Monday, 15 August 2011

CSC First Quarter Results - Comments and Analysis

CSC - "a very solid business with excellent prospects"
 This was Mike Laphen's description of CSC at its Q1 FY2012 earnings call of August 10th 2011. It shows that nothing much has changed. The company still tells shareholders that it is on the verge of success, there are just a few issues to sort out, and the future will be bright. Just the same as always.
How many times have we heard this message in the past?  Unfortunately, each time an outstanding issue is sorted out, a new and sometimes bigger issue seems to appear. We knew about the NHS situation, the Nordic accounting irregularities, the SEC investigation, the Audit Committee investigation, the lack of revenue growth, the Class Action lawsuit and the Long-term Investor Investigations. We can now add MSS (outsourcing) segment business performance to the list of issues.
The business highlight of the Q1 results release was the collapse of the MSS segment profitability from 10% ($175million) in Q4 FY2011, to just $9million in Q1 FY2012. In constant currency, Q1 FY2012 MSS revenue was 6% down on the same quarter of the previous year, which is a possible cause for concern given the annuity nature of MSS. The explanations given for this profitability collapse seem plausible, workforce rationalization, impact of the strike in Denmark, higher than planned project costs (again), and so on. But maybe we are beginning to see the impact of the lack of service delivery investment over the years? Read the comments from this blog to see how CSC has over years; curtailed travelling so that senior managers cannot visit the widely scattered workplaces to review work and acutally 'manage', and  cut out training which must have inevitably reduced the skills of its work force.
It seems that what the business performance failed to deliver was compensated by the accounting performance. Tax planning initiatives created an exceptional one-time credit of $85million in Q1 FY2012, which turned a poor pre-tax profit of $101million into a healthy profit after tax of $186million. One would normally expect a tax charge of about 25% or about $26million  for the quarter, so the delta impact of this credit was some $110million or almost 60% of the net profit.

Readers may recall that in FY2009, CSC similarly benefitted from a one-time tax credit of $166million. Just how many of these tax credits are there and where are they coming from? Is CSC now a finance house instead of IT Services provider?
The CSC balance sheet shows the book value of the company as $7,500million, while its market capitalization is only $4,600million. So why is the market value of CSC so much lower than its historical book value?  One indicator  is CSC's poor P/E ratio, (its share price expressed as a multiple of the annual earnings per share), which reflects the market's view of the company's future prospects. CSC's P/E ratio is only 6.20, while competitor Accenture, for example,  is 17.20, almost 3 times more. This means the market has much more confidence in Accenture's future performance than it does in CSC`s. This is corroborated by historical performance. Today, a CSC share is worth about 40% less than it was 5 years ago, while an Accenture share is worth over 95% more.
According to Michael  Laphen, CSC is "a very solid business with excellent prospects", Its share price has suffered because of a "severe overreaction in the market....which is so volatile that if you pop up with a surprise you'll get severely penalized for it"   This reassurance will no doubt come as a relief to worried shareholders.
Back in 2006, the then CSC Board of Directors reportedly turned down a takeover bid in the "low $60's" as they felt it undervalued the company. Since then, the CEO has changed, but most of the non-executive directors are still in place. Do they ever reflect on the wisdom of that decision? With CSC stock now below $30, what would the shareholders rather have? Mike Laphen's reassurances of a rosy future or the chance to accept a $60 takeover bid?

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