The company’s co-founder and long-term CEO Serge Godin moved upstairs to the chairman’s office in February, and one month later, CGI announced 1,000 job cuts and a CAD 90m ($79m) charge due to lower than expected revenue from its main client, Bell Canada.
Declining profitability in the subsequent second and third fiscal quarters have helped push CGI’s shares down more than 20% from a year-high of CAD 9.94 in January to CAD 7.80 on Thursday, leaving the company with a market capitalization of CAD 2.3bn ($2bn), a 38% discount on last year’s CAD 3.7bn ($3.3bn) annual revenue.
But according to the new man in the CEO seat, former COO Mike Roach, the company remains well set to become one of only a handful of surviving global IT services players in what he describes as rapidly changing and consolidating market.
Roach told Computer Business Review that he: certainly did not have a long honeymoon period after taking over the reins in February, but points to the company’s high client satisfaction and retention ratings, and recent contract extensions with the likes of the Commonwealth of Virginia and Caisse de Depot, as well as Bell Canada, as evidence that the company is on the right track.
As part of the shift in relationship with Bell Canada, the operator sold its stake in CGI back to the vendor for around CAD 859m ($758m) at the beginning of the year. This means that more than 90% of the company’s workforce now owns stock in the company, which Roach said helps to foster an entrepreneurial spirit within the organization: You never see anyone washing a rental car. They look after it a whole lot better if it is their own.
The amount of M&A activity in the IT services sector has accelerated in 2006, and Roach said that this consolidation is being driven by globalization, increased outsourcing, and a shortage of key skills, and he predicts that the highly fragmented IT services supplier community is set for a major shake-up. I believe that there will eventually be just eight to ten global players left and we intend to be one of them… Buying back stock means that we are protected against a hostile takeover. We are looking at the menu, we are not on the menu.
Another group of companies looking to make a big impression in the IT services sector are telecoms operators. BT Group, Deutsche Telekom, and Telstra are competing for some large out-and-out IT services deals against the likes of IBM and CGI, and the lines between the two areas are becoming increasingly blurred. This week, US operator Verizon, launched a desktop management service aimed at large and medium-sized organizations, while even Bell Canada has grown its own IT services arm through the acquisitions of Nexxlink and Createch.
Roach, a former Bell Canada employee, is sceptical about their potential to become long-term winners in this space. He said: Telcos are coming at the market from a different angle. They see a server as an extension to a network, whereas a systems integrator sees it as an extension to an application, and looks at how it can help its performance. One of their biggest challenges is how they protect their network revenue while building up their services operations. Will a company like BT be happy to manage a non-BT network for a client as part of a big services contract?
CGI has made more than 60 acquisitions to date, its most recent coming in May, when it snapped up the former French division of German SAP integrator Plaut for an undisclosed sum. Roach said that the company was eyeing similar takeovers in the SAP services space, citing strong demand for new SAP rollouts in the financial services sector, where he said a large number of clients still rely on ageing, homemade back office systems.
The company’s biggest acquisition to date was its $858m takeover of American Management Systems in 2004, which took the company into the big league of suppliers in the US. One of the key legacies of that purchase is AMS’ applications portfolio for the government sector, which includes its Advantage and Momentum products, which Roach describes as being like an SAP system for the back offices of local and federal government agencies.
The company is also aiming to increasingly deliver applications to clients as a flexible, pay-as-you-use service. It gives the example of its work with a number of Canadian hospitals, where it gives them rented access to an SAP back office application on an on-demand basis.
This is the type of arrangement that was promised under the application service provider hype of five years ago, and Roach acknowledges that the main obstacle that held the movement back then, persists today the applications vendors’ revenue models. He said that CGI had to acquire the license from SAP, and then has to try to recoup its investment over a multi-year period through renting access to end users, whereas under a true ASP model, SAP would also get drip-fed revenue each time the system gets accessed.
Roach said: Software vendors are built around making a short-term, large ROI on a product sale, whereas the services business is all about the annuity model. But the market is getting there, and it is being driven by clients increasingly looking at working with their one-time competitors to gain greater economies of scale by sharing systems and processes.
CGI has been less aggressive in building up its offshore delivery capabilities in India than some of its peers. The company currently has around 1,200 of its 24,500 employees based at centers in Mumbai and Bangalore, some of whom were inherited from the takeover of IMRglobal in 2001. The company also has delivery centers in Canada, Spain, and Richmond, Virginia, and said that 20% of its staff are now based in these facilities.
Roach said: The average age of programmers in India is around 24 or 25, which means they don’t have a lot of experience. There is a huge gap in cost, but there is also a huge gap in knowledge, and I believe that in our industry, more value gets lost through poor project management, than is gained through labor arbitrage.
The recent strength of the Canadian dollar has had a negative impact on CGI’s top line growth, but Roach said that currency changes are not affecting the number of US-based clients from using Canada as a near-shore location for delivering lower-cost IT and back office services. He said: We have not built a business model to rest on the differentiation in currency, as it has been too volatile. Clients would get nervous about entering a seven- or 10-year deal with a vendor that bases its profit margin on currency fluctuations.
