional modus operandi of allowing its acquired entities to operate autonomously, we do not expect the acquisition to grossly impact Virtustream’s innovation capabilities (barring potential integration and cultural challenges)

Virtustream’s rationale for being acquired?

The development may have come across as a surprise for many market observers, given that the company was grappling with the idea of going public barely six months ago. While Virtustream was going great guns, the brand recognition of a cloud provider typically plays a huge role when it comes to large enterprises looking for sourcing options. Consequently, hitting the “next level” of growth trajectory potentially becomes a significant challenge for players such as Virtustream (especially with a large enterprise focus).

Therefore, it comes as no surprise that Virtustream’s CEO, Rodney Rogers, claims to have considered multiple suitors over a period of time, before choosing EMC (based on terms offered and a chance to become a part of the EMC Federation).

Does this point to more consolidation in the cloud IaaS market?

The EMC-Virtustream deal has been preceded by multiple notable acquisitions in the cloud market over the past few years (Terremark by Verizon, Savvis by CenturyLink, SoftLayer by IBM, Metacloud by Cisco, and GoGrid by Datapipe). As various players in the enterprise cloud market, be it global IT service providers, telecom providers, or public cloud providers look to gain a stronger foothold, it is hard to bet against other similar acquisitions happening in the near future. The question is which company will be the next one to get gobbled up? CloudSigma? DigitalOcean? Joyent? ProfitBricks? Or even Rackspace? That only time will tell.


Photo credit: EMC

The CSC Split: More than What Meets the Eye | Sherpas in Blue Shirts

By | Blog

Yesterday, Computer Sciences Corporation (CSC) announced that it was splitting the company into two independent, publicly-traded entities – U.S. Public Sector and Global Commercial. The split, expected to be completed by October 2015, will be accompanied by a special cash dividend of US$10.5 per share. After the bifurcation, the U.S. Public Sector business will focus on federal, state, and defense customers within the country, and employ 14,000 people. The remaining 51,000 employees will be a part of its Global Commercial business that will focus on commercial customers, and public sector organizations outside the United States. The two businesses generated US$4.1 billion and US$8.1 billion, respectively, in annual revenue during FY2015. Everest Group’s CEO Peter Bendor-Samuel shared his top-level insights shortly after the announcement. Following is our evaluation of the different potential scenarios arising out of the split.

Last attempt to avoid a buyout?

The announcement comes after the latest set of rumors about CSC’s potential sale. In February 2015, Carlyle Group and Capgemini were reported to be in talks to jointly acquire the company. Around the same time, CSC was said to be working with Royal Bank of Canada to review buyout options. Similar reports emerged in September last year with CSC exploring leveraged buyout via multiple private equity firms, including Bain Capital and Blackstone Group. CSC’s buyout (if it had materialized) would have been the largest leveraged buyout since Dell went private for US$16 billion in 2013. However, the talks over the year fizzled out as buyers baulked at CSC’s expected valuation.

If this move is a precursor to a possible sale, the question comes around to the identity of the suitor. Rumors have floated about interest from HCL and Accenture, but things don’t add up with those two suggestions for a number of reasons. HCL already has what it needed from CSC through its alliance, and Accenture already enjoys pole positon in the consulting markets, so they would have to radically depart from their infrastructure strategy to take on the CSC asset base. Given that Accenture is integrating infrastructure with operations as part of its GTM (go-to-market) strategy, we do not see the change in strategic direction that would indicate acquisition of an asset like CSC. A more plausible candidate would be someone looking for scale in the North American enterprise market with allied economic models creating scale and IP synergies.

Driving rationale 

The decision to split can be viewed as the culmination of CEO Mike Lawrie’s efforts to revitalize this ailing company. Since his inception in 2012, CSC has witnessed firm-wide cost takeout measures as a part of the “Get Fit” phase of its turnaround efforts. Attributable to these efforts, the company managed slight melioration in its operating margins during FY2014 and FY2015. Recognizing the fact that the cost takeout measures have already liquidated as enhanced bottom-line, and in the absence of a successful buyout, the management has settled on forming two separate business entities catering to different customer segments. Increasing profitability and value for shareholders could also shore up CSC’s valuation.

Apart from catering to different customer segments, the two entities have inherently exhibited great divergence in terms of their growth profiles and cash flow dynamics. The Global Commercial business has faced strong tailwinds, with revenue in FY2015 declining due to contract completions and lack of new opportunities. On the other hand, the Public Sector business managed to maintain the figures, backed by demand for next-gen IT solutions such as cloud. As it gears up for a potential sale, the government business is potentially value dilutive, and may not find many takers. There’s also an aspect around risk compartmentalization – troubled contracts in the federal marketplace can get service providers stuck in long-drawn out lawsuits and punitive damages.

The future

Keeping this context in mind, splitting the overall businesses can play out in a number of different ways for CSC. It can help offload the new entities of assets not core to their business, enabling them to be more strategic in serving clients and pursuing new opportunities. The new entities will be in a better situation to position themselves as specialists in their respective markets. While this may not be a pivotal factor for the Global Commercial business, it could be a turning point for the Public Sector business, wherein, organizations increasingly seek to engage with specialized technology partners. Despite the split, both entities stay as multi-billion dollar businesses, thus, ensuring that none of the two entities face any scalability issues in the market.

With its decision to split, CSC joins the league of technology companies that have lagged in adapting to the changing market dynamics (shift to mobile, cloud computing, and the As-a-Service economy), and are splitting up in response to market pressure. Last year, HP, another service provider plagued by similar challenges, announced a similar split. Two years ago Science Applications International Corp. (SAIC) went down the same path and spun off its government technology services business as SAIC and rebranded itself as national security and engineering company Leidos Holdings Inc.

While the ultimate success or failure of such a strategic move is murky at best, it is beyond doubt that a rapidly disruptive and evolving services landscape will lead providers to ponder hard choices. In the last year we have seen multiple instances of this realization translating into different maneuvers – movement towards an integrated value proposition (Cognizant-TriZetto), geographic/vertical expansion (Atos-Xerox and Capgemini-IGATE), and focus on next-generation tenets (Apple-IBM). As this continues to happen, expect more industry churn, realignment, and consolidation.