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.

Quite simply because of the revised revenue guidance for 2014 from growth of at least 16.5% to at least 14%. This is a huge cut of ~$220m (from ~$10.3bn to ~$10.08bn), all of which coming in H2. This forecasts:

• Q3 as having the lowest y/y topline growth since we started tracking Cognizant’s financials over a decade ago (at around 10.6% to 11.9%)
• H2 overall as coming in at around 10.3% growth, a big drop from the 18.1% achieved in H1.

CEO D’Souza highlights two main factors contributing to the reduced guidance:

• A small number of U.S. and U.K. clients experiencing difficulties, leading to lower discretionary spending
• Longer than anticipated sales cycles for certain large integrated deals.

Of these, the largest relates to client-specific issues at a handful of clients. The implications in the earnings call were that these were temporary issues but in at least one case (including a U.K. retail sector client), we believe Cognizant has lost business to an Indian competitor.

On a positive note, Cognizant has been selected for three major outsourcing contracts with a TCV of $3.5bn that it expects will bring in incremental revenue of $200m in 2015. And the new business is all long-term outsourcing ... whereas, if we are correct in our understanding, the business that Cognizant is losing is primarily ADM type activity. These new contracts will help accelerate Cognizant’s revenue mix from being still very dependent on traditional custom applications development projects and application maintenance engagements (activities which we believe have been growing for Cognizant at lower than the company average for some time) to having a greater mix of what the company terms “Horizon Two” (BPO, IT infrastructure management) services, where it was arguably somewhat late in building scale. Similarly, Cognizant was relatively late in investing in Continental Europe, but is now reaping some benefits from its CI Group business unit acquisitions. One of the three new large signings is Vorwerk, a European consumer goods firm.

By far the most important signing in Q3 will be that with Health Net, not just because of its size (at $2.7bn over seven years, the largest in Cognizant’s history), nor because of the breadth of services being provided (BPO plus applications outsourcing and IT infrastructure management), but because it appears that the intention is for Cognizant to leverage the software IP and the delivery capabilities it will acquire with the deal to set up a BPO utility for other U.S. health payors.  This would indeed be transformational for Cognizant - and for the sector.

The third large deal, with an unnamed financial services client, illustrates Cognizant expanding an existing relationship to include both BPO and ITO. Again, now that it has scale in some areas of BPO some areas if industry-specific financial services BPO, F&A) and in IT infrastructure management services, Cognizant is much better positioned to secure complex multi-service outsourcing deals than it was a few years ago.

Cognizant claims its revenues from SMAC services are around $500m per annum: if so, then its Horizon 3 businesses are also gaining traction.

So, the short term loss of revenue is obviously a major setback that will continue to be a headwind in 2015, but recent investments and new wins position Cognizant well to resume stronger topline growth in the mid-term. It certainly claims its pipeline is healthy. We may also see further inorganic growth in Continental Europe.

Finally, Cognizant is contending with offshore attrition by offering a wage hike (10%) that is at the higher end of the industry, a tactic that works well in India.

If we look at where the growth is coming from:

• The more established ADM services (where Infosys took its eye of the ball in FY 13) contributed an estimated $173m in additional revenue, or 35.4% of the y/y growth of $490m. (Infosys achieved $53m growth in its ADM businesses). Enterprise solutions contributed over 19% of the growth. Assurance services and IT infrastructure services both continue to enjoy very strong growth and between them contributed over 27% of the y/y growth. IT infrastructure services and BPO both crossed the $400m revenue mark this quarter. The only service line not delivering double digit topline growth is the software business (TCS BanCs), for which the market is soft
• By vertical, the y/y growth is dominated by BFSI, which contributed an impressive $200m (nearly 45 of overall growth) in incremental revenues this quarter: full FY 2014 revenues are likely to approach $5.8bn. TCS is confident of sustaining ongoing growth in this vertical. In two other verticals, the difference between TCS and Infosys is marked:
  • Telecoms: Infosys continues to experience negative growth (down 10% in Q3 FY 14) and says its client budgets for next year are down. In contrast, TCS saw accelerated revenue growth this quarter (17.8% estimated, or $50m)
  • Life sciences & healthcare, which Infosys indicated a few years back was a new target market but now considers is soft.  TCS, in contrast, is enjoying over 30% growth, again with $50m in additional revenues.

These data points, are, of course, simplifications, but they do expose significant gaps between the two.

Among the regions, y/y revenue growth, unsurprisingly, continues to be dominated by North America (an estimated $232m in additional revenue. But Continental Europe contributed an impressive $122m in additional revenue. If anyone is in any doubt about its penetration of Continental Europe, TCS is likely to achieve over $1.5bn in revenue in the region this FY, with the U.K. delivering around $2.3bn. It is a major player in EMEA, and by far the largest IOSP.

Looking ahead, TCS is very bullish about prospects for FY 2015. CEO N Chandra commented on expecting FY 2015 to be a "much stronger" year than FY 2014. With 16.5% topline growth in FY 2014 nine months year-to-date, that indicates very aggressive targets for next fiscal. Should we expect some acquisition activity for IP-based capabilities, to boost efforts to drive non-linear growth?

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]

• Revenues were $5,759m, down 9.3% y/y, and down 1% sequentially
• EBIT was $255m, a margin of 4.4% down 223 bps y/y.

Fiscal Q4 2013 revenue (and y/y and sequential revenue growth) by service type was:

• Infrastructure technology outsourcing $3,563m (-9%, -3%)
• Application and business services $2,196m (-10%, +1%).

IT outsourcing contributed 62% of HP ES business, application and business services ~38%.

Q4 bookings were up over 30% y/y, driven by strong renewals

FY 2013 results for HP ES were:

• Revenue of  $23.5bn, down 8.2%, down 7% in CC
• EBIT of $679m, a margin of 2.9%, down 119 bps.

FY 2013 revenue (and revenue growth) by service type was

• Infrastructure technology outsourcing $14,682m (-7.0%)
• Application and business services $8,838 (-10.0%), primarily due to softness in the applications business.

12-month trailing book-to-bill at end FY 2013 was approximately one in line with prior guidance.

For HP Group overall, fiscal Q4 2013 revenue was $29,131m. Revenue (and y/y revenue growth as stated and in CC) by region was

• The Americas $13,400m (-2%, -1%)
• EMEA $10,195m (-4%, -5%)
• Asia Pacific $5,535m (-1%, +4%).

For HP Group overall, fiscal 2013 revenue was $112,298m (-7% y/y, -5% CC y/y).

- See more at: http://research.nelson-hall.com/sourcing-expertise/view-all-vendors/?avpage-views=article&id=201480&fv=2#sthash.O34tiq29.dpuf

HP Enterprise Services (ES) today announced its fiscal Q4 2013 results, for the period ending October 31, 2013:

• Revenues were $5,759m, down 9.3% y/y, and down 1% sequentially
• EBIT was $255m, a margin of 4.4% down 223 bps y/y.

Fiscal Q4 2013 revenue (and y/y and sequential revenue growth) by service type was:

• Infrastructure technology outsourcing $3,563m (-9%, -3%)
• Application and business services $2,196m (-10%, +1%).

FY 2013 results for HP ES were:

• Revenue of  $23.5bn, down 8.2%, down 7% in CC
• EBIT of $679m, a margin of 2.9%, down 119 bps.

FY 2013 revenue (and revenue growth) by service type was

• Infrastructure technology outsourcing $14,682m (-7.0%)
• Application and business services $8,838 (-10.0%), primarily due to softness in the applications business.

On the face of it, the decline in revenue across the board does not look very impressive, but in fact, the data shows that the "fix and rebuild"  is broadly heading the right way.

Firstly, the revenue performance at HP ES throughout FY 2013, the "Fix and Rebuild" year, has been better than the guidance a year back of revenue decline of 11% to 13%. This is partly due to slower than expected ramp downs. However, the delayed revenue run-off will put further pressure on services revenue in FY 2014, negatively impacting Q1 growth and putting pressure on H1 results overall. Management highlighted that signings for "strategic" enterprise services, which include cloud, big data, application modernization and security, were up double digits. In FY 2014, HP ES is focusing in a sales force retooling program.

Secondly, FY 2013 operating margin of 2.9%, boosted by the 4.4% margin achieved in fiscal Q4, is at the high end of prior guidance of between 0% and 3%,

HP ES continues to focus on changing the mix of its portfolio towards services using the "new style of IT". This is being boosted by the added emphasis on innovation and an increase in engineering headcount announced today.

The group-wide focus on innovation has seen HP bring out new capabilities that HP ES could potentially leverage in its pursuit of "new style of IT" deals. Examples of recently announced technologies include HP OneView, unveiled in September, a new integrated software-defined management capability for converged infrastructure, extensively in virtualized BladeSystems and Rack server environments. Also new is Salesforce Superpod which was announced at Dreamforce 13. It is a dedicated instance in the Salesforce multi-tenant cloud, to run on HP's Converged Infrastructure for enterprise data centers. The Superpod is targeted at very large clients and will be offered to existing Salesforce clients at an additional fee.

HP ES continues to work on its turnaround strategy. Measures currently underway include:

• Flattening the labor pyramid, in terms of both skill sets and locations
• Focus on getting better at taking contracts away from competitors
• Building up HP ES’ advisory offerings
• Building client road maps in every area to help clients go from the traditional to the “new style of IT”.

These measures were covered in a recent NelsonHall blog "HP ES Turnaround Strategy Update - New Style of IT, New Style of HP ES" - See more at: http://research.nelson-hall.com/blogs-webcasts/nelsonhall-blog/?avpage-views=blog&type=post&post_id=73#sthash.b0nY9tIP.dpuf .

HP Group as a whole delivered >$9bn of FCF, well above its most recent outlook of ~$8bn. Net debt was reduced by >$1bn for the seventh consecutive quarter and HP has now achieved its net debt goal ahead of plan.

NelsonHall will be shortly updating its Key Vendor Assessment in HP ES to include these results.

• 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.
• - See more at: http://research.nelson-hall.com/blogs-webcasts/nelsonhall-blog/?avpage-views=blog&type=post&post_id=73#sthash.b0nY9tIP.dpuf

Pindar has become the third CEO of a major U.K. outsourcing company to resign this year. The other two, Nick Buckles of G4S and Chris Hyman of Serco, both left behind companies that are being investigated for fraud by the British Government. No such allegations have been directed at Capita.

The company has done extremely well under the leadership of Pindar. In the past ten years alone:

• Its revenue has more than doubled (from £1,081m full year in 2003 to £1,891m in H1 2013 alone)
• The share price has increased by > +316% over the last 10 years, compared with the FTSE (>+52%).

Pindar leaves the company in good shape, with:

• £2.9bn of major new contract wins so far this year
• An anticipated organic topline growth of 8%
• An operating margin that is expected to stay steady at 12.5% to 13.5% for the foreseeable future.

Today's announcement coincides with the news that Capita has resolved the problem of its under-performing personal insurance BPO businesses. It is selling Lancaster Insurance Services, Sureterm Direct, BDML Connect and Delta Underwriting to Markerstudy Group for an undisclosed price. The four businesses (685 personnel based across three locations) are expected to generate ~£47m in revenue and make a combined operating loss of £15m in 2013. Capita is also closing its SIP administration business based in Salisbury.