Tag: earnings

UK Outsourcing Giants Take Diverging Paths | Sherpas in Blue Shirts

Last week both Serco and Capita announced their interim results. Not only did the two companies show a widening gap in terms of financial performance, but they also highlighted diverging business strategies.

Firstly, their financial performance in H2 2014 to date was very different:

Operating margin:

  • Capita has managed to stay on track to achieving at least 8% organic growth, net of attrition, for the full year 2014 (2013: 8%). It also stated that it expects to maintain its operating margin in the range of 12.5% to 13.5% for the foreseeable future
  • In contrast, Serco announced that the 2% organic growth in H1 2014 has turned into a mid-single digit decline in H2. This has been primarily due to reductions in volume of work in the Australian immigration contract but also due to contract losses and reduced volumes elsewhere. Serco expects to shrink significantly by 2016, with revenue reaching a nadir of £3 billion to £3.5 billion from a forecasted adjusted revenue of £4.8 billion in 2014. It expects to return to growth in 2017
  • Serco also announced a proposed equity rights issue of up to £550 million in the first quarter of 2015 to strengthen its capital structure
  • Capita announced that it has secured £1.63 billion of major new deals to date in 2014 (nine months). This is down by £1.27 billion year-on-year (largely accounted for by the signing of the £1.2 billion O2 mega deal in 2013). At £4.1 billion the bid pipeline is also lower on a sequential basis compared with £5.7 billion announced in July 2014. However Capita reports a strong win rate of one in two
  • Serco reported £900 million of contract awards since the half year to date. It also said that its current pipeline and win rate are considerably weaker than before

Secondly, the strategic directions of the two companies are diverging:

  • With its strategic review still ongoing, Serco announced that it is going to focus entirely on business to government (B2G) in the areas of justice and immigration, defense, transport, citizen services, and healthcare
  • In contrast, Capita aims to grow its private sector business and in particular in the customer management services (CMS) arena. Like Serco, it made a number of CMS acquisitions in the past few years including Ventura and parts of Vertex. Another growth target is its burgeoning legal business with the acquisition of Eclipse Legal Systems. It is also expanding its presence beyond its UK stronghold to countries such as Ireland and Germany
  • Serco will be divesting a number of businesses that are now non-core to its strategy. These include the Environmental and Leisure businesses in the UK, Great Southern Rail business in Australia, and the majority of its private sector BPO business which are mostly CMS businesses delivered by two companies that it acquired in recent years: Intelenet and The Listening Company
  • Capita has made 13 acquisitions to date in 2014 for £285 million, with more likely as it continues to expand or enhance its capabilities

Interestingly, both companies have also announced changes to their boards:

  • Alastair Lyons, Serco’s chairman has resigned
  • Capita’s CFO Gordon Hurst is stepping down following a 27-year stint at the company

Serco’s tale of woe began in 2013 when the British government discovered that it had been overcharged by Serco for offender tagging services to the Ministry of Justice (MoJ). The company is still recovering from the fallout more than a year after the issue first came to light, and having repaid more than £68 million of fees and gone through several reviews and management changes. It is ironic that Serco’s new board has chosen to focus on B2G services only, given that the troubles began in a government contract. That said, front line government services is and has always been at the core of the company’s business.

Serco has suffered from failures of governance and risk management. As it rebuilds itself, it will seek to enhance these significantly. In terms of business strategy, it will target growing opportunities in the government sector, as the pressures from aging populations and rising demand for services pushes governments to outsource more. Serco will seek to differentiate itself with its international approach, as part of which it will give its businesses a portfolio of services to go to market within specific regions of the world, to share experience and expertise.

Capita boasts of robust financial and governance structures and highly selective approach to opportunities that it pursues. Robust governance is highly needed given Capita’s aggressive acquisition strategy that has seen it take over more than a dozen companies a year for many years. Even with robust governance problems can still occur. For example, in its eagerness to win more government clients, in 2012 Capita acquired Applied Language Solutions (ALS), which had been awarded responsibility for courts interpreter services in England and Wales. For a while service delivery was less than smooth leading to the MoJ withholding fees in some instances and bad publicity in the press. Overall though Capita has benefited from many niche and strategic acquisitions that it has fully internalized, and which have largely created value and revenue.

Serco and Capita

There are lessons to be learnt from the performance of the giants of UK outsourcing. Today, one thing that is common to both is the belief that bid and governance structures have to be robust and maintained at all times.

More New Faces at Serco to Help Turn the Company Around | Sherpas in Blue Shirts

Serco’s H1 2014 results were poor but in-line with expectations. Adjusted revenue was £2,433m, up 1.1% year on year but adjusted operating profit was down 59.1% year on year to £50.7m.

Profits were impacted by £30m from reduced volumes of work for the Australian Government Department of Immigration and Border Protection (DIBP) and other contract attrition (principally Electronic Monitoring and U.S. contracts).

Changes in other contracts impacted profits by an additional £25m. These included work with AEGON and Shop Direct  moving from transformation into run and maintain phases.

A further £30m was wiped off profits due to two other troubled UK government contracts, COMPASS (for the provision of accommodation for asylum seekers) and PECS (Prisoner Escort and Custody Services) and the internal corporate renewal program.

Serco fared better in other geographies with 10% revenue growth in AMEAA and 7% in Americas.

The focus on fixing major contract problems in the UK has taken management attention away from sales. The pipeline declined by £4bn year on year down to £8bn. Furthermore, Serco has lost eight major new bids and two major rebids in this period.

To help the company turn around, Rupert Soames, Serco’s new CEO, has brought in a number of new executives. These include:

  • Liz Benison, soon to be the new Chief Executive Officer of Serco UK & Europe, Local & Regional Government division. Benison joins Serco from CSC where most recently, she was VP and General Manager for the UK business, managing a £1bn business and its 8,000 employees, with over half of its revenues coming from government customers. Her experience of working with the public sector is key. She has also worked for Capgemini and Xansa plc (now Steria)
  • The latest executive appointment to be announced is that of Angus Cockburn as Group Chief Financial Officer as from the end of October 2014. Angus is currently the interim Chief Executive Officer at Aggreko plc, having replaced Soames who joined Serco in May this year.

A strategic review is underway and in the coming months we expect to see:

  • More money put into strategic and targeted bids to improve the poor win rate and the pipeline
  • Better qualification of opportunities to focus on returns and not revenue alone
  • Further reorganization to simplify the business – the company operates in 47 different business segments, some of which are loss making – more divestments are very likely
  • Steps towards eliminating loss making contracts
  • Reduction of internal costs through improved internal functions, managing a troubled transition to shared services, and better management information.

Serco left its outlook for 2014 unchanged and expects revenue attrition of circa 5% in 2015.

The company is on a turnaround path to rebuild itself, its reputation and its pipeline. The strategic review is bringing out some clear weaknesses that it can address. With fresh faces on board to support the turnaround, Serco also needs to reenergize its workforce and, as Soames said, become a magnet for top talent.

Surprising Strong Profit Performance by Syntel and TCS Bodes Well for the Industry | Sherpas in Blue Shirts

The Q2 earnings reports for Syntel and TCS show not only a strong performance for both companies but, surprisingly, show stronger earnings growth than revenue growth. We’ve seen stronger earnings than revenue results with other providers in the past, but this is surprising. That’s because it reverses a trend the industry has been experiencing.

This strong performance comes at the same time we’re seeing a rupee appreciation, which puts a slight downward pressure on margins and reduces Indian providers’ ability to make money.

But as we dig below the surface for deeper significance, the strong earnings indicate that the industry is maintaining pricing. Amidst competitive pressures, providers are successfully resisting significant price discounting on new work, despite well-documented attempts by procurement organizations to drag pricing down. So the Syntel and TCS earnings reverse a trend of increased pressures on margins.

I think this is a result of further honing their offshore model and flattening their labor pyramid. It’s particularly impressive given that we’ve had modest rupee appreciation during this time frame.

The news is encouraging and bodes well for the industry, particularly given the modest uptick we see in the recovery of the global and North American economies.

The Son-in-Law | Sherpas in Blue Shirts

To date, the global services industry in 2014 has all the signs of being a “son-in-law.” As many parents will tell you about their prospective son-in-law: “He’s nice, but … I was hoping for something a little better.”

2014 arrived with so much promise, both in IT and BPO. Europe’s economy was improving. We hoped the U.S. economy was ready for robust expansion. We hoped we would see a surge in discretionary spending. And we hoped that the uncertainty that characterized the past four years would recede. We also anticipated that disruptive technologies and new solutions in cloud, big data and analytics would generate robust growth opportunities in the services space.

All these things happened. The economy has stabilized and new technologies are generating growth opportunities.

But as we look at the net results of the first quarter, well — it’s nice … but it does feel like a son-in-law. We were hoping for something a little better.

Pondering TCS’s Modest Morsel | Sherpas in Blue Shirts

TCS posted industry-leading financial results in its FQ4 2013 report. But what caught my attention was its quarterly guidance to investors where management stated they believe TCS can add “a few billion dollars” from digital as a growth driver. Really? Just a few billion? We believe TCS is substantially underplaying its digital hand.

Management talked constructively about taking the digital business area seriously. But they are guiding to only modest aspirations, almost a mere morsel of the market share potential in the seismic disruption cloud and digital are creating.

Although we recognize TCS’s need for measured conservatism and modesty in investor guidance, we at Everest Group feel no such need. We believe TCS is strongly positioned to exceed the modest goal of a few billion. Here’s why: From our industry analysis, we predict that 30-50 percent of workloads will migrate from traditional infrastructure models to cloud-based models.

As this occurs, we expect that TCS will garner substantially more than a few billion dollars of revenue.

Genpact’s Q4 Performance: A Cautionary Tale for All Service Providers | Sherpas in Blue Shirts

The past year was not kind to Genpact. Q4 results show it underperformed the S&P by 25 percent over the last six months and by 7 percent year to date. This is surprising given that Genpact is a great organization with a record of superb delivery and a history of great performance. Unfortunately Genpact is a victim of the changing market and its sweet spot has lost its sweetness. We expect other providers will become victims as this story plays out again and again across the services industry. It’s a cautionary tale about growth engines.

Genpact does many things well, but its finance and accounting BPO practice has been the heart of its growth engine. Its F&A sweet spot was the $50-$100 million transaction size, and historically it expanded those contracts to even greater value. The sad fact is the number of new F&A deals of that size coming into the marketplace dropped precipitously as the market matured.

Today’s F&A transactions are different. Organizations often bundle F&A into larger transformation deals — where Genpact has a disadvantage against players like Accenture and IBM. They are better positioned to win broad transformation contracts, and they’re also the masters of the sole-sourced deals that now hit the F&A space.

The maturing market left Genpact with a string-of-pearls strategy, requiring stringing together a lot of small transactions to make up the difference. But there aren’t enough of them to make up for the volume of growth Genpact enjoyed in its sweet spot for the past five years.

To Genpact’s credit, it seems to be doing everything right to offset the shifting market: headquarters shifted to the United States, a world-class sales and marketing executive took over as CEO. Genpact saw the market shift coming and worked very hard to set up new lines of business. But its core F&A market matured faster than Genpact could put the new growth engines in place.

Even the best firms struggle to keep their growth engine up. We believe this story will be repeated again and again across the services industry as the labor arbitrage market matures and growth engines slow.

Cognizant Shows New Signs of a Market Maturing | Sherpas in Blue Shirts

In its latest quarterly earnings report, Cognizant recently guided to slower growth than they achieved last year. Although it is usual for Cognizant to be conservative in its guidance, it is still notable that it is sanguine about repeating last year’s strong performance in what most regard as an improving economy. Cognizant has been the bellwether in terms of fast market growth and the envy of every service provider in the marketplace in its ability to consistently growth faster than the market. So why is Cognizant guiding down on this year’s growth?

Hard Truths

To be clear, Cognizant still expects to grow substantially faster than the rest of the industry and raised its guidance relative to past year. But with an economy expected to improve and discretionary spending on the rise why the recent indication of slower growth ahead?

It’s an important question. The answer: Cognizant always guides lower than it performs, and it knows that growth is becoming more difficult and more expensive in the maturing marketplace. This is especially true in its Horizon 1 offerings (application development and maintenance), which is core to Cognizant’s business.

Having said that, Cognizant is still well positioned for growth because of its Horizon 2 focus (BPO, IT infrastructure and consulting) and Horizon 3 offers in in cloud, mobile and next-gen solutions. Even so, Cognizant’s latest guidance to slower growth indicates it is guiding the market to a realistic perspective.

The Outlook

I believe this acts as a warning for the overall marketplace and supports Everest Group’s long-stated guidance for the last few years that the outsourcing space, especially the talent-based space, has moved into a more mature phase.

In a maturing marketplace, clients are more discriminating. They pressure service providers on price points. And they ask their providers to know more about the client’s industry and business. Those demands will likely result in slower growth and fiercer competition.

Photo credit: Cognizant Technology Solutions

IBM Remakes Itself | Sherpas in Blue Shirts

You can bet IBM Global Services doesn’t want any more earnings announcements like its Q4 2013 report.  Big Blue posted year-over-year revenue growth of only 4 percent instead of the 7 percent it indicated just three months ago and its 5 percent Q3 growth. Its margins are good, but clearly IBM has a growth issue. However, IBM is unfolding its strategic readjustment to drive global services growth in the future. It’s a three-pronged plan.

1. The exit path

Step one is to jettison the low-margin, commoditized and mature parts of the business, and I’ve blogged before about the crucial timing aspect of this strategy.

2. What is IBM doing with two acquisitions per month?

In the plan’s second prong IBM replaces its jettisoned revenue and direction by acquiring both software and services businesses. At the moment its acquisition pace is torrid — a little over two companies a month!

Rather than building products to move into more profitable business areas, Big Blue is buying companies so it can quickly shift high-growth platforms and embracing automation and the cloud. Four acquisitions show us where IBM is doubling down on acquiring capabilities:

  • Softlayer (2013) — global cloud infrastructure
  • UrbanCode (2013) — software delivery automation
  • Green Hat (2012) — software quality and testing for cloud
  • Big Fix (2010) — management and automation for security and compliance software updates

Two particular focus areas in automation platform and services stand out:

  • Analytics (automation of high-end analysis)
  • BPaaS (Business Process as a Service), which is an automated version of IBM’s infrastructure business.

Years ago IBM put hard caps on scaling the company by adding headcount, and this is a driver in chasing automation as IBM exits low-margin, labor-arbitrage offerings.

3. Battle-tested advantage

Unlike many of its peers building and piloting solutions and products, the third prong in IBM’s growth plan ensures the companies it acquires have fully formed battle-tested models. Instead of creating a baby that has to crawl before it walks, IBM acquires “teenagers” that can run — companies that already conducted pilots and ensured there is a market for the offerings. And then IBM super-charges the model with Big Blue’s awesome brand and sales and marketing strategies. This is a time-tested formula that has worked for IBM in the past.

As we watch IBM remake itself in this three-part plan to drive services growth, we expect the strategy will be successful.

Photo credit: Irish Typepad

The ABCs of WNS | Sherpas in Blue Shirts

The jury’s in — the back-to-basics strategy is working at WNS. The results of this strategy pop out in its FQ3-14 earnings report. Net revenue increased 5 percent to $120 million. Gross profit increased 16 percent year over year to $45 million. SG&A expense went down four percent. Adjusted earnings per share rose to $0.38, above the consensus of $0.36. During Q3 WNS also signed its fourth-largest deal to date.

When Keshav Murugsh took over the CEO reins at WNS, he instituted a new management team, simplified the value proposition, focused on the arbitrage market and drove a more aggressive sales strategy. It’s a classic back-to-basics strategy, and the market is rewarding WNS in revenue growth, an eye-popping shareholder value and 107 percent year-to-date returns through December 2013.

Many of the Indian service providers are going back to the basics after investing in the products space in lieu of the services space. WNS was one of the first to return to this basics strategy, and Infosys followed closely on its heels with a similar strategy. Like the ABCs are basics for the benefits of reading and writing, the Indian services firms are finding fertile ground in getting back to the basics with increased execution, and the results that follow show customers and shareholders are enriched.

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