Atos has made an unsolicited offer for security, SIM cards, and payment cards technology vendor Gemalto. The offer is sizeable at €4.3bn (plus Gemalto’s net debt of €938m at end of H1 2017) financed in cash. It runs until December 15.

Gemalto is another major acquisition for Atos: in its fiscal year ended June 30, 2017, Gemalto generated revenues of ~€3bn, with an EBITDA margin of 17.1%. If the acquisition goes through, Atos and Gemalto will have combined revenues of €15bn, and an operating margin of around 10%; Atos would thus achieve the double-digit margin it has been targeting for years. NelsonHall has published further details of the proposed transaction in its Daily Tracking Service.

Perfect timing by Atos

Gemalto has issued several profit warnings this year related to its Payment and SIM card businesses, which last year represented 51% of its total revenues.

SIM cards are on a secular decline with the stagnation of mobile devices, and delayed investment by telecom service providers in newer SIM technology. The decline in SIM cards revenues accelerated in H1 2017 with a ~16% decline, where Gemalto was only expecting a 5% decline. Atos has stated it will launch a strategic review of the business, if it completes the acquisition.

Growth in its Payment business (smart cards used for payment cards, and related software and services, and mobile payments) in the past had been driven by the late migration of U.S. banks to the EMV standard. After a flat year in 2016 due to market saturation in the U.S., Payment revenues are down, by an estimated 16% in CC in 2017 YTD. Atos highlights that market conditions remain favorable in the mid-term with large geographies such as India still transitioning from a cash economy to electronic payments.

Gemalto has been investing in developing its cybersecurity portfolio, acquiring SafeNet in 2015 and 3M Cogent in 2017, and its M2M business (connected devices, tokens, and related software and security) saw double digit growth in Q2 and Q3 after a flat Q1. Some of its security solutions are experiencing difficulties (notably the Authentication business is transitioning from hardware to software), while others such Data Encryption are doing well. Other units are in different dynamics: Government security and identity is doing well while the Enterprise unit is challenged.

Following several profit warnings, Gemalto’s share value has been at its lower levels since 2011, in the €30-€32 range in the past month. Investors are moving away from Gemalto, not even encouraged by the reaffirmation of the full-year 2017 guidance. There is certainly an opportunistic element in Atos’ unsolicited offer: a 42% premium at €46 a share. This is not as generous as it may seem, as Gemalto’s share was trading at this level only a few months ago, in September.

Breton has also got the backing of state-owned investment bank bpiFrance, which owns a 8.3% stake in Gemalto.

And of course there will be TLCF benefits for Atos in France.

What does this mean for the Atos portfolio?

Currently, Atos has three main hardware and software businesses:

• Its Big Data and Security (BDS) business includes a variety of assets, including specialized servers, supercomputers/HPC, security software, command and control systems. BDS is doing very well and is expected to grow by at least 12% per annum. 2017 revenues will approach €700m
• Its Unify communication hardware and software business that it is currently restructuring and transitioning to cloud software. Unify overall is a €1bn business and is now trending towards revenue stabilization
• Worldline in the payment software and services business, with revenues of ~€1.5bn, and aiming for organic revenue growth to reach 6%-8% by 2019.

Then comes the philosophical question: does it make sense for Atos to further expand into software and hardware? If it acquires Gemalto, Atos would add another €3bn in revenues from a variety of software and hardware assets that would represent overall ~40% of the group’s revenues. Is Atos is spreading itself too thinly across over an extensive portfolio of IT services, hardware (from quantum computing to specialized phones) and software? 

And what are the implications for Worldline? Gemalto has software payment security capabilities that Worldline would be able to use for its payment services - and Worldline has been very open about its ambitions to be the European payment services consolidator.

Outside of payments, how complementary is Gemalto's security portfolio to Atos? And will Atos be able to find a potential buyer for Gemalto’s SIM card business?

Atos' profile is increasingly moving away from building a consistent IT services and payment portfolio to becoming a hardware-plus-services & solutions firm. While this may appear to be contrary to what has been the prevailing trend, Atos has demonstrable expertise in identifying promising targets at a competitive price, subsequently integrating and restructuring problematic businesses at pace, then driving profitable growth from the acquired capabilities.  When Atos acquired Bull, for example, Bull was a €1.1bn firm spread thinly across servers, HPC, software, and IT services; the technology part of Bull now lies in BDS, which has become a high growth and highly profitable business. However, Unify, in particular the S&P business, which Atos had been treating as a discontinued operation, is still a work-in-progress.

Gemalto would bring a new and different set of challenges for Atos and its approach to addressing these is not yet clear. However, on balance, Gemalto brings in a set of capabilities that could prove very useful to different parts of the Atos Group.

NelsonHall has just published a comprehensive Key Vendor Assessment on Atos which looks at both Atos (excluding its hardware businesses) and Worldline. For details, please contact Guy Saunders. 

Financial objectives for the 2013-2017 period include:

• Revenue growth of 5% to 7% (2013-2017 CAGR) all organic (2012 revenues €1,066m, +5%; 2013 estimate +5%)
• At least a 200 bps increase in its operating margin (before depreciation and amortization) by 2016 (to ~20.0%), from 2013 (2012: 17.2%; 2013 estimate ~18.0%).

Organic revenue will come from:

• Growth in payment volume counterbalanced by pricing pressure
• Clients investing in their payment and digital software, as a result of
  - Regulatory changes such as SEPA 
  - Consumer behavior changes e.g. mobile payment and wallets; "drive" in the retail industry; 
  - Changes in the market: M2M or value-add services: card analytics, fraud management
• Internationalization of Worldline e.g.
  - Expanding the service offering in Germany from merchant issuing and Belgium from acquiring
  - Rolling out in new geographies either directly or through partnerships.

The margin improvement will come from revenue growth, and Worldline implementing its TEAM program (consolidate datacenters, delivery centers creation and consolidation, application consolidation). The intent of TEAM is to maintain costs under control while revenues grow.

Worldline is structured into three global service lines:

• Merchant services and terminals (H1 2013 revenues €178m; +3.7% organic growth, 18.3% adjusted operating margin)
• Financial processing services and software licensing (€189m; +2.8%; 18.5%)
• Mobility and etransaction services (€182m; +10£; 11.4%).

Its intent is to roll out each service line in all geographies. The company believes that with the integration of several SIS units and its past growth, it now has large enough service lines to grow organically while covering SG&A costs.

Geographical priorities are:

• Latin America: where Wordline is present mostly in Chile and Argentina in Mobility and etransaction services
• APAC: China and Hong-Kong, Taiwan, Singapore, Malaysia, Indonesia and India: Financial processing services and software licensing
• Europe: France, BeLux, Germany, U.K. and Spain.

In addition Atos is to provide an additional entry point to 25 other countries where Worldline is not present. The company is also looking at addressing larger clients, especially in the Financial processing business to 69 large accounts.

In detail, the action plans are:

• Merchant services and terminals
  - Doubling indirect channel network
  - Expanding offering by introducing two new vertical offerings per year. Areas of focus include mobile payment and mobile commerce for e.g. movie theaters. The unit want to achieve 10% of revenues from mobile transactions in the next 2 years
  - Driving value-added services e.g. an instant survey on a payment terminal
• Financial processing services and software licensing
  - Consolidating application platforms
  - Introducing two to three new offerings per year
  - Consolidating presence from Germany, France and Belgium into U.K., Austria, and then expanding to Latin America, Asia, Northern Europe and Eastern Europe (Poland)
• Mobility and etransaction services:
  - Investing in mobility and big data offerings and around security and privacy
  - Introducing in each country a more segmented service approach
  - Focusing on connected living services e.g. rail: journey planing, payment and ticket fulfillment, within 2 years (and double revenues).

Worldline and Atos management expressed strong confidence in the future of Worldline, and highlighted its size now permits a service line approach to the geographies in which it operates, in a profitable manner. The carve-out of Worldline will also bring flexibility and timeliness for inorganic moves as well as for any partnerships. Acquisitions is a clear priority. Worldline's targeted growth over the next three years means revenue of ~€1.36 - €1.47bn in 2017. Given the scale of Atos, higher growth in Worldine will not have a major impact on the revenue growth of Atos overall.

Worldline currently comprises a set of country operations with very different businesses; there is a lot to do before Worldline is able to go to market with a broadly similar portfolio in its core geographies, let alone achieve its ambitions for global expansion.

Ultimately, the IPO is about giving financial power to Worldline. NETS, the second largest payment services in Europe is reported to be on sale for an amount ranging from €1bn-€2bn. NETS had 2012 revenues of ~€800m and a net profitability of ~€92m. This gives an idea of the market capitalization of Worldline.

Dominique Raviart and Rachael Stormonth