Computer Associates has clinched its biggest services acquisition to date with the $435m cash purchase of Computer Management Sciences (CMSI). We’re trying to build a $1bn services business as fast as we can, says Chris Wagner head of CA’s Global Professional Services (GPS) division, still slightly defensive over well publicized plans to reach this size by the close of its fiscal year next month. CA is on track to do half of that and the division will have a $500m run-rate.
The addition of the Jacksonville, Florida consulting and implementation business will make an immediate difference to GPS’s year-end numbers just by virtue of the fact it is a cash transaction. CA almost exclusively makes cash acquisitions because it means that the revenues of the target company can simply be added in after the purchase, and any subsequent comparisons made will be against CA’s financial status before the transaction. That means acquisitions go straight to CA’s growth curve. CMSI will therefore provide an immediate injection of $12.4m in profits and $90.2m in revenues. Furthermore, it adds 800 billable consultants, bringing the total GPS headcount up to 3,000.
With a set of strong fundamentals and no long term debt, CMSI had been deemed a prime acquisition candidate for around six months, and given CA’s high profile services acquisition strategy it is surprising that the two names had not been linked before. CMSI was not initially interested in selling the company, says Wagner but there has been some suggestion that the co-founder’s continuing ill health had prompted talks with CA.
At least three times the size of any services acquisitions it has made so far, CA paid a 19% premium over CMSI’s $23 closing price on the day the deal was announced. This has to be considered cheap. CMSI has one of the highest margin services businesses in the industry with a gross margin of 39% and profit margins touching 20% of late. But this has done little to allay fears on Wall Street that CA is continuing to damage its business model by pursuing a services business via acquisition. We remain guarded that the degree of margin deterioration brought about by this services expansion is uncertain and could weigh on CA, says Chris Shilakes at Merill Lynch, who is maintaining a neutral rating on the company’s stock.
CMSI has managed to maintain these margins by carrying out the vast proportion of customer application development work off-site at System Outsoucing Centers (SOCs). Highly paid consultants are hired to carry out the high level design work at the customer’s site, while lower paid programmers carry out the more mundane coding back at the SOC. The company makes a point of hiring programmers with very little systems expertise who subsequently can be trained to work at the SOC using CMSI’s specialized Software Factory Process. The recruit strategy effectively means it can pay the bulk of its staff around $28,000.
The company has also been moving towards securing more fixed- price projects, which has had an additional positive effect on margins. Fixed-price contracts are attractive to clients because the cost is agreed up-front and a deadline agreed by which the project has to be completed. In January CMSI won $1m in fixed- price projects and is currently working on a further three fixed- bids that individually are larger than any other project previously completed. CMSI is good at fixed bid projects, says Todd Allen, an analyst at Kenny Securities. And CMSI will be on target to hit the $116.7m revenue estimate for fiscal 99, according to Allen.
CMSI also focuses on state and local government projects that are lower risk businesses than previous CA acquisitions. In the last quarter, 21% of revenues came from state and local government; its utility practice provided 19% of total revenue; the insurance practice was at 17% of total revenue; financial services was 11%; and communications was 6%.
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Aware of the cost-effective nature of the SOC model, CA plans to rapidly increase the number of SOCs both at home and abroad and will add 12 centers in the US and the same number in Europe, in addition to the eight US sites CMSI had already. The set-up costs should not be too prohibitive since CA has the potential to use existing facilities to spawn additional SOCs. Each site should amount to no more than $3m in capital costs with some costing as little as $750,000.
CMSI is a very different animal to the services acquisitions CA has made so far. Realogic, Aventura, LDA and XCOM were all much smaller acquisitions (adding 200, 300 and 60 employees, respectively) that provided a vertical focus with some localized expertise. These companies specialized in workgroup applications such as Lotus Notes and smaller e-commerce deployments whereas CMSI focuses on enterprise-wide projects of enterprise-level software.
The company saw 35% of revenues from client/server development and 21% of revenues from application development in its most recent quarter, the fourth quarter 1998. This focus makes it a better vehicle for Unicenter and Jasmine consulting projects that CA feels may be a source of rich pickings. We will use Jasmine, Opal, Ingres, and our Cobol tool to accelerate new application development within the SOC and then try to persuade customers to use Unicenter to manage that application, says Wagner. á
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