Is Capgemini Up for Grabs?

Some analysts think so, given the stock's recent downturn and what seem to be the IT-services outfit's solid prospects for a comeback

By Eric Wahlgren

Capgemini, one of Europe's biggest information-technology services companies, is in a bit of a funk. While rivals are starting to benefit from the slow but steady pickup in IT spending, the Paris-based multinational has performed lately like it's still in tech-bust times.

The latest disappointment? On Sept. 9 Capgemini announced a surprising $24.6 million operating loss -- a profit had been expected -- for 2004's first half, due in part to major contract overruns. Wasting no time, the board that same day said its chief financial officer was being replaced.

The stock dropped 13% on the Paris bourse. Since then, Capgemini shares have basically flat-lined, closing on Sept. 29 at $24.35 -- more than 50% off their 52-week closing high of $55.37 on Nov. 3, 2003.

NOW OR NEVER.

  The decline is leading to speculation that Capgemini, which itself gobbled up the consultancy arm of U.S. accountant Ernst & Young in 2000, may be one of the Continent's top takeover targets. With the global economy improving, analysts are betting on consolidation in Europe's tech-services sector. Many of the top players are itching to expand their reach. Plus, competition from Indian upstarts is forcing more established outfits to broaden their offerings while simultaneously cutting costs, no easy task.

"If Capgemini isn't a takeover candidate now, it never will be," says Jonathan Crozier, a technology-research analyst with WestLB in London. Crozier notes that Capgemini's stock fell to lower levels in 2002, when the entire industry was in a downturn. But now that the outlook is brightening, "the company is attractive."

The drop in Capgemini's stock has reduced its market cap to about $3 billion. Still, analysts say that any acquirer would have to pay a hefty premium of 30% to 40% or above that. Capgemini spokesman Philippe Guichardaz declined to comment, saying the outfit has a policy of not remarking on market rumors.

NATIONAL CHAMPION.

  Several analysts believe Capgemini, whose stellar list of U.S. and international clients includes Ford (F ), Airbus, ChevronTexaco (CVX ), and Sprint (FON ), could be in play. The multibillion-dollar question: Which rival might be preparing a bid for the outfit, which has 55,000 employees and posted 2003 revenues of $7.08 billion?

Analysts think the usual suspects -- IBM (IBM ), Hewlett-Packard (HPQ ), and Computer Sciences (CSC ) -- may no longer be interested. Why? Peter Olofsen, an analyst with Effectenbank Stroeve in Amsterdam, doubts U.S. companies are in the market for another multinational that already has a presence on their home turf. About 30% of Capgemini's 2003 revenues came from the U.S. Says Olofsen: "I think they would look for a national champion or a strong player in a market where they want to grow their presence."

Instead, company watchers believe that if any deal occurs, it will likely involve a name closer to home. Crozier thinks Atos Origin, a French IT-services group, would be a likelier buyer. In contrast with Capgemini, the Paris-based group's first-half operating profit rose 29%, to $194.7 million, on 72% higher revenues of $3.26 billion. "Atos Origin is the most obvious predator," says Crozier. "It's a company with a stated ambition to keep growing."

Such a move by Atos, says Crozier, would double its size in Italy, Spain, and most important, Germany, which is considered by many observers to be Europe's most prized tech-services market. By Eric Wahlgren

TROUBLE FOR SALE?

  Another analyst, who declined to be named, also rules out any potential purchase by U.S. IT-services biggies. In addition to Atos, this analyst adds British Telecom and Japan's Fujitsu to the possible suitors list. Not to be dismissed, the analyst says, are German heavyweights Siemens Business Services and Deutsche Telekom's T-Systems. "The unifying thing is people want to get into the German market," says the analyst. "Why couldn't a German company decide to make an acquisition?"

For now, no one is commenting on the speculation -- and not everyone thinks Capgemini is a walking bull's-eye. "Who would want to take over Capgemini?" says Bob Djurdjevic, president of Annex Research in Phoenix. "When you acquire something, you acquire the problems, not just the benefits."

Deal or no deal, it appears that Capgemini is headed for more change. In its Sept. 9 press release, the board said CEO Paul Hermelin "intends to strengthen the senior management team in the near future." CFO William Bitan was replaced with insider Nicolas Dufourcq, who cut his teeth at Wanadoo, France Telecom's Internet arm.

But analysts say Capgemini probably won't stop at the CFO switch. "I think they'll go further," says Olofsen. Some suspect even Hermelin's days could be numbered. "It's arguably surprising that he has survived as long as he has," says Crozier.

PRESSURE IS ON.

  As Capgemini moves to fix its problems, one of the top priorities will be limiting the overruns on a number of contracts signed in 2001 and 2002, which the company describes as burdened by "terms that have proved difficult to meet." The miscalculations ended up costing Capgemini an $98.4 million charge in the first half. They stem from its tech-services business, which handles projects such as systems installation and application management. The pressure is on as the unit, which represents about 37% of first-half revenue, competes with nimble Indian outsourcing companies and others.

Guichardaz says plans are afoot to reduce overruns to a more normal level -- 2% of turnover -- within 12 months. Also key for Capgemini, analysts say, will be reviving its fortunes in North America, where revenue saw a 22% drop (at constant exchange rates) in the first half, due to "a weak level of bookings" in the second half of 2003. The region represented 30% of 2003 sales, Olofsen says, adding: "It's obviously quite a substantial business for them." In the Sept. 9 release, Capgemini said it was seeking to reenergize its North American operations.

Overall, Capgemini reported a 50% wider net loss of $166 million in the first half of 2004, vs. the first half of 2003, on 7.1% lower revenues of $3.65 billion. The company says it's going to take other measures such as cutting costs further and shuttering money-losing nonstrategic units.

"SEXIEST DEALS."

  Capgemini has its bright spots. The U.S. market should start to pick up, thanks to a $3.5 billion outsourcing deal inked with Dallas-based energy company TXU (TXU ) in 2004, says Djurdjevic. He calls the 10-year pact the first "megadeal" in the U.S. won by a foreign-based IT services company, saying: "They have scored probably what is one of the sexiest deals in IT services."

Also looking up is Capgemini's unit for small and midsize businesses, Local Professional Services, which now represents 17% of revenues. Already Capgemini's most profitable, the division has strong growth prospects. Until recently, IT-services outfits have spent most of their energy going after big customers. The small-to-midsize field "is pretty rich," says Djurdjevic. "And nowhere is the opportunity greater than in Europe, which is their home turf."

On the order-book front, the news is also encouraging. As of June 30, Capgemini had $15.50 billion in booked orders, more than double what it had chalked up at this point in 2003.

NO BASKET CASE.

  Indeed, the main headache is the tech-services unit and its overheads. The remaining two-thirds of the business is pretty solid, analysts say. "It's important to remember that the outsourcing business and consulting business are doing slightly better than O.K.," says WestLB's Crozier.

Though that's hardly glowing praise, Capgemini is far from a basket case. Indeed, it appears more likely to be on the mend. Hermelin expects double-digit revenue growth in 2004's second half. That means any potential suitor will have to move fast.

Wahlgren is a reporter for BusinessWeek Online in Paris

Edited by Beth Belton

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