Annex Bulletin 2007-06                              February 15, 2007

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IT SERVICES

Updated 2/15/07, 11:30AM MST

Analysis of Capgemini's Fourth Quarter Business Results

Capgemini Caps Great Year, Saves Best for Last

Revenue Grows in Double Digits; Net Profit Doubles

SCOTTSDALE, Feb 15 - Capgemini saved its best for last.  The company capped a great year with an excellent fourth quarter.  Revenues surged by double digits (up 13% as reported, up 14% in constant currency), led by strong growth especially in Asia/Pacific, U.K./Ireland and German markets.

For the full year 2006, revenues were up 11% as reported (or 12% in constant currency) to 7.7 billion ($10.1 billion).  And the results were even more impressive in U.S. dollar terms, given the decline of the U.S. currency against the euro in the last 12 months.  The 2006 revenues were up 21% in U.S. dollars over the year before.

Net income for the year more than doubled, from 141 million in 2005 to 293 million ($384 million), beating the stock market estimates.  Analysts had forecast full-year net profit of 283 million.  Capgemini generated operating cash flow of 578 million ($757 million) in 2006, and raised its dividend by 40%.

The company's operating margins also surged from 3.2% in 2005 to 5.8% last year.  And the improvements are likely to continue.  Capgemini CEO Paul Hermelin said today during the analyst call that he expected the operating margins to grow to 7% this year, and then to 8.5% in 2008, as the company extends its recovery that started in 2004.

No wonder the Paris Bourse stock traders liked what they saw, pushing the Capgemini shares up by more than four points to a new multi-year high by mid-day today (Feb 15 - see the chart).

Business Segment Analysis

Geographies.  Europe, Capgemini's largest geographic segment that accounts for 82%wpe3.jpg (14738 bytes) of its business, also had the fastest (14%) growth rate in 2006.  The U.K. and Ireland had the best growth rate in the fourth quarter and for the full year (up 22%; up 24% organic growth).  But it was the Benelux countries that were the most profitable (operating margin of 13.5%).  Germany and Asia/Pacific also had double digit operating margins (10% and 16% respectively). Europe's overall operating margin was 6.7%, higher than the global average.

wpe6.jpg (14671 bytes)France, on the other hand, Capgemini's home and second largest country, barely broke even last year on revenues of 1.7 billion ($2.2 billion).  The main reason for that "blemish" was the Schneider megadeal, according to Pierre-Yves Cros, the company's chief strategist and the principal architect of its recent turnaround (also see "EDS: Curse of Megadeals," Feb 2002).

"Schneider (deal) was a drag on our profitability," he said this morning during a teleconference with American analysts that followed the fourth quarter release.  "Without it, France would have very decent profitability," he added.CAP1.JPG (38165 bytes)

Consolidation of the recovery in North America, on the other hand, where revenues have been rising all year, accelerated.  In 2006, business was up 3.8%, but revenues jumped 10% in the fourth quarter.   And the North American operation swung from loss to profit.  Operating margin improved by over seven points to 5.4% of revenues.

The company's offshoring efforts are also accelerating.  Capgemini's work force in India, Poland and China rose by 92% in 2006 to more than 9,000.  The Kanbay acquisition, finalized last week, makes India now the company's second largest country with more than 13,000 people. Capgemini expects its headcount in India to triple to 40,000 by 2010.  The company's worldwide employment at the end of 2006 stood at about 68,000 people.

Horizontal Segments.  Outsourcing and local professional services (SMB) were the fastest growing horizontal segments in 2006.  They were up 25% and 11% respectively,06_Cap1.jpg (18389 bytes) after the company reclassified its three biggest megadeals into CS/TS services, which went up 9%.  Consulting business increased by 6%, while Technology services rose by 10% last year.

Consulting services' profit margins improved by  five points in 2006, while those in Technology services rose by more than two points.  Outsourcing also saw a three-point rise in its operating margins despite the extra costs related to the Schneider megadeal.  Finally, Local Professional services (Sogeti) also improved its profitability by almost a point to 9.8%, putting it on a par with consulting, the company's most profitable activity with 10.1% operating margins.

CEO Hermelin warned that Capgemini expects the pace of growth in its IT outsourcing operations to slow this year as it approaches the end of some major contracts.  But he was hopeful, however, to offset that with the company's $1.25 billion acquisition late last year of Kanbay which specializes in IT services for banks (see "By Leaps and Bounds," Oct 2006).

"Kanbay takes us into areas of business where we weren't present before," said Hermelin. "We've already had approaches from French, Dutch and other international banks about the kind of offshore business we couldn't do before."CAP2.JPG (29450 bytes)

Industries.  Manufacturing and government were Capgemini's largest vertical business segments, accounting for 29% and 28% of total revenues.  The financial sector at 14% of total was its third largest.  But with the addition of Kanbay, which specializes in the banking sector, that will change in 2007, as the finance sector's share is expected to rise.

Bookings.  Capgemini helped grow its backlog with a 21% jump in new contract signings in 2006.  The company booked about 8.2 billion of new business last year ($10.7 billion), up from 6.8 billion in 2005.

But the 2006 total is still lower than the signings in the earlier five years (2000-2004, see the chart).  Which means that Capgemini needs to crank up its sales performance this year if it is to maintain its double digit revenue growth momentum.  

Outlook

And that doesn't appear very likely, even by the company's own projections.  Capgemini said it expected revenue growth of 8% in 2007 (at constant currency), well below the 12% rate the company has just reported.  Which would still be on the high side of the average industry growth rates. 

"We're very excited about our perspectives in 2007," said Cros in at the end of the conference with analysts.

Click here for detailed Capgemini 2006 P&L analysis (Annex clients only)

Happy bargain hunting!

Bob Djurdjevic

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Volume XXIII, Annex Bulletin 2007-06
February 15, 2007

Bob Djurdjevic, Editor
(c) Copyright 2007 by Annex Research, Inc. All rights reserved.
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