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Sopra Steria in 2015: Continued Strength in U.K., Challenges Elsewhere in Europe, and the Mystery of BPS

Sopra Steria has announced its financial results for 2014, focusing on its profitability performance (revenues were previously published in February). Our key takeaways from the announcement are discussed here.

U.K. Will Continue to Outperform Other Sopra Steria Geographies in 2015

Sopra Steria U.K. had phenomenal growth in 2014 (+18.2% organically) to ~€859m. Profitability was high (adjusted EBITDA margin of 9.9%, up 80 bps). The revenue growth results from the SSCL series of contracts, including extensions to MoJ and Home Office contracts (€400m in TCV). U.K. public sector should keep on growing in 2015, albeit at a lower growth rate. The company is being cautious about the potential impact of the May 2015 U.K. general elections. The intention is to expand in the commercial sector, with financial services as a priority, potentially based on selling Sopra Banking Software products bundled with BPS.

Profitability at the former Steria U.K. will, however, be lower in 2015 than in 2014, largely due to investment in sales and further capex investments in its SSCL venture for building new applications and on-boarding the new MoJ and Home Office contracts.

Turning Around Legacy Steria France Will Take Time

Steria France was impacted in 2014 in terms of revenue growth and profitability by the termination of the Ecotaxe contract (truck toll collect) in H2 2014, merger distractions, losses in its Infrastructure Management (IM) unit, as well as high restructuring costs. Going forward, Sopra Steria is expecting its new size to help it reach contracts of higher TCV. C&SI for the whole of Sopra Steria should be growing modestly in 2015.

Sopra Steria Likely to Divest IM in France?

Sopra Steria is expecting IM only to improve slowly in France, with a gradual return to break even profitability. At the same time, the company is increasing its level of cross-selling internally for its software products and for C&SI, and is driving more coordination between C&SI and IM around cybersecurity and infrastructure professional services. Meanwhile, the reason why Sopra Steria has carved out its French IM business remains unknown. In our opinion, a sale is likely given the size and net margin of the unit (€220m in revenues and a net loss of €14m).

Turning Around Germany Will Also Take Time

Steria has suffered in Germany from its transformation from a consulting-led systems integration business towards a more resilient business. Revenues declined with the economic conditions. The management has changed, and attrition has increased. Revenues in Germany were €212m and net loss was -€9.5m. Meanwhile, Sopra Germany is also a business under stress, with revenues of €14m, down 30%, and adjusted EBITDA margin negative 50%! Sopra has suffered from Airbus reducing its R&D service spend in the country, impacting small suppliers.

In NelsonHall's view, performance in Germany is likely to be flat for the legacy Sopra. Steria Germany will remain impacted by a lower number of consultants. Fixing such a consulting business will not be easy.

Scandinavia: Mediocre Profitability a Surprise

Steria in Scandinavia, and in particular Norway, has been a solid growth driver over recent years, growing frequently by 10% organically. Performance in 2014 was solid in terms of revenue growth (+13.8% organically). The surprise was that the adjusted EBITDA margin has been low in 2013 and 2014 (4.2% and 3.6% respectively) and declining due to a higher level of subcontractors. This is news to us as we expected Steria to achieve high margins on the back of its Norwegian public sector contracts. In all likelihood, Sopra Steria will selectively revisit contracts and look at SG&As. Lowered growth in Scandinavia is very likely.

Expanding Vertical Focus to Defense & Homeland Security

Sopra Steria is also changing its vertical focus somewhat. In the past the company was particularly active in the service industries, including financial services, public sector, transport and utilities, and manufacturing (largely for Airbus). It will maintain its focus on financial services and public sector. However, it is expanding in aerospace, defense and homeland security. Transport & utilities, telecom & media and distribution are becoming less important in the short-term.

The approach is fairly traditional for IT service vendors, focusing on key accounts. What is new here is that while Airbus is the largest client of the group, it has not traditionally been involved in defense & security outside the U.K. Sopra Steria is aiming to expand its service offering in France with the planned acquisition of CIMPA (2014 revenues of €100m), a subsidiary of Airbus. The acquisition raises question marks, given the growth prospects of French R&D service spending currently.

Changes at the Top Confirm Merger was a Take-Over by Sopra

Francois Enaud, long-time CEO of Steria and CEO of Sopra Steria for just six months, departed during Q1 2015. He is replaced by Vincent Paris, Sopra’s former Deputy CEO, with John Torrie as Deputy CEO. The departure of Mr. Enaud was expected, as Head of the Supervisory Board Pierre Pasquier maintains a strong grip on the group’s destiny. Unsurprisingly, this confirms that Sopra acquired Steria and is rolling out its model across Steria.

Software Products Remain a Priority in the Mid-Term

Software products now represent 13% of revenues and Sopra Steria wants to reach 20% to 25% in the mid-term. This will come from acquisitions, as organic growth will not be sufficient to bring ~€300m in additional revenues.

In the short term, the company is accepting lower profitability for investing in the development of its software products. 2014 saw good levels of license sales, but at this point the company has no visibility of how license sales will behave in 2015.

No Mention of BPS or Acceleration of Indian Offshoring

Importantly, Sopra Steria did not mention how it is going to use Steria’s competitive advantage – its large BPS unit (€471m in revenues in 2014) –  and spread its usage across Continental Europe. There’s also a question mark over how Sopra Steria will accelerate adoption of Indian offshoring. To a large degree, Steria had been a success story until its Xansa acquisition in 2007. However, outside of the U.K., evidence of contract wins has been low, suggesting that the company hasn’t made the most of its twin assets of BPS and a 5k personnel presence in India.

At this point, Sopra Steria has a similar profile to that of legacy Steria: reliance on U.K. operations, mild growth prospects in its domestic country, and mixed successes in its other European subsidiaries. What Sopra Steria has that Steria standalone did not have is its sizeable software product business. Software products can bring high margins but they are also cyclical and depend on fourth quarter performance. 

Sooner than later we would like Sopra Steria to show a clearer roadmap, and in particular its intentions regarding BPS.

See also NelsonHall’s blog from April 2014 at the time of Sopra’s acquisition of Steria.

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