NelsonHall recently caught up with Genpact to discuss their recent acquisition of OnSource and their plans to integrate it with BrightClaim – we were not surprised to hear that the two acquisitions are indeed connected, and part of Genpact’s strategy to introduce new digital process models in P&C insurance.

To set the scene:

• Earlier this month, on the day of its Q2 earnings results, Genpact announced it had acquired OnSource, a small software house based in Boston, MA. On its own, OnSource will not make a meaningful contribution to revenues
• In May, Genpact announced it had acquired BrightClaim, a U.S. domestic P&C insurance BPS provider with centers in Atlanta, GA and Austin, TX and its associated company National Vendor that provides content evaluations, through its large field force, and content fulfilment services.

Genpact has an active M&A strategy currently; the priorities include adding

• Digital and analytics capabilities to help accelerate the build out and deployment of digital assets, as OnSource does
• Domain capabilities in targeted verticals and services, as BrightClaim does.

BrightClaim brings in a new client base of Tier 2 carriers for Genpact to cross-sell its services - and indeed the short-term opportunities include adding global delivery options for some of its services offerings. But the strategic opportunities are in applying disruptive technologies to some of the touchpoints and currently manual interventions within the claims process. And OnSource provides an opportunity to do this in certain areas.

Applying digital solutions from auto FNOL to improve the inspection and appraisal processes in property claims

Now BrightClaim’s client base is around 85% property/15% auto insurance, whereas OnSource has essentially the reverse ratio with its client base - so what are Genpact’s plans in integrating these two companies, based in different regions, and serving different segments?

Quite simply, they center on applying Onsource’s ‘Inspection-as-a-Service’ solution, developed initially for the auto insurance market, to the loss estimating process in property claims. The solution uses either mobile devices or drones to obtain photos and videos (also written evidence) that are used to assess damage and generate loss estimates for claims payouts. Carriers can use the solution to offer customers, when making a claim, a choice of:

• A self-service approach to the FNOL process, using the OnSource ‘Instant Inspection’ mobile app to connect to a Virtual Appraiser’s desktop for a claim submission. The photographic evidence provided can be downloaded directly to the insurer’s appraisal software. The app can also be used by motor repair shops for any supplement approvals
• An assisted solution using a network of 17k ‘Uber-like’ field photo inspectors who can walk the customer through the claim submission process using an iPad.

The benefits of Onsource’s ‘Inspection-as-a-Service’ solution for carriers and also their customers are obvious:

• In terms of the customer experience, either method (self-service or assisted) offers ease of use and a significant reduction on the traditional cycle time – Genpact claims by around 30%
• And for the carrier, there are major cost reductions in loss adjustment expenses (LAE) from eliminating the traditional field inspection process and from more efficient workflows - Genpact claims by 50% plus – and the visual MOI can also mean more accurate indemnity.

In short, digitizaling this process can help in improving three priorities which carriers have to balance: customer satisfaction, expense control and loss control.

The use of mobiles in submitting photographic and video evidence of damage in auto claims is now very well established, and the use of drones as a Method of Inspection (MOI) for high value/ hard to access property claims assessments has also been gaining traction in many Tier 1 carriers over the past few years – but both methods remain fairly new for Tier 2 carriers in their personal property lines. Video technology will become increasingly important across the P&C insurance sector over the next few years. The FAA has taken some time in sorting out regulations for the commercial use of drones which slowed things down slightly: OnSource brings with it a nationwide network of certified drone operators; this capability has the potential to transform the independent property appraisal services offered by BrightClaim. The ‘Instant Inspection’ app could also be applied to some of the contents evaluation services provided by National Vendor, enabling some activities to be done remotely.

Genpact’s integration streams for OnSource and BrightClaim are moving at pace.

With its P&C BPS services, Genpact has positioned on its domain knowledge combined with expertise in lean process mapping, intelligent automation, and workflows for straight-through processing, analytics, as well as offshore delivery. With OnSource, Genpact has another digital solution it can offer to BrightClaim’s carrier client base.

Further Acquisition Activity in Support of New Digital Process Models by Genpact Highly Likely

Genpact is one of a number of BPS specialists that have in the last few years been energetically reinventing their portfolios to embrace the sometimes dramatic shifts afforded by Digital in enterprise operations and develop new digital business process models (NDPMs).

Genpact’s other acquisition this year was that of Rage Frameworks, whose NLG software has enhanced its AI capabilities. We expect to see more investments by Genpact soon, including possibly acquisitions that bring more cognitive tools into the Cora platform, and/or more consulting-rich domain expertise to help clients in the digital transformation of their middle and back offices.

Genpact has had a traditional presence in offshore-based adjudication support services for the property & casualty sector but is now, supported by its acquisition of BrightClaim, aiming to reposition as a disruptive provider of claims managed services.

The acquisition of BrightClaim provides Genpact with deep onshore domain and loss adjusting capability, which Genpact is looking to combine with its offshore services and a new digital operating model to enhance its value proposition to P&C firms.

In particular, Genpact is looking to extend its value proposition beyond the traditional BPO proposition of expense control to impact both loss control and customer satisfaction. Its new value proposition for low-medium complexity claims across property and auto encompasses:

• Claims operations cost reduction of up to 40%
• Improving customer experience, CSAT, and NPS by 10%-20%
• Reducing the cost of losses by 3%-5%.

Introducing a New Digital Process Model for Claims

While most carriers have introduced apps and self-service at the front-end, and use of photos has become commonplace in auto claims, Genpact perceives that there has so far been a much lower level of innovation in property claims processes and is aiming to take advantage of this lack of delivery maturity. Genpact has accordingly established a new digital business model that encompasses end-to-end claims services across both property & auto claims. It includes:

• FNOL & claim set-up: using digital channels, IoT and smart home sensors, Intelligent Automation for claim set-up & verification, analytics & Big Data for claims triaging, fraud and subro identification
• Loss estimating: use of photos and drones and computer vision to enhance turnaround time and improve customer service, and integration of estimating tools with claims systems
• Adjudication: automation of fraud, subro and litigation propensity using analytics & Big Data; and using Intelligent Automation in support of claims verification, updating, and communication
• Special Investigation Unit & Litigation Management: supported by Big Data and analytics
• Payment, recovery & claim closure.

BrightClaim: Complementing Genpact’s Offshore Services with Onshore Desk and Field Assessors

Earlier this month Genpact acquired BrightClaim, a P&C claims administrator company based out of Atlanta founded by ex-Crawford executives. BrightClaim and its associated company National Vendor have full P&C policy lifecycle claims and administration capabilities for low and medium complexity claims, including an extensive network of contractors. BrightClaim segments its business into:

• Property field services
• Catastrophe
• Contents services (through BrightClaim’s 2016 acquisition of National Vendor)
• Liability/auto
• Warranty (now viewed as non-strategic)
• BrightServ (managed repair program through its network of contractors, includes a partnership with Home Depot).

BrightClaim has around 200 employees in Atlanta and Austin conducting desk reviews and estimation and managing BrightClaim’s network of ~1,000 field property adjustors. These field loss adjustors could also be used as a desk appraisal resource as Genpact increasingly replaces physical onsite reviews with photos from mobiles sent by the customer and drone images, the latter being particularly applicable for property roofing assessments. Genpact intends to incorporate drone services into its delivery and has several drone pilots underway with carriers. The fact that BrightClaim’s field loss adjustors are contractors rather than employees made the acquisition particularly attractive as it facilitates the drives towards an increasingly digitized service delivery model.

BrightClaim has its own loss adjusting systems which connect to core insurance systems such as Guidewire and legacy P&C platforms and to the principal estimating platforms used in the U.S. Genpact will create a common platform around these using PNMSoft for workflow and incorporating automation and cognitive technologies to achieve its new digital business process model around claims.

Extending Targeting to Mid-Tier P&C Carriers

BrightClaim has around 100 P&C carrier clients, including half of the top 20 U.S. carriers, and there is some overlap with Genpact’s existing U.S. P&C client base. Its focus is on low to medium complexity claims which can be more readily digitalized, with a 70/30 mix between personal and commercial. In the property space, Genpact will target personal and light commercial claims, while all auto third-party liability activity is in support of personal claims.

Genpact’s priority is the top-tier P&C firms where it is looking to sell three broad groups of services while demonstrating synergies and digital integration between these:

• FNOL & claims triage, likely to be a growing area of activity with Genpact promoting how analytics can drive value downstream in the claims value chain
• Loss adjusting and claims adjudication, using blended onshore/offshore delivery
• Subrogation, fraud, and recovery services.

In addition to targeting top-tier carriers for transformation of parts of the value chain, the BrightClaim acquisition also creates an opportunity for Genpact to target mid-tier U.S. P&C carriers with end-to-end claims services supporting them in the digital transformation of their entire value chain. Several conversations of this type are already underway.

Genpact has been on a bit of an acquisition spree recently, and this is not likely to pause. BrightClaim is a U.S. operation, and Genpact is looking for a similar opportunity around claims management services in the U.K., Germany or the Netherlands – expect to see another regional claims-related acquisition.

On March 15, WNS announced its intended acquisition of HealthHelp, in what, at $95m, will be its largest acquisition to date. HealthHelp, founded in 1999 and headquartered in Houston, TX is a 400-FTE strong healthcare utilization management specialist.

In many ways, the HealthHelp acquisition has much in common with WNS’ Value Edge acquisition. HealthHelp, like Value Edge, will become part of WNS’ healthcare business unit and is rooted in research & analytics. While WNS’ healthcare unit has a traditional “administrative” BPS business, around claims, billing, & collections, serving healthcare payers, the bulk of WNS’ healthcare revenues are derived from the pharmaceuticals sector. This acquisition is intended to assist WNS’ healthcare unit in achieving a more balanced revenue mix between healthcare payer and pharmaceuticals.

Targeting Direct Care Costs in Addition to Administrative Costs

The acquisition gives WNS’ healthcare payer capability a major boost and enables WNS to position on reducing the direct cost of care for healthcare payers, and not just on reducing their administrative costs. Post-acquisition, WNS is now going to market in the healthcare payer sector with a combination of administrative BPS services, analytics, and the collaborative care management services from HealthHelp. WNS was already targeting its existing healthcare payer BPS clients with analytics services, though mostly on a project basis; this acquisition provides it with an opportunity to enhance its existing healthcare analytics capability with a high value-add service to assist payers in establishing improved treatment rules and guidelines in collaboration with providers. WNS is already in conversation with several large national payors regarding its new combined offering and will be targeting both national payors and regional payors.

And, of course, in addition to targeting existing WNS healthcare payer clients and prospects with its HealthHelp capabilities, WNS will target existing HealthHelp clients with its complementary established claims management and analytics capabilities.

Cross-Fertilizing into Workers’ Compensation

Because of the complementary nature of HealthHelp’s services and WNS’ existing healthcare payer offerings, the integration of HealthHelp into WNS should be relatively straightforward leaving the delivery organizations of the existing entities largely unchanged. The principal integration activities involve creating a joint go-to-market and integrating WNS’ existing technology with HealthHelp’s Consult software.

In addition, WNS has evaluated using HealthHelp’s Consult pre-authorization tool in support of workers’ compensation utilization, which uses similar data sets to healthcare payer, and pharmaceuticals utilization, and is likely to enhance Consult to support workers’ compensation in the near future.

Supporting an Under-Penetrated Market

HealthHelp began life supporting Humana and was initially centered on supporting Medicaid and Medicare claims. Indeed, Humana still accounts for over 60% of HealthHelp’s revenues; it now also has contracts with a number of smaller payors. So WNS and HealthHelp have an under-penetrated market with considerable potential opportunity.

The areas currently supported by HealthHelp’s collaborative care management are cardiology, radiology, oncology, pain & orthopaedic, sleep care, and emergency medicine. For each of these areas, HealthHelp has established “evidence-based guidelines to directly help providers order the most appropriate tests and procedures for their patients”. The service works on a non-denial basis and aims to reduce the cost of treatment to payers by educating providers on the most appropriate procedures and avoid unnecessary or inappropriate tests and treatment.

This knowledge is encoded in HealthHelp’s Consult clinical decision support platform which provides healthcare providers with guidance for performing the most appropriate tests and procedures and typically approves 75% of provider recommendations automatically, with the remaining 25% being subject to HealthHelp’s nurse review. Here, HealthHelp nurses collaborate with physicians to discuss alternative treatments and propose clinical guidelines more relevant to the patient’s condition. HealthHelp has ~400 FTEs with the majority based onshore in the U.S. principally in Houston. Other U.S. locations include a contact center in Albany, New York, and an office in Annapolis, Maryland from where it serves the radiology community. In addition, HealthHelp has customer service personnel based in the Philippines. The company also collaborates with ~100 MDs and 11 university medical systems, that are involved in guidance in ~6% of more challenging cases, with HealthHelp supporting the physician seeking guidance with a specialist in their field.

HealthHelp estimates that removing the threat of denial and providing “collaborative consultation and education between providers and payors’ utilization management organizations” has resulted, for example, in 15%-30% savings for radiation oncology and 12%-25% for medical oncology.

At the same time, HealthHelp’s utilization management process aims to reduce the overuse of screening and diagnostic tests by detecting redundant testing, sequential testing, and physicians billing for unauthorized procedures.

A further benefit to payers is that many of HealthHelp’s services qualify as “activities that improve healthcare quality” within the MLR requirement and so do not count as an administrative cost to payer organizations.

Pricing for HealthHelp is currently based on a standard PMPM (per member per month) model. WNS may look to evolve this to outcome-based pricing models as it looks to assist healthcare payers in driving down the overall cost of medical care.

Opening the Door to Regional Payers and Healthcare Systems Outside the U.S.

In summary, the acquisition of HealthHelp lifts WNS’ healthcare payer proposition beyond the legacy and mature area of administrative cost reduction into direct care cost reduction and provides WNS with an onshore “door-opener” for both national payors who have traditionally been receptive to offshore-centric administrative services and for regional payors, who have not.

The new capability also potentially has applicability to other areas of the wider healthcare-related industry where organizations need to reduce direct treatment costs, including workers’ compensation, pharmaceutical spend, and even potentially healthcare systems outside the U.S. Here, WNS could potentially target the NHS in the U.K., a country where WNS has an existing strong presence.

WNS’ RPA journey is moving quickly, with six pilots underway and five more ready to go. WNS has decided to wait on AI for the time being, in favour of developing its process automation capabilities, which has included the launch of eAdjudicator (a bolt-on RPA tool for claims adjudication) and InsurACE (a policy administration workflow tool) earlier this year.

RPA delivering 25% savings; 40% achievable with employee retraining

Echoing its peers, WNS started by applying RPA to defined, rules-based, and transaction-based insurance activities, specifically in payments and first notice of loss (FNOL), followed by subrogation, since these sub-processes are relatively standardized and do not require human judgement. Based on its pilot experience to date, cost savings in these areas have been around 25%, but in order to realise further cost savings, there is a ‘Phase 2’ that requires re-training of the labor force and process reengineering to take advantage of the automation, which could see a further 10-15% savings. Three of the pilots are in this second phase.

To take its journey forward, WNS required a technology partner who had an insurance focus, a cloud-based offering, and a particular strength in robotics for analytics – specifically with a capability to handle the vast number of compliance requirements imposed by the different U.S. states.  It found these in Blue Prism (although it continues to be open to additional partnerships with other technology vendors), who also happened to be looking for more traction in the insurance space – something that WNS brought to the table.

P&C FNOL, Claims & Underwriting the Focus for 2016

In 2016, WNS has three focus areas in which it will be applying RPA, based on client appetite: FNOL, claims processing, and underwriting (UW), with an overall aim of removing the unnecessary steps in each sub-process.

As yet, there does not seem to be huge traction on the life insurance side and, as such, WNS will be focusing on property & casualty (P&C) processes. An example of a recently on-boarded UW client is a U.S. P&C insurer who was seeking to reduce the number of UW assistants it would need to hire. The client expected to hire ~75 UW assistants, but since partnering with WNS, the expectation is now that it will be in a position to hire ~30% less than this, and a further ~20% additional capacity will be created. The client moved from pilot mode for this first line of business (personal auto) to full production in April 2016, and is set to add further lines of business to the scope, each one going through separate pilots.  

An example of cost saving achieved through applying the Blue Prism framework to a set of UW processes was with a client whose workforce operated in a predominantly virtual environment. The ‘before’ state saw work passing through ~40 handoffs, which WNS was able to bring down to 7, using workflow mapping. This alone has yielded ~35% savings for the client and has proved ‘transformational’ for the business.

In most cases, the conversations appear to be led by WNS. One of the key concerns raised by clients, however, is around what happens to staff allocation once RPA is deployed. Typically, staff are still very much required, but need re-training to make the most of the new systems and to ensure they operate effectively.

For now, WNS believes that sufficient savings and efficiencies can be gained through applying RPA to an insurance sub-process such as claims logging, which will provide the claims adjuster with a better summation of the situation and enable the handler to carry out the insurance process more effectively and accurately. For example, reducing the number of claims pages down from 50 to 10, and eventually to as little as 7 bullet points of actionable items.

Other similar areas in which WNS has successfully applied this type of RPA include medical review and transcription. However, WNS is of the view that there are some sub-processes that cannot be carried out by anything other than human effort, e.g. bodily injury; as it stands, WNS has not found a way to simulate the experience of the claims handler with RPA for this type of process.

Areas that are now progressed beyond pilot mode and are proving successful for WNS are:

• Vendor payment
• Subrogation (clients are almost all on transaction-based pricing)
• Claims logging
• FNOL (~60% of clients are on transaction-based pricing).

If we look at Q4 2015 revenue performance in Cognizant’s two largest vertical groups:

• Financial Services, was up 16.6% to $1,308m, with the strongest growth in insurance
• Healthcare (includes payer, pharma, biotech and medical devices) was up 23.2% y/y  to $952m, with the strongest growth in life sciences

These two vertical groups accounted for 70% of Cognizant’s total revenues in Q4, and for 74.5% ($366m) of the company’s overall y/y topline growth.

So why did Cognizant’s share price take a bit of a dive following these results, and furthermore drag down some other stocks with it, before showing some recovery on Friday?

The fact that sequential growth, at 1.4%, was below that reported by Accenture and Infosys may have had something to do with it. At NelsonHall we largely ignore sequential growth, as it ignores seasonality impacts, which may vary slightly from vendor to vendor, depending on their client base.

But the main concern was over Cognizant’s soft guidance for Q1 and full year 2016. Revenue guidance for:

• Q1 2016 is in the range of $3.18bn - $3.24bn, y/y growth in the range of 9.2% to 11.3%
• Full year 2016 is in the range of $13.65bn - $14.20bn, or growth in the range of 9.9% to 14.3%: the expectation is for back-ended growth.

In providing some color on guidance, management highlighted softness in both major vertical groups:

• Financial services, in banking more than insurance, where some of its banking clients are “taking a cautious approach”, putting some projects on hold
• Healthcare, where the major consolidation that is playing out in the payer industry means that some of its larger payer clients are delaying IT plans until their merger plans are clear.

In financial services Cognizant expects to see some level of growth, but given some current project delays in banking, says it is adopting a “wait and see” approach, and until then being conservative in its forecast

In contrast, in healthcare CEO Francisco D’Souza claims to be feeling “very, very good” about the pipeline of large deals Cognizant has for 2016, many of these leveraging TriZetto. The expectation is that healthcare will have a slow start in 2016, with strong growth from H2 and into 2017.

Indian financial and business media was more alarmed by Cognizant’s references to softness in the financial services industry. At one point D’Souza commented “our expectation is that we continue to grow faster than (the) industry… certainly others in the industry I think will probably have some of the same outcomes in financial services that we do”.

In a pointed response to this, TCS issued an investor alert on the Tuesday referring to its own performance in financial services in 2015, pointing out that revenues from the Banking and Financial Services industry vertical in CY 2015 grew by 15% in CC terms, compared with 13.5% CC growth for the company overall, and that, on an organic basis, TCS' CC revenue addition of $1.85bn in CY 15 was “the highest in the industry”. In an interview with India’s Economic Times, TCS CEO N Chandrasekaran claimed “we have not seen anything negative with any client” and that “for financial services as a whole, it is going to be an excellent year for us.”

So why does one major vendor call out softness in BFSI and another major vendor make such positive comments? Has one of them got it badly wrong? Well, clearly not: they are obviously talking to their clients! But a vendor can refer only to its own client base, and to the services they themselves are delivering to that client base. As an indicator of the differences this can mean, where TCS has been suffering headwinds in recent quarters in its insurance business because of its Diligenta BPO unit, for Cognizant, insurance has been the growth engine in its BFSI business recently.

Every vendor today is emphasizing its capabilities in various areas of digital - but it is in the discretionary spend of their clients’ budgets that some vendors are now feeling the pinch. Having a strong outsourcing business delivering recurring revenues is clearly advantageous – and we note that Cognizant’s outsourcing services businesses have been lagging its consulting and technology services businesses, delivering just 7.6% y/y growth this quarter.

This leads us to the other area of softness called out by Cognizant: its healthcare business, which includes payer, pharma, biotech and medical devices. Recent growth has been driven primarily by continued strength in life sciences (which we estimate accounts for about a third of its healthcare revenues) but it is the payer sector that Cognizant has placed its bets, looking to leverage TriZetto to build a BpaaS utility. Cognizant continues to highlight that it is in advanced stages of discussions for some very large deals, that current issues are related specifically to M&A activity, and that it expects some of these deals to close from the second half of this year. To an extent, the consolidation happening in the sector makes a platform-based BPO offering more attractive to buyers. But will Cognizant build a true utility with TriZetto? NelsonHall research shows that while healthcare payers may be amenable to a BpaaS model for some industry-specific activities, as in other sectors, appetite for a true utility service (i.e. a multi-tenant platform model) tends to be low.

Finally, the company continues to generate lots of cash, nearly $700m in Q4, and now has over $4.5bn in cash and equivalents. As well as share repurchase, we may well see further acquisition activity this year, which is, of course, one way of returning to “above industry average” topline growth. It is in the public domain that Cognizant has walked away from negotiations for Dell Services (essentially the former Perot Systems, which has a sizeable healthcare business) because of price. A few weeks ago, Cognizant announced its acquisition of KBACE Technologies; will we see another acquisition announcement in the next few months?

NelsonHall will be updating its Key Vendor Assessment of Cognizant in the next few weeks. This is the most comprehensive profile of Cognizant available on the market. For details, contact [email protected]

Capita states it believes the acquisition would:

• Position Capita as a leading provider of technology-enabled BPS
• Provide a stronger platform for Xchanging to accelerate sales growth and to develop its offerings
• Enable Capita to secure £35m+ in cost synergy benefits
• Be immediately earnings accretive.

Capita has been in discussions with Xchanging since early August regarding a possible offer, upping its initial 140p offer to its final 160p proposal on September 24 - which Xchanging’s board confirmed it would be willing to recommend on September 29 should Capita make a firm offer. Capita was granted due diligence access and had until 5pm on November 2 to make an announcenent.

There is another suitor, Apollo, with whom Xchanging has been having discussions about a potential 170p offer. Will this announcement push Apollo into making a counter offer? Xchanging's share price has surged since the news of the potential talks (over 165p at the time of writing, though still below its one-year peak).

Xchanging has been contending with a range of issues, and its global portfolio lacks coherence, partly a reflection of its heritage in a few large and diverse “Enterprise partnerships”. Xchanging is currently between CEOs, Ken Lever having announced his intention in July to step down at the end of the year, and new CEO Craig Wilson not yet started.

If Capita were to complete, this would be its largest ever acquisition, dwarfing its second largest, the £157m acquisition of avocis this February (though there have been a number of £50m+ acquisitions since 2011, helping Capita expand into new markets or extend its IT capabilities).  So why is Capita so interested?  

In recent years, Xchanging has repositioned and invested to emphasize its capabilities in “technology-enabled BPS”- exactly what Capita is emphasizing with its own various BPO offerings.  Also, the private sector is increasingly important to Capita (over 60% of its current pipeline is in commercial sectors) and Xchanging would increase its presence in the Lloyds market, where Capita already has a presence for specialist services.

Looking in more detail at Xchanging assets that would be attractive – or at least very relevant - to Capita:

1. Xuber software suite for the non-life commercial market: the biggest investment to date (a whopping $200m+ in total investments since 2011), both in platform development and in acquisitions: in 2014, Xchanging invested £75.6m in acquiring Total Objects, whose binder software is now integrated into the Xuber suite, and Agencyport Europe,extending its software into the health insurance sector, with software for international private medical insurance and exposure modeling (acquisition was delayed), plus a further £11.7m on development of Xuber. Xchanging has found converting interest in Xuber to sales more challenging than anticipated, particularly in the U.S. Will Capita’s greater commercial clout help? It would inherit sales teams from Xuber, Total Objects and Agencyport Europe that need integrating into a single unit to cross-sell, where relevant, the portfolio. Would Capita place the Xuber business in its newest operating division “Capita Digital and Software Solutions”, or would it place it in an insurance sector division?
2. The Xchanging Claims Services BPS unit : Capita is already active with a range of specialist services in the London insurance market: this capability would neatly expand its portfolio
3. Xchanging’s business in Germany, where it provides investment account administration BPS for Fondespot Bank, will also be of interest to Capita, who is building a presence in the DACH region, via an acquisition spree in the CMS BPS market, also via an insurance BPS contract with Zurich. The complex administration services in Germany that Xchanging would bring in to Capita would fit well in its Asset Services division
4. Procurement: Xchanging has been through a significant change of direction with its procurement services in recent years, to technology-led offerings, boosted by the acquisitions of MM4 (which was U.S centric) and Spikes Cavell Analytics Ltd (SCAL, which was U.K public sector centric). These offerings may find traction in the Capita client base
5. Expanded offshore IT services capabilities: in India, Xchanging has centers in Chennai and Pune, Bangalore, and tier 3 cities such as Shimoga (Karnataka).  It also has a center in Kuala Lumpur, Malaysia, most providing IT infrastructure services to YTL Communications, and a smaller ADM unit in Singapore (where Capita also has a small presence, targeting the reinsurance sector). There is also some offshore BPO activity in India and Malaysia. Capita may rationalize some of these sites, but would certainly be interested in the expanded offshore application services and BPO delivery capabilities
6. IT services: Xchanging has some networking capabilities, with a client base in the education and health sectors, as well as Lloyds – this would fit well into the Capita IT Enterprise Services division, which has grown through a series of acquisitions in recent years

And less attractive to Capita?

• The Australian operations, where Xchanging’s New South Wales Workers’ Compensation contract was not renewed, and where its procurement business has not really gained traction.
• The U.S. business: Capita’s international efforts are currently focused on Northern Europe. It would be a major change of strategy for Capita to start targeting the U.S., and its management will be highly aware of other service providers who have tried and failed to penetrate the U.S.

But overall, Xchanging’s portfolio is particularly well suited to Capita's business and where it is looking to develop over the next few years. And the cost synergies from the head office rationalization are also a particularly good match.  

We thus believe is highly unlikely that, even if there is a higher counter offer from Apollo, the Xchanging board will change it recommendation to shareholders: Capita presents a better option longer term. Howver, a counter offer from another IT services vendor might be more attractive.

NelsonHall has just published a comprehensive Key Vendor Assessment on Capita. We have also historically included Xchanging in the KVA program.

• Revenue was $4,817m, down 15.5% y/y, and down 10% in constant currency (CC), reflecting key account run off and weakness in EMEA
• Segment earnings before taxes (EBT) were $194m, a margin of 4.0%, up 143 bps y/y.

Q2 FY 2015 revenue by service line (with y/y revenue growth) was:

• IT Outsourcing $2,871m (-20.2%, -10% in CC)
• Applications and business services $1,946m (-7.6%, -2% in CC).

HP ES contributed 18% of HP Group revenue and 8% of Group EBT (up from 5% last quarter)

HP Group is nearing the completion of its 2012 restructuring plan. In Q2 FY 15, ~3.9k people exited HP making the total reduction to-date ~48k. The program has a total of 55k people expected to exit by the end of FY 2015, so a further 7k departures over the next two quarters.

HP has maintained full FY 2015 guidance for Enterprise Services of a revenue decline of between 4% and 6% on a constant currency basis, with an improvement in H2.

So where are the positives in HP ES' performance this quarter?

• A significant improvement in revenue performance in the Apps and Business Services segment, with a CC y/y decline of just 2%. This is led by the BPO business. And some geos are showing flat to slight CC growth
• Signings were up year over year, even without the $2bn Deutsche Bank deal closed at the beginning of the quarter (see our commentary here).
• And “Strategic Enterprise Services” signings continue to grow.... though no details are provided.

But the problems continue at  HP ES’ ITO business. It not only continues to be impacted from contract runoff from three large accounts continues, but is also being challenged by the evolution in the market. Meg Whitman refers to “risk in the longer term sustainability of this profit level if we don’t do further cost reductions”. As such, the current intention is to streamline HP ES and take up to $2bn of gross annualized costs out of the business over the next three years in pursuit of a longer term EBT margin target of 7% to 9%. The likely charge represents around 9% of HP ES overall revenues - and 14% of the revenues of the ITO business.

The restructuring actions in HP ES and in particular ITO will include initiatives such as further offshoring, data center automation, pyramid management… the same actions highlighted by CSC earlier this week.

Nevetheless, Whitman has made a clear statement of commitment to the future of HP ES: "the Services business in ES - (and the) -  TS Consulting businesses are  becoming more strategic to the future of Hewlett-Packard Enterprise…. “increasingly, services is becoming the tip of the spear”.

The acquisition will enhance Accenture’s digital capabilities in analytics, cloud and mobility for federal agencies. It also will add agile delivery expertise. Agilex brings in capabilities in agile software development for digital solutions. The company currently serves a number of federal departments and independent agencies, such as the VA, DoD, DHS, and Department of Commerce.  Commercial sector clients have included Amtrak.

Agilex was founded in 2007 by the late Robert La Rose (who had previously founded Advanced Technology Inc. and Integic, both of which were subsequently acquired), Jay Nussbaum (ex. Citibank and Oracle) and John Gall and quickly attracted senior talent to its leadership. The company offers services around

• Mobile applications for activities such as field inspection, emergency response management, performance dashboards, biometric identification, asset management, case management, personal productivity, etc.
• Healthcare IT - for example Agilex was involved in the deployment of the NHIN CONNECT Gateway. Also m-health - for example in May 2014 it was awarded a contract by the VA to develop and implement an enterprise web and mobile application image viewing solution
• CRM solutions.

Agilex has grown from 20 employees in 2007 to about 800 today. Nussbaum and Gall will leave when then acquisition closes, while the company’s leadership team will be integrated into AFS.

So why the acquisition? 

• AFS is already one of the largest U.S. federal systems integrators – this is about continuing to evolve its capabilities to be at the forefront of newer areas of demand; quite simply, Agilex brings in capabilities around digital technologies – and digital is clearly among the top priorities of the government sector
• And governments, not just in the U.S., are looking with much more interest in agile delivery as they move away from massive monolothic projects (for example, agile delivery has been a key element in the U.K. in the development of a new Universal Credit system for the DWP)

Accenture’s 2013 acquisition of ASM Research expanded its presence in the military healthcare market (DoD and VA) - and Accenture has worked alongside Agilex in projects at the VA. 

However, IBM is in the midst of a major adjustment of its portfolio. In line with this, the company is reporting $25bn in revenues (and 16% revenue growth) in 2014 (out of a total of $92.8bn) from its "strategic imperatives". IBM's acquisition of Softlayer, where it continues to invest strongly, appears to be delivering $3.5bn annual "as-a-service" run rate and IBM reports that its "Cloud" business had 2014 revenues of $7bn and 60% revenue growth (this includes hardware, software and services),

The revenue growth reported from IBM's other "strategic initiatives" were:

• Analytics +7% (2014 revenue approx $17Bn)
• Security +19%
• Mobile >200%.

Maintaining a high mix of software remains important to IBM but its strategy is now much more nuanced than the simplistic "software good" strategy the company sometimes appeared to adopt in earlier years, with the company rediscovering success in IT infrastructure management. Indeed IBM's acquisition of SoftLayer and its ongoing investment in Cloud infrastructure including in additional in-country SoftLayer data centers and cloud enablers such as security and its Bluemix cloud development platform is arguably having more impact on its signings than any of its investments outside Watson and analytics. In Q4, IBM's cloud infrastructure business moved way beyond the standard fare of IaaS contracts with start-ups to facilitating major infrastructure transformation contracts with values of a $1bn+ with the likes of Lufthansa and WPP.

Indeed, while the impact of SoftLayer was insufficient to lead to material growth in IBM's outsourcing revenues in Q4 2014, its impact is certain to be felt on outsourcing revenue growth  in 2015 as a result of these and additional major transformations to cloud infrastructure. Led by these deals, IBM's outsourcing signings transformed in Q4 2014, up 31% (in constant currency and adjusted for disposals). IBM now just needs its application management business, which is continuing to decline under competitive pressure, to undergo a similar transformation.

On May 9, the Texas Health and Human Services Commission (HHSC) announced that the state was terminating its Medicaid claims administration contract with the Texas Medicaid and Healthcare Partnership (TMHP), a coalition of contractors led by Xerox.  Cited for cause is that Xerox staff approved tens of thousands of prior-authorization (PA) requests for braces and other dental interventions for poor children that were not medically necessary.  Texas Medicaid payments for orthodontic services grew from $6.5m in 2003 to $220.5m in 2010 (over 3,300%), while enrollment over the same period grew by just 33%.

The termination was followed by moves to agree a contract with Accenture (the largest TMHP subcontractor under Xerox) to assume TMHP's role in processing claims until a bidding process could determine a new lead vendor.  The new contract has a three-year base period with two one-year extension options, with responsibility for processing over 12m claims per month.  NelsonHall estimates the base-period contract value at just over $500m.  Accenture has been involved as a subcontractor in the operation of the state's Medicaid claims payment system since 2004, when ACS started operations as prime contractor for fiscal agent services to the state.

In the re-bidding process, Texas is expected to divide the contracted work a few more ways across the vendor base to minimize the potential for disruption of Medicaid services, should additional conflicts surface in the future.  Specifically, the state is targeting the following services: collection and analysis of managed-care transactions, staffing call centers and collecting drug-manufacturer rebates.  All of these key services were previously provided by Xerox.

The damage to Xerox Services is substantial, in

• Revenues
• Its work to improve margins 
• Reputation: more grist for competitors HP and CSC as they contest the MMIS system build at New York State (though the two activities are essentially different: one about the  PA adjudication process, the other a new platform build)

This is the third quarter of improved topline growth. Management has raised revenue guidance for full FY 2014 to growth of 11.5-12% (up from prior guidance of 9-10%, and double the level of growth achieved in FY 2013). This would mean Infosys is getting back to Indian IT services market growth rates (NASSCOM predicted 12-14% for FY 2014).

So where has the growth come from this quarter? It is the last quarter of acquisitive growth from Lodestone (acquired Oct 2012) contributing 41% of the y/y growth (55% last quarter).  Infosys’ traditional areas of ADM (which underperformed for much of FY 2013) contributed a healthy 28% of the overall growth. This indicates the effectiveness of the recent drive at Infosys to go back to basics; its BITS businesses overall contributed 55% of the overall growth this quarter. Management commentary on client budgets emphasized their ongoing focus on initiatives cost optimization, is where Infosys BITS service lines play.

In terms of service lines, BFS and Manufacturing continue to be the growth engines. But Telecoms continues to be a major drag (down an estimated 9.6% y/y): it has declined from contributing 12.9% of revenue in FY 2011 to 7.9% this quarter.

The revised FY 2014 revenue guidance implies anticipated y/y growth in Q4 of between 8 and 9.9%, thus H2 overall will deliver slower growth than was achieved in H1. Accenture also saw a slowdown in its quarter ended November 30: the indications from these two bellwethers are of slower revenue growth in Q4 CY 2013: we shall know more next week when more results are published.

The operating margin of 25.0% is up 322 bps sequentially (up 150 bps excluding the one-time visa provision last quarter). Infosys has been stripping out costs by offshoring both billable (where relevant, depending on service type) and non-billable roles (notably in marketing: sales & marketing expense is 5.0% of revenue, down from 5.8% last quarter, with management referring to increased investment in sales). Narayanan Murthy commented on ensuring that “all jobs that can be done in lower cost locations are done in lower cost locations”. Increased pricing also contribute to the sequential margin improvement. Nevertheless, this is the sixth consecutive quarter when operating margin is down y/y.

Another factor contributing to the sequential improvement in margin is the 1.1% q/q decline in headcount (the last time this happened was four and a half years ago, in the June 2009 quarter), or 1,823 employees.

Infosys has been looking to get utilization up to its 78% to 82% target range, but it has again declined sequentially to 76.9% (from 77.5% last quarter).

Attrition continues to increase, to 18.1%; this may be part of the drive to weed out underperformers, but is also possibly indicates a trend in employee morale, in spite of the wage hikes from July 2013. There has been a string of departures of senior execs in the last six months (since the return of N.R. Narayana Murthy) and this is likely to have caused some short-term disruption.

As part of a reshuffle at the top, B. G. Srinivas and Pravin Rao have been appointed as Presidents, with B. G. Srinivas focusing on global markets and Pravin Rao focusing on global delivery and service innovation, on top of their existing portfolios. These are clearly the two front runners for the next CEO after S D Shibulal retires in May next year, unless Infosys elects to go for an external hire. One indication of the level of rethinking that is going on at Infosys is that just a couple of months ago it significantly expanded its Executive Council. That same Council is being disbanded from April 1 with the two new Presidents being given responsibility to put in place “appropriate governance sectors for their respective areas”. Historically, Infosys was a company where any major changes tended to focus on its long-term vision and were planned in detail beforehand; today it appears to be focusing on shorter term imperatives.

Infosys continues to enjoy a very strong balance sheet, ending the quarter with $4,236m in cash, up from $4,130m in the prior quarter.

Looking ahead, management shared its outlook for FY 2015 client IT spending; the tone was cautious, referring to “a mixed bag” across segments.

So what should we expect from Infosys in FY 2015? The company is clearly making progress on getting back to basics with its BITS offerings and it continues to enjoy the boost from the Lodestone operation; next quarter will indicate whether Lodestone is helping drive organic growth in its consulting business. It is still too early to tell whether the newer PPS offerings, on which Infosys places so much store, will pick up steam this year and begin to approach, even outstrip overall company growth. PPS businesses currently contribute 5.3% of company revenue, down from 7.1% back in FY 2012. PPS is key to Infosys' long-term vision, but two years on it is hardly a success story. Indian media is speculating on setting up a separate subsidiary for PPS; we would expect to see some inorganic growth in the next year. Meanwhile, there are several new key roles still to be appointed including a global Head of Sales. Infosys is looking in a better shape now than it was three quarters ago but it going through an unsettling period.

NelsonHall will be publishing an updated comprehensive Key Vendor Assessment of Infosys within the next few days. For details, contact [email protected]

Looking firstly at the HP group-wide picture, turnaround measures till now have included restructuring, retooling, and reducing costs.  Successes so far include:

• Outlook given during the Q3 earnings call is above the midpoint of the full-year outlook that the company announced at the 2012 Securities Analyst Meeting
• Cashflow was $7bn during the first three quarters of fiscal year 2013, ahead of guidance for the full year
• In Q3 cash conversion cycles have been reduced to just 18 days, lower than initial target of 24-26 days
• Operating net debt, excluding the debt associated with the financing business, was lower by $8bn
• HP is on target with its restructuring plan to get costs in line with its revenue trajectory; to reduced run rate of labor costs by >$3bn in 2014
• Reduced costs and during the first three quarters of fiscal 2013, an operating margin at the high end of the outlook given last year.

At HP Enterprise Services (HP ES), the program so far has resulted in:

• The elimination of red or underperforming accounts: this is almost complete
• Headcount reduction:  average headcount in the first three quarters of 2013 is down by 9% versus a revenue erosion of < 7% in constant currency
• Growth in the “new style of IT” business: HP ES is focusing on growing its “new style of IT” services business which largely includes cloud, mobile and big data. It estimates that the total addressable market is $131bn and growing, compared with the traditional IT services segment which is $410bn and declining. HP ES claims “new style” currently represents about 7% of overall signings. It sees plenty of opportunity for growth in the “new style of IT” which it expects to grow to represent ~25% of the market in 2016, at about $179bn
• Focusing on transitioning clients to the new-style of IT has helped with increasing renewal rate to > 90% in FY13.

The turnaround program is now in full swing, and the initial steps to rebuild the company have already started to deliver results.

HP ES has also started to extend the scope of its strategic measures in its multi-year turnaround program to include:

• Flattening the labor pyramid, in terms of both skill sets and locations: currently HP ES is weighted towards high-cost location with over-skilled personnel in relation to their duties. In future it will take more advantage of its  global delivery centers including those in Bangalore, Manila, Sofia, and Costa Rica
• Focus on getting better at taking contracts away from competitors: in FY 2013, ~ 4% of HP ES’ sales force has been deployed on proactive new logo wins. In FY 2014, this is going to increase to 29%, with a clear focus on new business and selling the new style of IT
• Build-up HP ES’ advisory offerings, to put itself in a stronger position to shape the transformation activity that comes from advisory work
• Build client road maps in every area to help clients go from the traditional to the “new style of IT” e.g. for workforce or workplace mobility with the addition of advanced analytics and integrating multiple devices with enterprise applications.

Each of these measures is a logical evolution, given HP ES capabilities and broader market dynamics.

Building its advisory services is key for HP ES to shape the transformation programs that it undertakes for its clients. This will enable HP ES to expand its customer interactions well beyond CIOs, to include heads of business units that are becoming increasingly influential in IT decision-making and who want agility and speed to market. HP ES’ cloud capabilities are already a good fit to this changing market. The advisory and transformation services should dovetail into them and so substantiating HP ES' mantra of advise, transform and manage.

The roadmaps for transformation to the new style of IT make up a strong addition to the portfolio. We expect to see more such offerings in the future, more focused on verticals. These will also increase HP ES’ ability to interact with the new IT decision-influencers.

HP ES is increasingly facing direct competition from Indian-centric vendors, e.g. it recently lost a major IT infrastructure outsourcing contract at Anglo American to HCL. HP ES needs to pull all the cost levers that it can and so it is increasing delivery from off-shore and lowering cost of transformation for its clients with pre-built road-maps. Increasing its portfolio of vertical offerings can help reduce costs further.

Costs continue to dominate ITO decisions and in the IaaS market in particular, where companies such as Amazon have established a strong presence. While HP has always competed on the added value enterprise ticket, this might not stand the test of time and an acquisition or two may be necessary.

Overall, HP ES is completely on track. It is quietly reinventing itself within its turnaround program and should not be underestimated.

Related article: HP Updates Analysts on Its Turnaround Strategy: Revitalization of HP Enterprise Services.

It is not possible to determine the precise level of organic growth (excluding Lodestone) as Infosys is folding some of its consulting capabilities into Lodestone Consulting: this has happened already in the U.K. and is occurring now in the U.S. and Germany; the incremental $20m in revenue contributed by Lodestone this quarter ($90m, up from $70m last quarter) also includes a benefit from a change in accounting policy for revenue recognition. Nevertheless, we estimate organic revenue growth is around 9%, making it Infosys’ best quarter since Q4 FY 2012. Infosys management referred on several occasions to being ‘cautiously optimistic’ for FY 2014, though maintaining the 6% to 10% revenue growth guidance. We expect this guidance to be refined slightly by end fiscal H1

Looking at some of the service lines:

• Both applications development and application management have had their best quarter of topline growth for a year, though still far short of the double digit growth that Infosys used to enjoy
• Testing and infrastructure services continue to see double digit growth but at 15% of group revenue are not the growth engines, accounting for just 20% of the y/y growth this quarter
• Over 60% of the growth was from consulting and systems integration, mainly due to Lodestone, though revenues are also starting to come through from the 12 month $49.5m contract to build a health exchange for the District of Columbia. Management incidentally commented that there is likely to be less opportunity than it had anticipated for similar work to support other states’ health exchanges because of states opting for the federal exchange
• It is pleasing to see BPO back to growth; last quarter’s negative growth appears to have been a blip.

In terms of geographies, the U.S. continues to outperform Europe, which, excluding Lodestone, is achieving minimal y/y growth (we estimate under 2%) and was down 3% sequentially. This is attributed to being a consequence of some projects coming to an end, though clearly bookings to replace these fell short. Lodestone will clearly bring revenue synergy opportunities to Infosys and should ultimately boost the European business in those countries in which it operates. In the U.K., where Lodestone does not have a presence, and where Infosys has folded its consulting business into Lodestone, it will take longer for this type of benefit to be seen. The recent (from May 1) 8% wage hike for the global sales force was an important boost: when Infosys recruits a new global head of sales, it will be interesting to see what the geographic priorities are.

Management highlighted both some of the uncertainties, e.g. currency volatility, that led to the decision not to provide margin guidance, also the various levers being applied to offset impacts such as wage rises, price sensitivity in rebids, costs in the ramp up stages of large outsourcing deals, and also to drive margin growth. Key among these is improving utilization to the 78% to 82% target range, which Infosys seems confident of achieving.  Slightly less was made by management of improving productivity through increased automation and reuse, though Infosys is working on this in its BITS service lines.

TTM attrition is the highest it has been for over two years; presumably the wage hikes from July 1 will go some way to address this.