NelsonHall Industry Insight: May 16, 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.

       BT Awarded £400m BPO/ITO Contract by Lancashire County Council

May 16, 2011 | Contracts by Sarah Burnett
industry: Local Government

BT Global Services has been awarded a 10-year contract worth ~£400m by Lancashire County Council for IT and BPO services. BT Global Services, who was selected as preferred bidder in October 2010, is to work in partnership with the council to generate major savings while improving service levels. Services are to be delivered through a private limited company called One Connect Limited that will be set up by the partnership to be owned 60% by BT and 40% by the County Council.

The initial scope of the contract includes

• ICT for the council and schools
• Management of HR and payroll
• The customer service center
• Procurement.

The partnership is looking to achieve savings of ~ £100m over the lifetime of the contract. Around 800 staff from the council will be seconded to One Connect.

ICT services account for 35% of the overall contract and include desktop support for a proportion of the council's 35,000 employees and physical connectivity e.g. broadband and voice. Longer term objectives of the ICT programme are data center virtualization and provisioning of infrastructure for cloud computing.

New HR and payroll software from Oracle will be deployed, as will a new CRM suite. The customer service component adds up to a package of 126 seats.

Analyst comments:

This is an important contract for BT as underlined by the appointment of Tony Chanmugam, BT Group Finance Director, to the role of Chairman of One Connect Limited. Having a financial heavyweight from the private sector, who has helped BT's recovery, is no doubt intended to help the venture get started on a sound financial footing. Tight financial controls will be needed if the contract is to deliver the estimated £100m savings. The incorporation of a new company to deliver services gives the partners the ideal opportunity to implement such controls to squeeze out costs. From a relationship point of view though, tough controls could lead to disharmony if the expectations and the objectives of the two sides are not fully aligned.

BT's latest financial results show its managed services revenue for fiscal Q4 2011 to be down by 3.7% y-o-y at £1,753m. Yet, the local government sector is seeing a burst of contract activity with budget cuts that are frontloaded thus pushing councils into seeking solutions for cost reduction without delay.

Having new client reference sites will help BT in bid situations particularly as it has recently lost two local authority clients in another area of its business. Walsall Metropolitan Council and Herefordshire Council have recently announced switching Public Sector Network (PSN) contracts from BT to rival Updata.net with pricing given as one of the key reasons. A successful partnership project that delivers large savings sustained over a period of time can do much to help BT grow its diverse business in the local authority sector.

BT's other recent contract awards in the local government sector include:

• August 2010: a 5-year managed desktop contract by South Tyneside Homes won by BT South Tyneside, a joint venture between BT and South Tyneside Council. BT South Tyneside was formed in July 2008 as a 10-year, £184m strategic partnership with the aim of creating up to 1,250 additional jobs in the region as well as deliver £28m of cost saving to the council.
• August 2009: two 5-year network management contracts by Norfolk County Council. The first, valued at £32.9m is to provide core voice & IP telephony services, mobile & flexible working services and implementing systems for the council's multimedia contact center. The second contract, valued at £7.3m, is for the provision and management of the Norfolk Schools Internet Exchange supporting c. 450 schools in the county.
• Xchanging Issues Interim Management Statement

May 16, 2011 | Financial Results by Charles Juniper

Xchanging has issued an interim management statement covering the period from 1^st January to May 2011.

The insurance unit excluding the U.S. workers' compensation business and financial services units, is performing slightly ahead of expectations. The U.S. workers' compensation continues to perform below expectations and procurement and HR and the Technology units have had a 'slower start than anticipated'. Xchanging typically has a 40:60 revenue generation split between H1 and H2. Management expects this profile to be more marked this year and that revenue improvement and cost reduction initiatives begun in H1 will have an impact from H2.

Within the Technology unit, Xchanging has ceased the reseller revenue program which resold IT infrastructure to clients as part of a wider service contract. It was essentially a pass-through transaction with very little margin but did have an impact on the cash flow. The reseller revenue was not included in the revenue forecast issued in March 2011: it will reduce revenue by ~£20, but will have negligible impact on margins.

The operational improvement initiative which aims to cut cost by up to £20m per year is progressing "slightly ahead of plan". The most immediate impact has been the rationalization and consolidation of a number of business units in the U.K and U.S. businesses and the removal of ~30 senior managers. Xchanging will be closing its London West End office and relocating to the Leadenhall Street site by end July. Other ongoing operational improvement initiatives include supplier renegotiations with the aim of achieving ~£5m of annualised cost saving from 2012 onwards.

The review of the group's working capital and capital expenditure is underway with a view to secure further lines of credit when current facilities expire in October 2012. Xchanging expects financing negotiations to have been finalized by August 2011.

Analyst comments:

Xchanging's new management is endeavoring to be more open and communicative with the market as it executes a turnaround at the company. The general tone this morning is that overall trading has been steady and performing in line with expectations.

Execution against the four-part plan announced in March 2011 (see separate article) appears to be making good progress with the cash position being slightly better that expected. Xchanging management stated that it expects to give more detail of progress at the interim results presentation in August.

•                CSC Unveils New Three-Year Financial Objectives

May 11, 2011 | Financial Results by Dominique Raviart

In its investor day CSC has unveiled its new three-year financial objectives and explained how the company is planning to achieve those objectives.

CSC is targeting revenue growth of 3 to 7% per annum for the next three years, of which:

• Its North American Public Sector (NPS) unit is expected to grow in the 0%-5% range annually. NPS, which currently represents 40% of revenues, is more likely to have flat revenues in the short-term because of the budget freeze in civilian budgets and the defense sector exiting budget freeze
• Its worldwide commercial business, which group includes its Managed Services and BSS units, is expected to grow by between 5% and 8% per annum.

As a result, CSC is to looking to grow organically to revenues of $19bn by fiscal 2014 (ending March 31, 2014). In addition, the company expects to make acquisitions representing $1bn over the next three years.

To achieve such growth, CSC is counting on several factors:

• Its traditional IT services business remaining flat over the next three years in $ value. Traditional services, which represented 91% of revenues for fiscal 2011 (~$14.65bn), are expected to represent 74% of revenues by 2014 (including acquisitions) (~$14.8bn)
• Its business solutions (proprietary application-based software, services and BPO) being replicated from financial services to other sectors, starting with healthcare, as illustrated by the recent iSOFT acquisition. CSC's financial services business solution business represents an estimated $1bn in revenues (out of $3bn for the total financial services unit). Healthcare represents ~$1.3bn in revenues plus an additional $0.36bn coming from iSOFT Business solutions currently represent 9% of revenues (~$1.45bn)
• Emerging services e.g. cloud computing, identity management, smart metering and cyber-security. CSC has launched a number of cloud computing offerings and has made a number of small-scale acquisitions in the energy and security areas.

By 2014, Emerging services and Business solutions combined are expected to represent 26% of revenues (~$5.2bn, of which $1.2bn coming from acquisitions).

By area, CSC is looking to:

• Grow within NPS its cloud computing, cybersecurity and identity management offerings
• Add $1bn in revenues in three years in Financial Services, to $4bn
• Double its ADM business
• Intensify cross selling to its client base
• Become a leader in cloud computing.

CSC is looking to improve its operating margin by 25 to 50 basis points annually until fiscal 2014, targeting a margin of 7.7% in its fiscal 2011 (ending on March 31, 2011).

Analyst comments:

Overall, CSC has announced conservative financial objectives with an annual growth of 3 to 7% organically. The North American Public Sector unit, once a revenue engine, will slow down overall growth in the short term. This forecast contrasts very much with the picture of CGI depicted in the market.

CSC's commercial business has ambitious growth targets (5% to 8% range), considering the weight of Managed Services, which represents twice as much as revenues as the more cyclical BSS business.

CSC's objective to add $1bn in revenues through acquisitions by 2014 is somewhat muted: competitors in other geographies such as Capgemini and NTT Data are much more ambitious.

Another area of disappointment is the lack of focus on emerging countries. Other global systems integrators IBM, HP, Accenture and Capgemini talk openly about increasing their exposure to high-growth countries organically or through acquisitions. Such interest in high-growth economies seems less important to CSC than its service offering approach to existing clients. CSC has referred several times to increasing its cross-selling to its client installed base, has reorganized its sales structure from responding to large bids (largely in the NPS and MS practices) to accompanying clients in the long-term.

On an anecdotal basis, CSC has responded mildly to the comments of the U.K. Prime Minister, David Cameron, who on May 11 said: "There are no plans to sign any new contract with CSC until the National Audit Office report has been reviewed and until the Public Accounts Committee meetings and the Major Projects Authority reviews have taken place." This statement was underplayed by CSC, which still plans to sign its MoU in the next few weeks with the U.K. government for the NHS contracts. NelsonHall estimates that the Local Service Provider business represents 3% of CSC global revenues. Nevertheless, the impact of the lack of revenue recognition from the NHS in fiscal 2011 is responsible (together with the findings on accounting misbehavior in CSC's Nordics region) for the decline in the operating income margin of the company from 8.75% in FY 2010 to 7.7% in FY 2010.

•                Serco Issues Interim Management Statement

May 09, 2011 | Financial Results by Sarah Burnett
industry: Government

Serco has issued an Interim Management Statement covering the group's performance since January 2011. Management confirms prior guidance of £5bn revenue and adjusted operating profit margin of 6.3% by end 2012.

At end December 2010 Serco's order book was £16.6bn and the pipeline was £29bn.

The company reports today £1.6bn of contracts awarded since the start of 2011, of which £1.4bn signed and £0.2bn expected as preferred bidder supplier.

Analyst comments:

In the face of public sector cuts, Serco now claims that expansion of its smaller sized contracts is key to any incremental growth. Smaller sized new signings since January 201 include:

• Two contracts with a total value of £15m over 4 years awarded by the U.K. Ministry of Justice to help ex-offenders into work in the South East and East of England
• A £5.4m 4-year contact center services contract awarded by West Sussex County Council to the Listening Company, acquired by Serco in March
• A £2.7m contract to upgrade Enfield & Derby Council's communications systems.

Among Serco's larger contract wins this year were:

• A 15-year £250m contract renewal to continue to manage HM Prison & Young Offender Institution in Doncaster
• A 7-year prisoner escort and custody services (PECS) contract with a potential value of £420m by the U.K. Ministry of Justice's National Offender Management Services (NOMS)
• Moving from prisons to hospitals, Serco's acquisition of Braintree Clinical Services Ltd brings in a £60m, 4-year hospital management contract with Mid-Essex PCT to support Braintree Community Hospital.

However, the U.K. remains challenging for Serco, who is achieving higher growth in other regions. 2010 results show revenue and growth of:

• U.K. £2,586.4m (+1.8%)
• U.S. £880.3m (+7.5%)
• Other regions £860.0m (+41.2%)

In November 2010 Serco was one of the last suppliers to sign a MoU with the U.K. government. Before this Serco had received negative publicity when it attempted to get a 2.5% cash rebate from its own suppliers, threatening them with a loss of future contracts if they did not comply. Serco was forced to do a U-turn, but this does illustrate one of the risks in BPO: when there is a substantial level of sub-contracting it can be difficult to achieve additional increases in cost reductions imposed by the client. This year Serco has benefited from opportunities created by the policies of the new government, e.g. the award of two Work Programme contracts by the DWP.

Internationally, Serco has seen strong growth in its Africa, Middle East, Asia and Australia (AMEAA) division expanding into new geographic markets such as New Zealand with the awarding of the Mount Eden prison management contract and India with a consulting win for Gurgaon Metro/Delhi Airport Metro. Serco is able to leverage experience gained in the U.K. to build presence in new markets; a recent example is the Fiona Stanley Hospital where Serco is preferred bidder for managing all non-clinical services.