CSC has announced it has entered into exclusive negotiations to acquire Australian IT services vendor UXC for AU$1.26 per share, a purchase price of ~AU$428m (~US$300m). The transaction is subject to completion of a five-week exclusive due diligence process. CSC expects it to be finalized by February 2016.

UXC is one of Australia’s largest independent publicly-owned IT services vendors. The news of its imminent acquisition is not in itself a surprise, as it has for some time been seen as a potential target by a global provider. And the decline of the AU$ against the US$ in the last couple of years will have made it a more affordable target. Our interest is what acquiring UXC will mean for CSC, assuming the deal goes through?  UXC would nearly double CSC’s revenues in the region to ~AU$1.34bn, making it one of the largest IT services vendors operating in Australia. But is CSC acquiring a coherent business in Australia?

Some clues are evident in UXC recent financials. Its FY15 (to end June 15) revenues were $686.4m, up 6.7% as reported. EBIT margin was 4.8% up 93 bps y/y, the margin improvement coming from a product to services shift and improved utilization.

Looking at FY15 performance by service type:

• Consulting & advisory. Revenue AU$109m, up 29%. Margin 7.8% (target 9% - 10%)
• Enterprise applications. Revenue AU$355m, up 10.1%. Margin 9.7% (target 11% - 12%)
• IT infrastructure. Revenue AU$223m, down 5.8%. Margin 4.9% (target 4.5% - 5.5%)

Over 50% of the business is Enterprise applications services: Microsoft Dynamics (UXC Eclipse, with a growing U.S. business), Oracle (UXC Red Rock), SAP, Cloud Solutions, ServiceNow, UXC Keystone acquired November 2013) 

FY15 revenue mix by activity type was:

• Services AU$371.4m (+7%)
• Annuity revenues AU$196.7m (+13%)
• Product and licences AU$123.1 (-2.3%), reflecting a strategic shift in revenue mix from these lower margin activities

UXC has grown through a series of acquisitions, the most recent being

• Saltbush, Oct 14 (66 staff), bringing in capabilities in cybersecurity
• Contiigo, May 15 (26 staff), bringing in SAP hybris capabilities

The newly minted CSC Global Commercial will be attracted by the Microsoft Dynamics and ServiceNow units and its burgeoning cybersecurity capabilities. But UXC does not bring any significant commercial sector expertise: the client base is too diverse: FY 15 revenue mix by sector is:

• Government 24% (~AU$164m, state government 13%, federal 11%)
• Capital goods and commercial services 12% (~AU$82m)
• Consumer goods and services 12%
• IT and Communications 12%
• Healthcare 11%
• E&U 9%; Resources 6%
• Also Financial services 4%, Education 4%, Retailing 2%

There are no very large accounts: the top 50 contribute 47% of revenues (~AU$323m). And, partly reflecting the product and licence business, there is a very long tail (the next 50 clients account for just 13% of revenue, ~AU$90m). A current drive, with a “large deal” team is to add new >$5m clients. And there is progress here: in July, UXC announced several new significant wins with a combined TCV of over AU$100m:

• Transpower New Zealand: 3-yr deal: DB, Oracle middleware and mid-range server support
• Beverage company: Oracle-based SaaS deal
• Australian construction firm: Oracle ERP implementation, then 5 year managed services
• Ixom (water treatment chemical distribution, formerly part of the Orica group): migrating from the Orica hosted IT environment
• NSW government agency: multi-year contract for service desk and end user computing support.

UXC has ~3,000 employees, of which ~2,500 in Australia. It has been expanding outside Australia, with FY15 revenues from

• U.S. (where it acquired Tectura) of AU$68m. 216 employees
• New Zealand/Fiji of AU$40m (NZ 179 employees. Fiji 25)
• Vietnam/India (where it acquired Convergence Group in late 14 to build an offshore presence) of AU$8m.  (108 employees)

In comparison, CSC Australia has ~ 2,100 employees and generated revenues of AU$724m in its FY15 (ended April 2) -  so a larger business than UXV,with fewer employees. But CSC Australia revenues were down 15% on FY14. Profitability also fell, with EBT margin down 2.8 pts to 5.3%.

CSC’s acquisition of ServiceMesh in November 2013 brought in operations in Australia as well as the U.S. and U.K. However, following the allegation that ServiceMesh’s ex CEO had bribed CBA employees, CSC started legal proceedings against him in May this year. It has also had to contend with accounting irregularities in the region, and some troubled contracts.

As CSC breaks into two companies (see here), the new CSC Global Commercial $8.1bn company is acquiring in its efforts to reinvent itself, lookng wth interest at SaaS services and industry specialization In August, for example, it announced its intended acquisitions of

• Fixnetix, which will expand its presence in the capital markets sector (see here)
• Fruition Partners, (now completed), bringing in ServiceNow integration capabilities.

And in some regions, CSC Global Commercial (which includes non-US public sector) is building a consulting capability in some regions, increasing its industry and digital capabilities. Areas of interest that will have attracted CSC would have included UXC’s enterprise applications practice, in particular Microsoft Dynamics, its cybersecurity capabilities, also its state government business, where CSC is already active,

Australia is a mature IT services market, where CSC has been a major player for years (alongside Accenture, Fujitsu, HP, IBM et al) for large traditional deals. And it is an important market to CSC, which in June, CSC opened a SOC in Macquarie Park, Sydney, one of five that it operates around the world. CSC cannot afford to lose ground in what remains an important market, one which has been attracting interest from some of the larger IOSPs, and which, like the rest of the world, is being disrupted by digital.  UXC is more active in the mid-market than CSC. It is higher margin than CSC and, importantly, may help CSC position as more of a local player in Australia while also becoming one of the largest providers in the country, just behind Accenture.

UXC goes to market via several brands (although recently it has been talking about becoming more integrated, including a shared services rationalization starting in FY16). Integrating these into a CSC brand could prove challenging. Expect to see CSC make more acquisitions like Fruition Partners and then seek on the back of these to build global practices for ServiceNow, Microsoft, etc.