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CSC Splits into Two to Maximize Shareholder Value: Moves from Turnaround to Reinvention

CSC has announced a planned break up by October 25 2015 into two firms: CSC U.S. Public Sector (FY 15 revenues: $4.1bn) and CSC Global Commercial ($8.1bn, also includes non-U.S. public sector). See here for details:

The announcement ends a long period of speculation over the posssible sale of CSC's North American Public Sector unit (NPS) to private equity funds and the sale of its Global Business Solutions (GBS) and Global Infrastructure Services (GIS) businesses to another IT services firm. Given some kind of breakup has been in mind for some time, the costs of the separation are not significant (certainly not compared with some of the exceptional charges CSC has reported in recent years): the estimates are between $50m and $75m.

The rationale of some aspects of the break up are not yet clear, for example why a distribution of shares to shareholders and not a flotation of NPS, like Atos did with Worldline to raise cash and have a quoted vehicle ready for acquisitions? But one thing is certain: CEO Mike Lawrie has aimed to increase CSC's stock value, and here he has succeeded: CSC now has a significant market cap of $9.8bn (Booz Allen Hamilton in U.S. federal: $4.2bn: CGI in commercial and in U.S. federal: $13.6bn). The intention with the split is to further increase the market cap of the two standalone firms and to maximize shareholder value, in a manner that is intended to be tax efficient. At closing, there will be a cash dividend to shareholders of $10.50 per share, intended to be tax free.

CSC's financial performance is a mixed story. Lawrie and his team have increased the operating margin of the company over the past three years: EBIT margin reached 8.0% in FY 2014, a very decent level. A lot of costs have been stripped out of the business: the "Get Fit" strategy has delivered $1.9bn in cost savings. But exceptional items continue to have a massive impact on CSC's EBIT margin: exceptional items in FY 2015 that are legacy issues include pension funding and a pending settlement with the SEC related to historic misreporting. CSC also announced a "special" restructuring charge of $246m. This charge, funded by the reversal of a tax loss in the U.K., will further increase the offshoring/nearshoring ratio of CSC's commercial business from ~40% by another ~600 bps. CSC management higlighted that eventually it wants to have this ratio reach 50% to 60%, also to reshape its age structure from a diamond to a pyramid, hiring many more young graduates.

In short, further restructuring will be needed over the next few years. We anticipate CSC's commercial business current target of an offshoring ratio of 50-60% will be revised upards over time by another 10% to reflect current market ratios in U.S., U.K and Nordics (NelsonHall estimates that at least two thirds of the revenues of CSC Commercial are located in offshore-friendly geographies - excluding CSC's presence in the U.K. public sector). A comparison: Capgemini with its pending acquisition of IGATE will have a presence in North America similar to that of CSC's commercial business (~$4bn for Capgemini vs. ~$3.8bn for CSC), with 50k Indian personnel servicing North America, an offshore ratio of 75%. Eventually, CSC will look to adjust to similar offshoring levels.

CSC is far from being over with its downsizing effort of onshore personnel. Another example of CSC's lack of push to offshoring: CSC, with its 2007 Covansys acquisition, gained a headcount of 14k in India. In FY 2015, headcount in India was 19k (including ~1k from the acquisition of AppLabs). In short, CSC has barely grown its Indian presence in the past seven to eight years. This is hard to believe given the fact that CSC probably derives ~$3.7bn in revenues from the U.S. commercial sector and that U.K. is a ~$1.6bn business too. CSC is also lagging in its ability to service clients in Continental Europe, only now building capabilities in Bulgaria and Lithuania.

Meanwhile, the revenue decline continues, down 8% in constant currency FY 2015, after a 7% decline in FY 2014. Back in 2007, CSC was a $16.7bn revenue business; it is now a $12.2bn business. CSC has divested a number of business units, which overall represent a NelsonHall estimated $1.7bn in revenues. Looking ahead, the revenue decline will continue in the short term: in FY 2015, bookings were down by 12% in CSC's commercial business. GIS continues to move away from capital-intensive deals towards smaller contracts relying on more standard services. GBS is more worrying: so far, the unit has failed to benefit from the positive market conditions in the U.S. in the past two years, the relatively good conditions in the U.K. and the improved conditions in Continental Europe. Within GBS, application services are not growing (down 5% at CC in FY 2015) and Industry Solutions and Software was flat at CC. CSC continues the reshaping of GBS, but is predicting slight growth in the unit in FY 2016, possibly a confident prediction. Uncertainty about the future of the company must have made it very difficult for to win new logo commercial sector business in FY 2015. Now there is more clarity, this should ease somewhat.

Apart from developing the global delivery capability and changing the age profile if the workforce, what else might we see with the Global Commercial company over the next few years?  

  • For the company overall, topline growth will not happen before FY 2017 at the earliest 
  • In the GBS business (down 5% in CC in FY 2015), its applications outsourcing business continues to look vulnerable. Will CSC become more successful in leveraging its industry IP in the insurance, banking and healthcare sectors to cross-and up-sell both project-based and also annuity services? 
  • The GIS business, where it has been hit hard by having a heritage steeped in large, traditional IT infrastructure management deals, will continue to lag GBS in the short- to mid-term at least as some contracts expire. Will CSC begin to see a demonstrable increase in the proportion of overall revenues coming fron newer and renovated parts of its portfolio such as cyber, aaaS offerings, and myWorkStyle? The shift to smaller, less capital intensive, and higher margin will become more evident. This requires a completely different go-to-market approach, a journey on which CSC has embarked. The days of asset and personnel transfer deals appear to be over for CSC. A separate challenge that will be more difficult to address will be the inability to cross-fertilize the cybersecurity and big data capabilities from the U.S. Public Sector business,

The NPS business is generally healthier, and will benefit from improving market conditions, though again topline growth will not happen before FY 2017

The turnaround of legacy CSC is coming to an end: its reinvention is still in its early stages.

Dominique Raviart and Rachael Stormonth

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