ER&D vendor Altran yesterday announced the acquisition of India-centric Silicon Valley-headquartered Aricent. Altran will be paying $2.0bn for Aricent through a capital increase of €0.75bn, the remaining ~€1bn in debt.

In the year ending June 30, 2017, Aricent had revenues of $687m and an EBITDA margin of 27.9%.

This is a significant acquisition for Altran, strengthening its position as the largest ER&D vendor globally. The combined company will have revenues of ~$3.1bn, and 44k employees, including ~12k in India. Altran, which already was the largest ER&D vendor in Europe, is now also a major player in North America, with revenues not far from those of HCL Technologies.

With this move, Altran will achieve several of its strategic ambitions: by 2020 to reach €3bn in revenues, an adjusted EBIT margin of 13%, and a global delivery network of over 10k.

As well as adding scale in North America, Aricent will also strengthen or fill Altran portfolio gaps in several key areas:

• Strengthening its capabilities in the telecom industry and in semi-conductors
• Bringing in expertise in software product development, internet technology development, and UX design (though the Frog subsidiary).

This is a highly complementary and strategic transaction. So why hasn’t the market’s initial response been warmer? Altran’s share price fell by 6% on the day of the announcement.

High Debt Level and Capital Increase

Much of the negative reaction relates to the capital increase (€0.7bn) vis-à-vis Altran’s market cap (~€2.4bn), and its increased debt (€1.3bn after the capital increase). Altran’s CEO has stressed that the target is to reduce its debt level from a leverage of 3.25 down to 2.5 within two years. The debt level will be high, but this is in the context of lowest interest rates ever.

What about Germany?

One likely impact of acquiring Aricent is that Altran is now unlikely to reach another objective, of deriving €500m in revenues by 2020 from Germany; this was also a key priority, along with the U.S. We estimate that in 2017, Altran will have revenues of €270m in its Germany/Austria business unit, half-way to its objective.

Does this matter? Well, yes; Germany is by far the largest ER&D service market in Europe, with half of its spending done by the automotive sector. While the German automotive ER&D market has been a difficult one in the past two years, resulting from changes in legislations, the reduction by Volkswagen Group (the largest spender in Europe) of its R&D spending, and price pressure, it remains a strategic country to be in for ER&D services vendors.

How Healthy is Aricent?

Altran management has not provided an indication of recent organic growth at Aricent, highlighting instead the rapid change in Aricent’s portfolio, which until the early 2010s had been very telecom-centric and had suffered from anemic spending in the sector.

Aricent has been through a reinvention, closing small geographies, and expanding its client base, from telecom equipment manufacturers to telecom service providers, and then semi-conductors (in chip design, through the $180m SmartPlay acquisition), and to automotive, relying initially on its network/connectivity expertise. In 2015, Aricent also expanded to software product/internet technology development.

Despite this reinvention, Aricent still derives 54% of its revenues from the telecoms sector. Semi-conductor/industrial has become significant (19% of revenues), Frog/UX design (16%), and product/technology development (11%) is a rising segment.

We note that Aricent has an IP partnership with an unnamed ISV: while IBM has not been announced as a partner, the structure of the deal is similar to the HCL Tech and Tech Mahindra IP partnerships, with Aricent acquiring $250m in software assets over four years, and already having a flow of revenues of ~$50m in LTM. We assume this flow represents software development fees from IBM.

Overall, a Bold Move

In short, this is a highly complementary and strategic acquisition. It does leave Altran exposed to financial stress, should market conditions deteriorate. And indeed there is some uncertainty in the automotive sector in the U.S., and in France around the key PSA account. But Aricent is not a major player in the U.S. automotive market.

Well done Altran for this incredibly bold move!

DXC Technology recently held an analyst day in the U.K., its first since being ‘born’ on April 1. It is still early days for this young organization and the integration continues (though there was little mention of this at the event). In its recent investor calls, DXC Technology has emphasized actions to strip out costs, apply financial discipline, and invest in next gen offerings, around digital and Industry Solutions and BPS.

Focus on Smaller Transactions…

It is evident that CEO Mike Lawrie is continuing the strategy he adopted at CSC with DXC. DXC has a different positioning than its legacy might suggest, having come from three of the four largest IT outsourcing firms (CSC, EDS, HPE ES) headquartered in the U.S. DXC does not consider itself to be a large IT outsourcing specialist, focusing instead on small to mid-sized contracts, cross-selling, and winning new logos, rather than being large transaction-based. This is the journey that CSC had been following in recent years.

To accompany this commercial emphasis on smaller transactions, DXC has transitioned its sales structure towards more technical sales. To this effect, DXC has adopted a two-in-a-box structure, with account managers complemented by a technical sales force aligned by service offerings. DXC is investing in online training for its account managers, targeting annual certifications, focusing on mastering the service portfolio, and also in taking a more consulting-led approach, taking a “client challenge”-centric view.

… and on Next Gen Services

Another priority for Lawrie during his tenure as CEO of CSC was building the portfolio of “next gen” offerings, and the transition towards more packaged and more repeatable services. This journey clearly continues with DXC.

DXC has reduced its service portfolio and number of offerings to under 100. In the past few months, DXC has unveiled several packaged offerings, including its series of 40 QuickStarts. DXC wants to maintain this level of discipline about its service portfolio: as the CEO of DXC in the UKI region pointed out, "if we need to create new offerings within each service line, we will have to carefully review the existing ones, and decommission a few".

Along with the streamlining and refresh of its service portfolio, DXC continues to work on increasing global delivery, and making it more industrialized, including applying RPA, AI and analytics. In its Workplace and Mobility unit, DXC is taking a systematic approach in identifying where its differentiation lies for each of the offerings, and is filing patents.

The next gen focus is taking a continuous improvement approach with the portfolio: once it has provided a similar solution/service to five to ten clients, the drive is to move to an industrialized delivery and packaged offering, making use of Indian delivery and its CoE approach.

Acquiring for Digital Capabilities

As part of its portfolio refresh, DXC has added two fast-growing service lines, Analytics, and Security, to the much larger Cloud, Platforms and ITO (CIP), Workplace and Mobility (WM); and Application Services (AS) units. The challenge with these units appears to be finding resources to meet market demand. Both Analytics and Security have a scale of 4k-5k personnel (NelsonHall estimate). NelsonHall will be publishing an analysis of DXC Analytics soon.

M&A is clearly part of the strategy, again continuing what CSC has been doing to jump start its Enterprise Cloud Applications, largely around Microsoft Dynamics (UXC Eclipse, eBECS, Tribridge) and ServiceNow (UXC, Aspediens, Fruition, and last week Logicalis SMC).

It is very clear that DXC is a very pragmatic firm. Do not expect big announcements about 'state of the art' offerings, or new business models. DXC is focusing on continuous improvement and on applying proven techniques to increase shareholder value, rather than seeking to reinvent the model. The approach Lawrie took at CSC continues at DXC. The latest example: this week, DXC announced the divestiture of its U.S. government services arm in a move that replicated the spin-off by CSC of its NPS organization two years ago. Rachael Stormonth published an analysis of this transaction here.

The acquisition gave Pininfarina an enterprise value of €92m (including €50m in net debt). So why did Tech Mahindra wanted to expand into design and styling services? What are the synergies between style and design services and IES? Why did Tech Mahindra pay such a high price? And how will it turn around Pininfarina? From our conversations with Tech Mahindra, we gathered the following.

1. This acquisition is about gaining further scale in automotive and strengthening relationships with automotive OEMs in Europe. Tech Mahindra had been looking for three years to make an acquisition in the key market of Germany. The acquisition is about being able to cross-sell IES to the client base of Pininfarina
2. Automotive is a strategic sector for Tech Mahindra: manufacturing is its second largest vertical after telecom and it has 25 automotive clients. It derives one third of its manufacturing sector revenues from IES, with automotive accounting for a third of its IES revenues
3. Pininfarina is likely to return to profitability: its lack of profitability in the past eight years is partly a reflection of its small series vehicle manufacturing, now discontinued and the resulting spare parts business (predicted to end by 2020). In addition, Tech Mahindra wants to grow Pininfarina by taking it into new geographies, China being a priority, also India and eventually Russia and Brazil. Tech Mahindra will also help drive the client base expansion that Pininfarina had initiated to the train equipment and luxury boats industries (currently involving 100 personnel)
4. Pininfarina provides more than style and design services. The company already derives ~60% of its service revenues from IES, servicing German clients (30% of service revenue) and, to a lower extent, Italian automotive OEMs (20%)
5. Pininfarina’s style and design capabilities will remain local and onshore but are a niche area: Tech Mahindra estimates that spending on style and design services account for 15% of spending in services related to new vehicle programs and 5% of existing program refreshes. IES accounts for the remaining 85% and 95% spending (respectively for new and existing programs). Tech Mahindra will maintain local onshore teams but believes there is vast room for expansion for Indian delivery
6. Within IES, Pininfarina brings in capabilities around vehicle body and power train, as well as interior design. This complements the capabilities of Tech Mahindra to the automotive sector, which include:

• Vehicle Engineering and Vehicle Electronics
• Connected Vehicle solutions and services around ADAS, Infotainment, etc.
• Software engineering, embedded systems including infotainment
• New IT-based offerings such as IT systems for car sharing schemes, and IoT (e.g. electric cars services, identifying parking spaces available).

Overall, Tech Mahindra was reassuring on the Pininfarina acquisition. Several question marks remain (pricing and structure of the deal with a double governance from Tech Mahindra and Mahindra & Mahindra). Yet, the deal highlights Tech Mahindra’s continued expansion in the key automotive sector for its IES activities, for its design and styling services to engineering capabilities, and a more comprehensive delivery model now expanded to Italy and Germany.

It may also come as a surprise to BPS professionals that the software testing industry has already massively invested in task automation, and created a high number of IPs and accelerators. This is such a significant trend in ST that one large IT service firm now says it has ~70,000 testing reusable artifacts.

So perhaps ST has experience to share with BPS? What can we learn?

1. Automation starts small: the holy grail of the BPS industry may be the automation of a whole process but before achieving full process automation, clients can benefit from limited scope and still cut times on repetitive tasks
2. Process improvement is not just about implementing best practices; it goes towards implementing business process modeling i.e. capturing business processes in diagrams. Those diagrams, running on specific modeling applications, are a starting point for automating processes, helping in identifying pockets of manual activities and prioritizing the roll out of IPs and accelerators
3. One area where the ST industry is investing massively is around the dev-to-test-and-roll-out-into-production process known as DevOps. DevOps poses many challenges to the ST community, with its reliance on many different software tools, whether COTS, IPs or open source software. There is another element to this complexity: the traditional alliances with major ISVs are no longer sufficient and the ST industry has had to drive partnerships with much smaller ISVs than in the past, including tech start-ups: something unthinkable five years ago. Some of the innovative vendors have made bets on technology vendors and pre-integrated heterogeneous sets of tools and IPs. The good news is that clients seem ready to accept such pre-integrated DevOps platforms
4. Most automation IPs and accelerators created by the ST industry are free-of-charge to their clients and are meant to drive service differentiation
5. Client organizations do not look overwhelmingly concerned about potential technology lock-up. Credit to ST vendors that have avoided lock-ups and systematically provided integration with major COTS and open sources tools in the market
6. Machine learning, cognitive intelligence (CI) and even AI are also on the roadmap but evidence of current usage is scant. There is some rebranding of agent software sitting on a server or a desktop and collecting data over time to drive dynamically analytics as machine learning.

All in all, we think software testing provides a good number of insights and direction to the BPS industry.

Final observation: has the software industry in spite of its investment in automation become non-linear? Not yet - but this may change with mainstream adoption of DevOps.

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.

Digital Transformation

Cognizant has created Digital Works to focus and grow its digital services. The practice has taken several personnel from Cognizant Business Consulting (CBC), and also from the relevant delivery organizations in mobile, web sites, social, analytics and Cognizant Cloud. The involvement of CBC in particular has helped filling a gap in the company’s traditional digital offering from the execution layer to business and technology consulting. Meanwhile, Cognizant is being selective on its digital offerings approach in terms of verticals and focusing on its traditional sectors: financial services, U.S. healthcare, and worldwide life science. Expanding its focus from short-point execution services to a more consultative approach is a priority (see below comment on CBC) to understand the business intents of the client, and also provide more back-end system integration. Like a number of peers, Cognizant is finding that most projects tend to be small in scope and small in TCV (although the company mentioned several large digital programs): differentiation from digital agencies will come from consulting and IT capabilities. Also, small independent digital agencies have a cost structure that Cognizant needs to have for digital projects such as mobile apps.

In digital in particular, Cognizant is promoting its “Fail Fast” approach, something it has learnt from its Horizon 3 initiatives. The basic concept is simple, in digital as in Horizon 3, accepting lack of success in several offerings and quickly moving on to a different offering. In order to accept failure, clients need however to limit spending and go through short development times.

Tuck-in acquisitions are also part of the strategy: three recent ones were itaas (digital video engineering), Cadient (digital marketing agency servicing pharmaceutical firms in the U.S.) and Odecee in Australia (mobility).

Market Expansion

Expansion into new geographies and new verticals is also a priority. Cognizant has mostly focused on expanding in APAC and highlights development  in its delivery networks (e.g. 1k personnel in its Singapore and 4k in the Philippines) as well as presence in China, Malaysia ANZ, Japan and India. The company is also increasing its sales focus in those countries: Cognizant referred several times to a contract with Narayana Health in India (a mobile app project to increase productivity of nurses and doctors), and a recent similar in an hospital in the Cayman Islands.

Cognizant is developing its public or para-public sector business, largely to date in the U.K. and in the U.S. Client references included Network Rail and Financial Conduct Authority in the U.K. Clearly, adoption, at least in the U.K. of Indian offshore by public sector has been increasing in past years and Cognizant is also taking its share of success.

New Business Models

Non-linear growth was also on the agenda, relying on Cognizant’s largest vertical, healthcare and life science. Several examples were explicated. First and foremost, Cognizant’s 7-year $2.7bn contract with Health Net Inc. in the U.S. The company has acquired a set of applications created by Health Net around member enrollment, compliance and regulation and other back-office feature. Pricing will be outcome-based (i.e. per member and per month). Cognizant is then planning to sell a service based on a productized set of applications. Another example is the 2014 TriZetto acquisition. On the payer-side, Cognizant wants to develop a platform based service, whether IT service or BPS targeting U.S. SMBs. Of course non-linear model remains a journey for Cognizant with client adoption for TriZetto BPO services likely to take several years.

Another interesting development is TransCelerate, a shared multi-tenant SaaS project for the pharmaceutical industry on drug investigation processes and reporting to the U.S. FDA. TransCelerate already has several big names in the industry as members (AstraZeneca, Bristol-Myers Squibb, Eli Lilly and Company, GlaxoSmithKline, Johnson & Johnson, Pfizer, the Roche Group, and Sanofi). The regulator, the FDA, seems to be in favor of TransCelerate as it may simplify its activities for drug reporting purpose. Again, TransCelerate is part of a journey.

Several years ago, Gordon Coburn stated in a discussion with NelsonHall that one of Cognizant's main objectives was to avoid becoming complacent, in spite of its huge success. The investments in TriZetto and Health Net are bold, both in terms of size, but even more in terms of their long-term return on investment. It is also interesting to note the co-existence within Horizon Three of digital, largely short-term small-scale contracts with new business models, probably as part of an effort to mitigate risk.

Meanwhile, Cognizant continues to invest in its other services lines, whether Horizon Two (BPS, the recently-renamed Cognizant Infrastructure Services (CIS), and CBC) or One (AD, application management and software testing, as well COTS systems integration). Horizon Two offerings have gained scale: BPS now has a headcount of 28k, CIS: 27k, and CBC: 5k). CIS has realigned its service portfolio and repackaged it by business objective e.g. digital IT infrastructure in order to make the offering less of a technical discussion and make it more relevant to business needs. The story is largely repackaging of existing service portfolio and remains a journey, we think. Meanwhile, CBC, with its 3k personnel across U.S. and Europe, is increasing its share of Indian national consultants to develop its presence in Continental Europe.

Finally, within the traditional Horizon One services, Cognizant continues to invest in its testing/QA service portfolio (now 28k personnel, located in various delivery organizations), also application management (“application value management”), around its service portfolio development and automation. Cognizant has expanded from its service catalog approach and is developing IPs, and domain knowledge in testing, and promoting business process-led AM (BLAs in terms of Cognizant). The company is clearly taking industrialization and service portfolio management seriously. 

TriZetto has a headcount of 3.7k (Cognizant at end of H1 2014: 187k.4). In its last 12 months, TriZetto had $711m in revenues and a non-GAAP operating margin of 18.4% (Cognizant in 2013: 20.6%).

TriZetto LTM revenues breakdown by service/product line is:

• Payer software: 40% (~$277m)
• Consulting: 23% (~$164m)
• Hosting: 13% (~$92m)
• BPO: 5% (~$36m). BPO services are provided on the Payer side
• Provider SaaS: 20% (~$142m).

Cognizant has higlighted the acquistion of TriZetto as an important step in the company's history:

• Towards a non-linear growth business. TriZetto is obiously an ISV business and has higher revenue per head (~$190k) than Cognizant (~$50k). Howevever, Cognizant is not buying a provider of plartforms: TriZetto is essentially a traditional ISV selling on premise perpetual licenses, where applications are implemented and customized by the client
  - SaaS revenues represent 20% of revenues, BPO services 5% only
• As a revenue generator with planned $1.5bn in additional revenues over 5 years. TriZetto has been a flat growth vendor overall in spite of M&As. In addition, the additional $1.5bn in additional revenues does not mean that Cognizant will triple revenues of TriZetto. Taking an assumption of revenue synergies happening towards the endof this 5-year period, TriZetto could reach sales of ~$1.3bn, up from $700m currenly. This is nice but hardly exponential for the company of the quality of Cognizant
• TriZetto with its software product business has high margins. Yet, TriZetto has lower operating margins than Cognizant. In addition, TriZetto under the ownershipby Apax Partners, offers little cost synergies. This means that under Cognizant, which will be focusing on revenue growth and investment in sales and products, the operating margin of TriZetto is likely to go down.

This lack of growth raises the question of price. Cognizant has not provided detailed information regarding its net profitability. Yet $2.7bn in cash for a company with flat revenues at best, a net profit likely to be  in the $70m-$100m range and no cost synergies expected seems a bit expensive. However the market seems comfortable with the price Cognizant paid for TriZetto: Cognizant's share price was relatively flat after the annoucement.

This acquistion will put on hold any other significant M&A for Cognizant for while as the company will be focusing on small tuck-in acquistions to strengthen specific capabilities and focus on share buy-backs.

• CS is to proceed to a €12m convertible bond issuance (maturity 5 years, conversion price per share: €3.6; interest rate: 4%; delivery: July 2014). As part of this issuance, Sopra agreed with DUNA & Cie, the largest shareholder (45.1% of shares) of CS, to buy 45.1% of all convertible bonds issued. In addition, the company has guaranteed the full bond issuance
• Sopra has been granted by DUNA a  first offer status, meaning that if were DUNA were to sell its stakes in CS, it would have to start negotiations first with Sopra
• Sopra is have one member of on the Board of Directions, acting as censor
• Sopra is to help CS improve its financial performance, further develop its existing "industrial and commercial collaboration" in aeronautics and defence, and expand to new offerings including security, space & energy.

In an article by Les Echos, Mr. Eric Blanc-Garin, CEO of CS provided further details about the agreement with Sopra:

• Sopra could own, once bonds are converted to shares, a 7.5%-16% stake in CS
• DUNA & Cie has 4 years, starting from July 2014, to sell its stake to Sopra.

CS is a public sector and aerospace specialist providing IT and engineering services e.g. embedded systems; real time applications; PLM services; cyber-security. The company is headquartered in the suburbs of Paris and has a large office in Toulouse.

CS had in 2013 revenues of €162m down 6.2% at CC/CP in 2013. Headcount was 1,791. Operating margin was 0.2%. Application service account for 90% of revenues. 80% of revenues are fixed priced. The company is heavily focused on defense spending, with its largest clients accounting for 29% of revenues in 2013.

The company derived in 2013

• 52% in revenues from the defense, space and security sector: Services provided include services around command centers, security, logistics and space applications, as well as increasingly, cyber-security
• 38% of revenues from aeronautics, energy and manufacturing:. Services provided include embedded systems , real time computing and PLM services. Key clients include Airbus Group, Praatt & Whitney in aeronautics; and CEA, IRSN and EDF in energy.

CS has faced in the past years a decline in revenues from its key clients in the defense sector, as the French Army reduces its spending.

The company has take several measures including

• Geographical expansion towards North America
• Sectorial emphasis on aeronautics, energy and manufacturing
• Scope re-definition including
  - 2007: the sale of its IT infrastructure management activities (€138m in revenue and headcount of 1.4k) to BT France for €60m
  - 2012: the sale of its transportation unit (€31m in revenues, headcount of 200) to SANEF, a highway operator, for €15m.

CS has been on restructuring mode for several years. in the past 2 years, the company has raised capital through several means including, in 2012 the sale of its transportation unit (for €15m), a capital increase in 2013 (€15m raised) and now through this convertible bond issue (€12m).

In 2014, CS has accelerated its transformation plan with:

• Increased sales activity
• More focused R&D effort to drive more products sales
• Cost cutting and streamling of processes.

Sopra continues its M&A activity after the recent offers to acquire Steria and the HR Access service line of IBM France. CS has been struggling for year and has only returned to break-even operating profitability in 2013. As a result, CS has a low market cap, €36m before the announcement. At this point however, it is still unclear how much Sopra will spend in total to acquire the full CS. 

CS has a different profile from Sopra. It is more positioned on technical IT and engineering services e.g. real time applications and embedded systems, where Sopra has a background in services around business applications. Sopra is only marginally present in embedded systems, servicing mainly client Airbus. CS is therefore a nice service expansion for the company. It also expands the vertical capabilities of Sopra into the defense sector.

The companies have worked together in two significant contracts:

• Sopra acting as sub-contractor to CS in designing the architecture and integration of a new application named SIA (Army information system). The purpose of SIA is lower IT costs (€3.5bn per year) of the French Army and drive its simplification.  SIA has an overall of €750m and aims to converge systems of three French Armies towards a single system. The contract is reported to have a value of €100m. It involves a reported 130 personnel, in Chartres de Bretagne
• The two companies were awarded in 2013 a consulting contact around the SIMAD project for the development of a system related to maintenance of aircrafts. CS was lead on this €32m contact with Sopra and SQLI as contractors. 

The challenge for Sopra will be to restore the profitability of CS, which CS has struggled to achieve in years. With Steria, Sopra had mentioned it was hopeful its own sales activtity was likely to absorb the bench of Steria. In all  likelihood, Sopra believes it can do the same with CS, whose headcount is just 1,700.

The French IT services market is going an incredible acceleration towards its consolidation. Major 2014 M&A transactions include Atos with Bull; Sopra with Steria; Capgemini with Euriware. Last year, Econocom had acquired Osiatis while TCS had purchased Alti. While many had announced the consolidation of the French IT services market, it had been slow to occur, until this year. Nevertheless, France still has a high number of mid-sized standalone IT service vendors: GFI Informatique. of course, but also Devoteam, Neurones, Groupe Open, Aubay, Businesss & Decision, or SQLI.

Sopra's rationale for the acquisition includes:

• Expanding its geographical presence from France to the U.K., Germany and Norway
• Gaining a new service portfolio in BPO services and IM.

Sopra is to launch a public exchange merger where Sopra offers 1 share of its stock for 4 Steria ones. The offer values each Steria share at €21.5 (based on a Sopra Group share at €86.16), a 40% premium to last Friday’ value of €15.74, and about 12 times Steria's forecast 2014 earnings.

The combined entity will have Sopra's founder and president Pierre Pasquier as chair and Steria's Francois Enaud as CEO.

The acquisition will be a major service expansion for Sopra, which had remained very application service centric: systems integration accounted for €730m in revenues in 2013, consulting: ~€95m; and application management: ~€530m.

In the past three years, since the IPO of Axway, Sopra Group has made several ISV acquisitions, of which the major ones were Callatay & Wouters in Belgium, and HR Access in France. In 2013, software products and related IT services accounted for ~€340m in revenues.

By comparison, Steria has an extensive portfolio of services, including IT infrastructure management (~€526m), BPO services (€316m), consulting & systems integration (~€649m) and application management (€263m). In fact, Steria brings Sopra capabilities in areas where CEO Pierre Pasquier had in the past expressed it did not want to go into e.g. IT infrastructure management for margin reasons. in todays presentation on the merger presentation, Pasquier's position on IM had changed, commenting that more clients are asking for AM services or SaaS applications together with the underlying IT infrastructure services.

In all likelihood, the potential acquisition of Steria for €722m in shares was a deal Sopra could not refuse. If we look back to 2007, Steria acquired Xansa for €680m in an all cash transaction. Today's valuation includes all the operations of Steria in France, Norway and Germany.

The big benefit of the Steria acquisition from a Sopra perspective is that it finally solves the company’s lack of internationalization. While Sopra Group has been successful in its domestic market with good organic revenue growth and operating margins, it has struggled to grow its U.K. and Spanish operations (both have remained at ~€80m in revenues). And Sopra's profitability in the U.K. and Spain has been hurting the company for several years. Steria brings a U.K. business with revenues of €692m and a 10.0% adjusted operating margin that is on the verge of high growth thanks to the ISSC2 contract.

Steria also brings a good country unit in Norway which has been performing decently.

The big question market remains its operations in France, where Steria had ben preparing for significant redundancies in back office and support activities. Interestingly, Steria France has put on hold its job redundancy program as Sopra France is expected to absorb some of the personnel on the bench through existing contracts and through removing subcontractors. SSG appears confident of being able to resume growth in Steria France rather painlessly.

Looking back, Steria has had a rather successful journey since 2002 and its first major acquisition, that of Integris/Bull. The company managed to increase its profitability year after year in spite of an unfavorable economic environment, adoption of industrialization and standardization and offshore. The acquisition of Xansa was a strategic (and expensive) move but it was impacted just nine months later by the U.S. subprime crisis impacting the global economy. However, Steria was was not able to cross-sell BPO and offshore to its client base in Germany and France. The company has clearly a competitive advantage it was not able to make us of. Currently, Capgemini now uses an Indian offshore leverage of 20% in its French operations. Steria does not. That is possibly the most major drawback of Steria’s performance in the past 15 years.

Sopra/Steria combined will become the third largest European IT services vendor, though some way behind Atos and Capgemini.

Consolidation within the European IT services market has been on the cards for some time, so today's news should not be too much of a surprise. Will we see further mergers or strategic partnerships in Europe this year?

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

Managed Services

Managed Services (MS) is planning to grow at a 5% 2013-2016 CAGR with a slight organic growth. The unit has stabilized (organic growth 2011: +1.7% ; 2012; +2.4%; 2013 Q1-Q3 -0.6%) in spite of having absorbed SIS' MS unit, whose revenues were declining due to SIS reducing revenues from loss-making contracts. The legacy Atos Origin MS itself was a relatively flat growth business line.

MS is still being impacted from its decision to exit or renegotiate loss-making former SIS contracts.  Those contracts represent ~€450m in revenues currently and should stabilize from 2014 to ~€250m. Atos is therefore expecting  a 1% organic growth for MS in 2014 and then an acceleration in its business in 2015 and 2006, driven by large wins.

MS is aiming to increase its adjusted operating margin by 30-60 bps by 2016, from 2013 (H1 2013 8.1%). MS intends to continue its effort on productivity (aiming to gain efficiencies in the 15%-30% range), global delivery (from 35% to 50% of headcount between 2013 and 2016) mostly in India, Poland and Philippines, driving its delivery center personnel to be servicing multiple clients as opposed to being client-dedicated. Meanwhile, MS is consolidating of 2/3 of its datacenter estate, closing 14 of those and opening 5 new ones. The unit is planing to have all datacenters be tier 3 by 2016.

The unit is launching a new effort on further improving its service quality, based on the understanding that further quality will help driving down incidents and effort, and increase client satisfaction. Specifically, Atos MS is working on a zero incident program on its top 100 accounts to reduce incidents by 15% in the next 12 months.

MS is also adjusting its portfolio by focusing on several offerings including service integration, security, vertical offerings, project services (expand from NL and U.S. from datacenter consolidation, US and desktop virtualization) and cloud computing (largely though Canopy). Examples of recent service integration contracts include NSN where Atos MS is coordinating 44 suppliers and the U.K. Post Office. Examples of verticalized MS offerings including for the manufacturing sector Siemens MES applications and the underlying IT infrastructure.

In addition:

• Managed Services assets that its recent midsized to large deals are not dilutive to its operating margin.
• Is is wining against competitors including IOSPs systematically
• Its specificity is to offset by 100% of datacenter carbon foot print.

Systems Integration

Systems Integration (SI) has the ambition to

• Growth by 3.7% (2013-2016 CAGR)
• Improve its margin by 120bps-240bps by 2016 (H1 2013: 4.9%). SI has potential for further operating margin improvement is the most important, especially since the service line has suffered specifically in two geographies: France and the Netherlands.

The service line is focused on several initiatives

• Continued development of near/offshore presence with currently 8k personnel offshore (representing 30% of SI headcount) and the intention to reach  50% by 2016
• Launch of its META program, focusing on
  - Account management (focus on top 30 accounts in addition to delivery and project managers)
  - Pursuing large deals
  - Expanding in North American, where Atos has appointed a form Cognizant, focusing on ERP, CRM and MES systems
• Portfolio aligned around
  - Mobility
  - Testing
  - Service integration (doing work for MS)
  - BI and big data
  - Security
  - Verticalization of offerings
  - Application management.

Atos is putting a renewed focus on its AM business, which represents one third of revenues of SI. AM has resumed growth in its business, gaining its first non-Siemens AM mega-deal (~$1bn, by NelsonHall's estimate) with a large network equipment manufacturer. It is also interested in small to midsized AM opportunities where there is the possibility to grow the account.

Meanwhile, AM is refreshing its service portfolio with a three-tier offering: core application maintenance and support, focused on cost reduction; business transformation of applications embedded in multi-year contracts; and IT modernization and cloudification in cooperating with Canopy/

AM is also introducing vertical-specific run-build-run offerings. Examples include:

• Energy production: nuclear power command and control plants; smart metering and grid management
• Manufacturing: design-build-run PLM, MES and ERP applications, integration of SAP and MES and PLM applications through its digital plant solution. The company services 5 automotive OEMs with this offering
• Financial services
• Telecoms.

AM continues its push towards global delivery with the intent of reaching by 2016 65% of personnel in low-cost countries (up from 50% in 2013).

Together with its effort in MS and SI, Atos continues its Sales Strategic Engagement (SSE) activity, focusing

• Continental Europe, where the company is targeting first generation ITO contracts with TCVs of €40m to €100m
• Expanding its offering to service integration
• Be opened to personnel and assets transfer. SSE has developed its M&A expertise to accommodate captive purchases.

Atos has provided some information on how its two main IT services unit Managed Services and Systems Integration will grow in the coming years. To some degree, Atos is moving to a financial model similar to CGI, where margins are relatively high. The comparison with CGI ends here: margins of Atos MS in particular may reach ~9%, at the upper range of the traditional industry margin range.

Systems Integration, traditionally higher margin than MS, will continue under-performing MS in 2016. This is unusual and signals Atos being conservative in its guidance, or acknowledging the impact of Indian vendors on prices or a long-lasting reinvention of its SI business. Atos highlights that by 2016 around 50% of its headcount will be located in low-cost countries. Unlike Accenture or Capgemini, Atos is more centric around non-Indian countries. Unlike CGI, Atos SI has not developed a large ISV business (which Atos has put into Worldline). AM is where Atos may find most success within SI: the company has now two AM mega-deal references (with Siemens and a large network equipment manufacturer). Atos' focus on large deals, traditionally in IT infrastructure management, may also pay off in AM: it has recently won two deals against competition from both IOSPs and global SIs. In the AM business, Atos has strong industry credentials in manufacturing and in nuclear energy, but there is work to be done in developing vertical offerings in financial services sectors, in retail banking somewhat surprisingly, given the heritage of Atos.

Finally, Atos, again net cash positive, is turning back to its former business model, of relying on acquisitions to fuel revenue growth.

Software testing is quickly evolving from a manual activity and use of testing COTS to a form of managed service with some level of pay-per-use and towards a more non-linear growth. This is good news as software testing has in the past and still is a very human labor-intensive activity.