NelsonHall Industry Insight: August 1, 2011

The following extracts are  commentary and insight from NelsonHall Industry Insight, NelsonHall analysts weekly views on key industry developments that impact your sourcing. Register to receive your copy weekly  This newsletter forms part of NelsonHall's Key Vendor Assessments service. For further details, contact Paul Connolly.

•·         Xchanging Announces H1 2011 Revenue Down 7% to £330m

Aug 01, 2011 | Financial Results by Rachael Stormonth

Xchanging has announced H1 2011 revenues, for the period ending June 30, 2010, of £329.5m, down 11.9% on H1 2010 reported revenues of £374.1m, down 1.3% at constant scope, and down 7% like-for-like at constant exchange rates. (In May 2011 Xchanging sold its loss-making U.S. workers' compensation and TPA operations *).

H1 2011 operating profit is £3.2m, a margin of 1.0%, down from a margin of 6.5% in H1 2010. Adjusted operating margin (exceptional items mainly relate to restructuring costs) is 4.2%, down 302 bps from a margin of 7.2% in H1 2010.

H1 2011 revenue (and year-over-year change) by business is:

• Financial services £97.7m (+9.7%)
• Insurance services £92.7m (+6.5%)
• Technology £52.4m (-3.2%)
• Procurement and other BPO £86.8m (-15.6%).

H1 2011 adjusted operating margin by business is:

• Financial services 2.7% (H1 2010: 7.7%)
• Insurance services 17.1% (H1 2010: 15.8%)
• Technology 4.5% (H1 2010: 13.0%)
• Procurement and other BPO 4.6% (H1 2010: 4.7%)

(* H1 2011 revenue of £41.2m from the discontinued operation includes a £11.5m exceptional release of deferred income on a contract termination).

Analyst comments:

2011 is very much a year of transition for Xchanging and today's results are in line with the interim management statement previously issued by Xchanging for the period from January to May 2011 with

• The insurance unit (excluding the now divested U.S. workers' compensation business) and financial services units performing slightly better than had been expected
• The Technology unit seeing lower revenue as Xchanging stops its reseller program
• Procurement and BPO having a slow start to the year and also being impacted by the loss of a pensions contract in 2010.

Describing 2011 as the period 'to stop the bleeding', new CEO Ken Lever highlights progress that has been made already in the Four Point Action Plan:

• A strategic and intrinsic value review, with the loss-making U.S. BPO business sold, the Cambridge restructuring completed, and an action plan to stabilize Kedrios under way, as are discussions with partners about repositioning the financial services business
• Operational improvements, with 127 management roles (including 40 senior managers) cut, Hanover Square closed, and increased offshoring
• Cash flow and funding structure, with the bank refinancing settled (just in time for today's results), the Cambridge restructuring completed, and a strong focus on cash flow
• Revenue growth - here Lever is pursuing a range of strategies to restore Xchanging to topline growth by 2012:
  - The key focus will be on differentiated areas of industry-specific BPO where Xchanging has expertise: London insurance market, securities processing and investment account administration
  - The intention is also to strengthen or develop capabilities in other verticals: property, education, transport and healthcare
  - Xchanging also plans to grow its technology business, particularly in insurance software services, data center hosting, and network management
  - Sector campaigns, focused at existing client relationships
  - Direct marketing of an offshore (India) BPO service
  - As predicted by NelsonHall, the new CEO is indicating the demise of the enterprise partnership model so closely associated with of David Andrews "We will no longer rely on the generation of Enterprise Partnerships to sustain growth in the future", but the company will be more likely to partner with other service providers.

Lever has acted fast to start a turnaround. It is very clear that he is looking to change the culture and dynamics at Xchanging: for a company of this size to cut 130 managers in such a short period is very much a 'new broom' scenario, as is a new performance management system and a revised incentive plan, currently under development.

As would be expected, the focus in the short term will be on improving profitability through taking costs out of the business, and on strategy refinement and margin recovery should become apparent as early as H2 this year.

In the plans for future growth, Xchanging will be well positioned in those areas where it already has expertise (and parts of technology business are heavily reliant on these), but it is not clear how the company will manage to invest in developing capabilities in other verticals.

Interestingly, there was no mention of the procurement or 'other' BPO business (other is essentially HR, but it doesn't merit a mention), even though Xchanging also announced today a competitive Procurement BPO win: does this indicate a de-emphasis in horizontal BPO in the long-term plan?

•                Xchanging Awarded €25m+ Procurement BPO Contract by L'Oreal

Aug 01, 2011 | Contracts by Rachael Stormonth
industry: Other Process Manufacturing

Xchanging has been awarded a 3-year 5-month indirect procurement BPO contract by L'Oreal in a deal that is estimated to generate revenues for Xchanging of >€25m over the contract lifetime.

Services to be provided by Xchanging Procurement Services from today to end 2014 to support L'Oreal's operations in France, the U.K., Germany, Spain and Italy, include sourcing and category management of a significant spend budget in categories including ITC, facilities management, HR (temp & permanent labor recruitment, learning & development, fleet management), travel, industrial supplies & services, utilities & lab supplies, light transportation & logistics supplies.

Analyst comments:

This is a significant win for Xchanging Procurement Services, whose revenue has been impacted recently by declining volumes. In terms of the level of spend being managed, this is probably the largest BPO deal in Europe signed this year.

Interesting features of the deal include:

• Co-sourced service delivery: of the 40 or so personnel, most will be deployed onsite, working with L'Oreal's procurement organization at various locations, be it in Paris for central management of ICT, or at factory sites to support categories such as FM where procurement is decentralized
• Payment model: L'Oreal has opted for a model which is heavily skewed toward risk-reward, the preferred model for Xchanging.

Both these points indicate market trends for a range of business models in procurement BPO, particularly where sourcing services are in scope. Organizations challenged with highly decentralized sourcing and procurement activities, a common feature in the manufacturing sector, are likely to be attracted by service providers who can offer a local onsite service, though this collaborative, dedicated approach will not be the most cost-efficient service. NelsonHall research shows some increase in interest in risk-reward models in procurement BPO, though it is far from being in the mainstream, and vendors need to be flexible in responding to client preferences.

For Xchanging, this presents potential opportunities, assuming successful delivery, of expanding the agreement both in terms of categories under management - perhaps to include transportation, also geographies in scope - the latter in particular could provide an opportunity for Xchanging Procurement Services to enter new regions such as the U.S. and Asia. As it stands, the contract will increase Xchanging Procurement Services' headcount in Continental Europe: it is recruiting 15-20 personnel to service this account and intends also to expand its sales and marketing headcount in Continental Europe.

•                BT Announces Fiscal Q1 2012 Revenues Down 5% to £4,764m

Jul 28, 2011 | Financial Results by Sarah Burnett
industry: Telecoms

BT Group has announced fiscal Q1 2012 revenues, for the period ending June 30, 2011, of £4,764m, down 5% year-over-year. Fiscal Q1 2012 group adjusted operating profit was £697m, an operating margin of 14.6%, up from 13.4% in Q1 2011.

Fiscal Q1 2012 revenue (and yoy growth) by business unit is:

• BT Global Services £1,905m (-5%)
• BT Retail £1,830m (-4%)
• BT Wholesale £1,004m (-5%)
• Openreach £1,255m (5%).

Fiscal Q1 2012 adjusted EBITDA (and yoy growth) by BU is:

• BT Global Services £130m (+6%)
• BT Retail £446m (+1%)
• BT Wholesale £307m (-9%)
• Openreach £538m (+5%).

Fiscal Q1 2012 revenue (and yoy growth) by product segment is:

• ICT & managed services £1,580m (-4.0%)
• Broadband & convergence £713m (+5.9%)
• Calls & lines £1,305m (-8.4%)
• Transit, conveyance, interconnect, WLR, global carrier & other wholesale £1,156m (-7.7%).

Analyst comments:

The overall 5% BT Group revenue decline was principally due to falls in fixed line revenues and calls and reduced mobile termination rates. BT joins the ranks of companies that have blamed the additional bank holiday in April for some loss of revenue.

Good news for BT GS included cost savings of 6% due to restructuring, growth in 12 month rolling order intake of 8%, a good pipeline in Asia Pacific and a 5-year, £133.45m contract with the Brazilian post office. The significant U.K. win in this quarter was the £400m IT and BPO services contract with Lancashire County Council (covered in a separate article).

BT is succeeding in growing its broadband revenue with every division returning growth in this area except for wholesale. The wholesale business suffered from the costs of a changing product mix, network migration costs and impact of regulatory decisions. BT has continued to reduce costs, by 7%, in this quarter but cost cutting alone is not sufficient to offset the decline in other product lines. The outlook is brighter than it has been. The broadband market remains buoyant with the next generation of products attracting more customers. Opportunities are also starting to emerge in the U.K. public sector.

•                Capgemini Announces Q2 2011 Revenues Up 11.4% to €2,406m

Jul 28, 2011 | Financial Results by Dominique Raviart

Capgemini has announced Q2 2011 revenues up 11.4% to €2,406m. Organic growth is 8.4%.

Q2 2011 revenue breakdown per country (and revenue growth on a published and organic basis) is:

• North America: €445m (+3.0%, +14.1%). Growth is coming from consulting services (CS; +40%), technology services financial services (TS FS; +30%) and Sogeti -+24%). OS is stable
• France €515m (+4.3%, +4.3%). Growth is coming from Sogeti (+7%) and TS (+6%)
• U.K. & Ireland €508m (+8.2%, +10.1%). Capgemini has redeployed TS personnel from public sector to commercial sectors: TS is up 10% but CS is down 31%. Aspire contract activity declined much less than expected
• Benelux €319m (-2.5%, -4.0%), with a decline across all practices, and CS and Sogeti both down 8%
• Southern Europe & Latin America €236m (+91.1%, +14.1%) of which +21% in Brazil, +13% in Italy and +6% in Iberia
• Nordics €161m (+19.5%, +14.4%)
• Germany & Central Europe €155m (+17.5%, +6.4%)
• APAC € 67m (+44.0%, +39.8%).

Q2 2011 organic revenue growth per service line is:

• Consulting Services -2.3%. The decline is coming from the Netherlands and the U.K. (due to public sector exposure)
• Technology Services +11.0%
• Sogeti +6.7%
• Outsourcing Services +8.2%; of which
  - Application management +3.4% (the lack of growth results from major renegotiations of contracts)
  - Infrastructure services +10.1% (of which Brazil, +25%)
  - BPO +20.8%.

Revenue growth from top line initiative services was 28%, representing 12% of revenues, of which:

• Software testing +29%
• Smart energy services +43%.

Capgemini has achieved 10% revenue growth on its top 42 accounts, driven by supporting these clients in their international expansion.

H1 2011 revenues are up 12.9% to €4,756m. Organic growth is 7.4%. Acquisitions contributed 5.9% in additional growth. Currency fluctuations had a negative 0.4% impact on revenues.

H1 2011 revenue growth by service line is:

• Financial services +13.7%
• Energy, utilities and chemicals +6.6%
• MALS +4.1%
• Public sector +1.4%
• Telecom, media & entertainment +20.4%
• Others +10.9%.

H1 2011 adjusted operating margin (before stock options, one off costs including goodwill depreciation, restructuring costs and M&A costs as well as pension costs) is €289m, representing a margin of 6.1%, compared with 5.8% in H1 2010.

H1 2011 adjusted operating margin by geography (and in H1 2010) is:

• North America 8.1% (4.3%). All units in high profits apart from OS, which is impacted by renewals of Canadians contracts, which are driving lower margins
• France 7.6% (5.1%): OS is only breaking even
• U.K. & Ireland 6.1% (7.3%)
• Benelux 6.2% (9.1%). The decline comes from CS and low profitability in TS
• Southern Europe & Latin America 0.7% (2.2%)
• Nordics 5.8% (6.0%)
• Germany & Central Europe 6.0% (7.9%).

H1 2011 adjusted operating margin by service line (and in H1 2010) is:

• Consulting Services 11.8% (11.1%). The increase comes from N.A. and France but is offset by Netherlands and U.K.
• Technology Services 5.8% (5.5%). The margin is improving in North America and Financial services but is suffering from Netherlands and the U.K.
• Sogeti 9.9% (7.2%), thanks to North America and France, in spite of the Netherlands
• Outsourcing Services 5.7% (6.6%). CPM Braxis is having a dilutive impact on margin (-1%)

Q2 2011 bookings were €2,783m, compared with €3,056m in Q2 2010, which included €500m in renewals from North America. Outsourcing bookings are €862m (down from €1,270m in Q2 2010) and project services €1,921m (€1,786m).

End of Q2 2011 headcount is 114,274, of which 42,592 in low cost countries and 34,565 in India. This is up by a net 2,147 (+1.9%) over end of Q1 2011, of which a net 1,055 (+3.1%) in India.

Capgemini has stated its financial objectives for its recent acquisitions:

• Fast growth economies i.e. CPM Braxis, and Praxis: ~organic growth of 15%, operating margin of ~5%
• Top line initiatives i.e. BICG, Atersys and Avantias: ~15%, ~10%
• Geographic strengthening i.e. SSS, CS Consulting and AIVE: 7%, 8%+
• New business model i.e. Prosodie:~5%, ~15%.

Capgemini has maintained its 2011 guidance:

• 9 to 10% published revenue growth. Organic growth is now expected to be above 5%, versus 4 to 5% before. Exchange rates effect will be negative in H2. The guidance does not include the planned acquisition of Prosodie (2010 revenues of 172.3m)
• A 50 to 100 basis point improvement over 2010 (6.8%) to 7.3% to 7.8%

Analyst comments:

Capgemini's 8.4% organic revenue growth in Q2 will probably position it as the best performance of an onshore vendor after Accenture. The company, historically very cyclical, managed during the recession to keep its decline in line with the industry, and is now showing an ability to rebound with good times. This quarter's performance is achieved in spite of having two of its key geographies, the U.K. and the Netherlands, which usually command high growth and high margin, not back to normality.

Profitability was only 6.1%. For the first time in many years, Capgemini's operating margin is below that of AtoS. The U.K. and Netherlands are key: had the two countries been at their normative profitability, Capgemini's margin would have been higher by 1%. And yet AtoS has a relatively further exposure to the Netherlands than Capgemini. AtoS is protected by its higher margin HTTS/Wordline unit. Capgemini's acquisition of Prosodie indicates that Capgemini is also looking to develop more higher margin business.

Capgemini's stock declined by 10% on the day of the results as investors reacted to the decline of the net cash position to just €167m. The net decline was caused by acquisitions but also by providing better DSO to suppliers. Capgemini has indicated it targets €0.25bn of net cash by the end of 2011, again, a surprise to investors. Later on, CEO Paul Hermelin reiterated in several media that Capgemini is going to make one to two small acquisitions in H2 but is looking to conserve its net cash, to please investors. The statement has the immediate impact of delaying any significant acquisition in China, a major priority of the year, also delaying any plan to make significant acquisitions in Mexico, Turkey and other fast-growth countries.

The acquisition of CPM Braxis will continue to have a dilutive impact on margins for some years.

•                Cognizant Acquires CoreLogic Global Services and is Awarded $324m Contract

Jul 26, 2011 | Contracts by Andy Efstathiou
industry: Business Services

Cognizant has announced two major transactions:

• It is to acquire CoreLogic Global Services, the Indian captive unit of CoreLogic, a provider of information, analytics and business services, for $50m in cash (and adjustments for working capital, other charges and credits to be determined at a later stage). CoreLogic Global Services has a headcount of ~4,000 and provides software product development services, analytical development, back-office services and technology services to CoreLogic and its clients in the U.S. mortgage and real estate markets. The company has offices in Bangalore, Hyderabad and Mangalore
• It has been awarded by CoreLogic a 5-year $324m+ contract. Services to be provided include business processes services and analytics solutions in mortgage from loan origination, escross, title and closing services through secondary markets, loan administration, and loan default management.

The seller CoreLogic provides estate information and analytics in the U.S. The company has developed databases covering the U.S. real estate market, mortgage applications, fraud, and loan performance. The company analyzes the data and provides analytics and business process services around property and mortgage information; legal, parcel and geospatial data; motor vehicle records; national coverage eviction information; non-prime lending records; credit information and real property tax information. CoreLogic has 2010 revenues of $1.6bn and has a headcount of 10,000.

The transaction is expected to close in August 2011.

Analyst comments:

Mortgage processing is being restructured to:

• Automate manual processes
• Eliminate process steps
• Improve valuation accuracy using increased data and analytics (and less individual opinion).

This acquisition by Cognizant ties it closely with a key analytics provider in the U.S. marketplace. This will position Cognizant to participate in the restructuring of mortgage processing and to win mortgage BPO contracts as banks restructure their operations.