Managing risks when offshoring services including a practical indian experie...
CGI Final
1. March 24th, 2015
Prepared by:
Nima Sarsangi (Portfolio Manager)
Zach Greenwald (Analyst)
Jordan Zaffino (Analyst)
Frank Coutinho (Analyst)
CAPITAL MARKETS GROUP: Equity Pitch – CGI Group Inc.
1
2. 2
Disclaimer
Strictly Private and Confidential
This presentation is being provided for the sole purpose of providing the recipients with background information about the security under
discussion. It contains the conclusion and analyses of Capital Markets Group (“CMG”) based on publicly available information. CMG has
made reasonable efforts to ensure that the information contained in this presentation is accurate as of the date hereof, however, there may
be inadvertent or unintentional errors. No representation, warranty or guarantee, express or implied, is made as to the fairness, accuracy,
completeness or correctness of information contained in this presentation, including the accuracy, likelihood of achievement or
reasonableness of any forecasts, prospects, results or statements in relation to future matters contained in this presentation. The views and
information provided herein are based on a number of estimates and assumptions that are subject to significant exploration, business,
economic, regulatory and competitive uncertainties.
This presentation provides authors opinion about the underlying security. It is not intended to be complete and the information contained
herein is not a recommendation or solicitation to buy or sell any securities. It is not intended to be relied upon as advice to investors or
potential investors and does not constitute a personal recommendation or take into account the investment objectives, financial situation or
needs of any particular investor. CMG is not acting as agent or advisor and encourages the use of independent consultants, as necessary,
prior to entering into transactions. The sole responsibility of the content of this publication lies with the authors. Its content do not reflect the
opinion of the Ryerson University or Ted Rogers School of Management (“TRSM”). Use any information regarded in this presentation at
your own risk.
3. 3
Table of Contents
Strictly Private and Confidential
1
2
3
4
5
7
Company Overview
Industry Analysis
Investment Thesis
Risks & Catalysts
Valuation
Recommendation
8 Appendix
6 Quantitative Analysis
4. 4
Company Overview
Strictly Private and Confidential
• Founded in 1976 and headquartered in Montreal, Canada, CGI is the 5th largest independent IT and business process
services company in the world. CGI Services are broken down as follows:
• IT Consulting - CGI provides a full range of IT and management consulting services, including business
transformation, IT strategic planning, business process engineering and systems architecture.
• Systems integration - CGI integrates and customizes leading technologies and software applications to create IT
systems that respond to clients’ strategic needs.
• Application development and management – Design, development, implementation, maintenance and
improvement of business applications
• Infrastructure services - Comprehensive infrastructure management capabilities that adapt to business
requirements and service priorities
• Business process services – Management of back-office business processes to streamline operations
• CGI solutions – Portfolio of 100+ CGI-developed solutions that reduce costs and create operational efficiencies
• 68,000 professionals present in over 400 offices across 40 countries
•2014 Revenue: CA$10.5 billion
•Estimated Backlog: CA$20.2 billion
STRONG GROWTH & COMPETITIVE POSITIONING
5. 5
Company Overview
Strictly Private and Confidential
• CGI’s main revenue driver is through management of
IT and business functions (outsourcing) services,
accounting for 52% of their total revenue
• US client’s account for 52% of CGI’s total revenue,
however, the majority of Q12015 new bookings signed
were in Canada (52%)
• Majority (54%) of IT solutions which CGI provides are
for Telecommunications & Utilities clients
SEGMENT REVENUE BREAKDOWN GEOGRAPHICAL REVENUE BREAKDOWN
43%
9%
48%
Application Development and Management/Infrastruture Services
Business process services
Systems integration and consulting
27%
15%
13%
13%
9%
7%
16%
U.S. Canada U.K. France Sweden Finland Rest of the world
VERTICAL MARKETS
34%
24%
19%
15%
8%
Government Manufacturing, retail & distribution
Financial services Telecommunications & utilities
Health
6. 6
Management Team
Strictly Private and Confidential
Serge Godin
Founder and Exec.
Chairman
Co-Founded CGI in
1976 at age of 26
Previous senior
experience in IT
Focused on growth
via acquisitions
(around 70) and
organic growth
Net worth: $1.17
billion
Andre Imbeau
Founder and Vice-
Chairman
Co-Founded CGI in
1976 at the age of 26
too!
Well regarded for his
leadership skills and
charisma
Nominated CFO of the
year in 2001
Michael Roach
President and CEO
Joined CGI: 2002
Previous senior
experience in Bell, and
telecommunications
Oversees many of there
acquisitions
Education: BA in
Economics and Political
Science and Honorary
Doctorate from
Laurentian University
Francois Boulanger
EVP and CFO
Joined CGI: 1998
Previous experience in
strategic management
Set up many of their
projects such as their
accounting programs
and several acquisitions
Education: CA and a
BBA from HEC Montreal
Jame Cofran
SVP and Chief
Marketing Officer
Joined CGI: 2009
Previous experience
at technology
consulting
Joined CGI after his
company American
Systems was
acquired by CGI
7. 7
Industry Analysis – Overview
Strictly Private and Confidential
• IT Consulting industry is composed of firms that help companies design and implement IT systems and software.
• Due to the low capital intensity of this industry, the majority of operators are small nonemployer firms (contract workers). As
business and government demand for web, computer and application design grows, M&A activity will rise as larger firms will seek
to acquire new talent and technology through purchases
• Total USA industry revenue was $354.2 billion with a profit of $26.9 billion in 2014, with a projected annualized growth rate of
4.0% between 2015 and 2020
• Total Canadian Industry revenue was $43.6 billion with a profit of $5.7 billion in 2014, with a projected annualized growth rate of
3.5% between 2015 and 2020
INDUSTRY OVERVIEW
KEY EXTERNAL DRIVERS
Private Investment in Computers and Software: As businesses invest in computers and software and increase the range
of equipment that requires expertise, there will be a greater demand for IT consultants who specialise in providing advisory
services and other supporting software.
Corporate Profit: Corporate profit is projected to grow between 2015-2017. Rising corporate profit enables firms to invest in
new technologies and advisory services, which precipitates increased demand for IT Consultants.
Demand from Finance and Insurance: The financial services sector represents the single-largest market for industry
operators. Finance and insurance companies handle large amounts of sensitive client data and require the use of IT firms to
secure confidential information. Demand from finance and insurance is expected to increase over the next 5 years,
Government Expenditure and Investment: Government organizations and agencies are a major market for the industry,
as they require assistance in effectively using technology. An increase in government expenditure and investment results in
a greater use of technology, thereby increasing industry revenue.
8. 8
Industry Analysis
Strictly Private and Confidential
COMPETITIVE LANDSCAPE
• The IT consulting industry is highly fragmented with the four largest companies accounting for only 13.6% of industry revenue
in the US and 12.5% in Canada
• Competition in the industry is based on price, quality of service, expertise, and breadth of service offerings
• Low barriers to entry result in a high level of competition and number of businesses 442,500 in US and 58,400 in Canada
• Opportunity for CGI to grow market share through acquisitions, thus increasing geographic presence and portfolio solutions
6.2%
4.1%
1.8%
1.5%
1.5%
0.8%
84.1%
IBM HP Booz Allen Hamilton EMC Corp Accenture CGI Other
5.2%
3.6%2%
1.7%
0.5%
87%
IBM Canada CGI HP Accenture EMC Corp Other
IT CONSULTING MARKET SHARE
United States Canada
9. 9
Industry Analysis
Strictly Private and Confidential
PRODUCT BREAKDOWN
COST STRUCTURE
• Wages comprise the largest cost due to the high level of
education and specialization that employees require
• Purchases are comprised of computer hardware &
software used in production of integrated systems
• Marketing costs are relatively small with a 2.4% industry
average, reaching up to 6% for large companies.
• System design includes custom servers & data storage.
System integration ensures different system components
coordinate and act as a whole.
• Application software allows companies to retrieve, organize,
manage, and manipulate data & databases
• Tech support uses expertise to solve problems related to
hardware, software, or entire computer systems
• Network management includes daily monitoring of client IT
infrastructure, data routing, and security analysis
• Technical consulting includes strategic management and
advice and training on using hardware and software
10. 10
Industry Analysis
Strictly Private and Confidential
PROJECTIONS
INDUSTRY REVENUE FORECAST MAJOR MARKET SEGMENTATION
• In the five years to 2020, corporate profit and demand from the finance and insurance sectors in Canada are both forecast
to grow at an annualized rate of 3.8%, with a forecast of 2.9% annually in the US
• The number of industry enterprises is forecast to grow at an average annual rate of 2.1% over the five years to 2020 in
Canada, providing CGI Group Inc. with M&A opportunities
• Increasing technology integration and product development will surge private investment in computers and software at an
estimated average annual rate of 5.5% over the five years to 2020.
• Industry Value Added (IVA), is projected to grow at an average annual rate of 4.6% over the next 5 years to 2020 in the
Canada and 4.3% in the US, primarily driven by rising industry revenue, increasing profitability and wages
USA
Financial
Services,
26%
Communications
and High
Technology, 20%
Federal and
State
Governments,
15%
Manufacturing
Industries, 15%
Other
Sectors, 14%
Retail Stores,
10%
CANADA
11. 11
Investment Thesis – Micro
Strictly Private and Confidential Sources: Bloomberg, IBISWorld
Acquisition of Logica
Other Acquisition Opportunities
Logica was a multinational IT and management consultancy company headquarters in the United Kingdom. It was acquired
by CGI Group in August 2012 for £1.7 billion in cash
• With an improved economic outlook in Europe, we believe continued progress (and revenue synergies) related to
the contrarian acquisition will be the next upward leg for this stock.
• Margins have steadily improved since the company closed the acquisition of Logica in fiscal Q4 ’12 due to the
benefits of the $575 million restructuring program. CGI reduced its exposure of low margin contracts through this
acquisition and we feel that this acquisition will to provide CGI with organic revenue growth opportunities
• CGI is expected to "transform" Logica toward higher margin/quality revenue over time through a gradual reduction
in lower quality/revenue contracts towards contracts that provide higher margin revenue (outsourcing/ application
development)
With CGI's integration of Logica now complete and the financial capacity available, we believe the company is ready to
make the next large acquisition. CGI Group Inc. has the cash on hand to execute on another sizeable acquisition:
• Over $2b in liquidity with 80% of outstanding debt fixed at 2.65% (after-tax)
• Potential target areas include IT services providers with exposure to U.S. commercial:
o US Commercial is a potential acquisition opportunity due to the strong US dollar, and will allow CGI
to easily integrate its current US IT services with a potential new acquisition
o Potential targets include software engineering and IT Consulting services, specifically EPAM
Systems and Syntel
12. 12
Investment Thesis – Macro
Strictly Private and Confidential Sources: Bloomberg, IBISWorld
• High switching costs make it hard for incumbents to enter the market.
• Whenever a modern business is looking to expand they can almost always use an IT solution to improve results.
• Strong growth out of Europe will result in increased demand.
• $1.5 trillion in global IT spending still done in-house.
• We believe global growth will be in line with World bank estimates of 3% in 2015
• Based on IBIS World industry research we expect IT outsourcing revenues to increase by 3.5% a year up until 2020.
• Strengthening European and US economies are beneficial to the company as they recognize revenues in those
stronger currencies.
Strengthening Economy
Global Analysis
We feel that the IT solutions industry is well positioned to see continued growth going into the future. As global economies
continue to recover from the great recession and companies continue to grow and expand their offerings they will
increasingly need the right IT solutions to get the job done right. CGI, now with a global presence through their acquisition
of Logica and strong product offerings are well positioned to take advantage of these coming opportunities.
Looking at the Global economy we expect growth to be inline with the World bank estimate of 3.0% in 2015 and increasing
modestly as labor markets continue to recover. This growth will be beneficial to CGI as they look to build out their global
presence and increase revenue.
13. 13
Investment Thesis – Timing/Setup
Strictly Private and Confidential Sources: Bloomberg, IBISWorld
With the stock showing relative strength over the last two years we would like to build out a position on weakness. Our target entry range
is in the $54-52 range. Although this isn’t the perfect technical setup, we like the name and think it’s worth owning.
14. 14
Catalysts
Strictly Private and Confidential
CONTRACTS
• CGI awarded $32.5 million contract to modernize systems for Virginia State Corporation Commission
• 4-year partnership on ‘Commission 2.0’ will replace Clerk’s Information System and align business
processes to better use technology
• efluid ( French utilities company) renews contract with CGI for 15 years
REVENUE DRIVERS
• We believe that CGI group will continue to see revenue growth in both their US and European markets
with the weakening Canadian dollar.
• Q12015 had CA$20.62 Billion in backlog, which is a key indicator of future revenue used by CGI’s
management to measure growth.
CLIENT DEMAND
• The continued decline in oil prices provides an opportunity as companies look to reduce costs through
the use of IT solutions.
• CGI has created a separate business unit to target the Toronto financial sector where their services are
currently under used and the see potentially large revenue growth.
• Increasing reliance on outsourcing IT services among leading global companies has shown to be a
win-win as the firms are able to better manage expenses.
• CGI can increase market share through aggressive B2B marketing strategies and client satisfaction.
15. 15
Risks
Strictly Private and Confidential
ECONOMIC
WEAKNESS
• A major risk to CGI would be European weakness which would pressure margins.
• Weakness in the Canadian economy from a slow down in housing or weakness in labour markets due to
high unemployment from low commodity prices will dampen revenue growth.
COMPETITION
CLIENT
CONCENTRATION
RISK
• A large percentage of CGI’s revenue comes from US government contracts. Although we don’t think it is
likely for these agencies to switch due to the high switching costs, a move away from CGI would have a
substantial impact on revenue.
• Changes in government budgets, while not moving away from the services provided, may cause for a
pull back in consulting and IT services spending.
• The IT services industry is a highly competitive landscape with many firms fighting for business.
Although CGI has a strong market position there are several firms with dominant positions in foreign
markets that can make it hard to compete.
• With global growth we are staring to see a shift in the skilled labor supply dynamics and the ability to
retain skilled talent is vital to future growth.
16. 2014A 2015E 2016E 2014A 2015E 2016E 2014A 2015E 2016E
Priced as of March 23, 2015, Canadian ($)
Large Cap Global IT Services
Accenture PLC NYSE:ACN $114.57 $71,875 $66,263 2.3% 11.3x 10.8x 10.2x 19.5x 18.3x 16.8x 1.8x 1.8x 1.7x
CACI International Inc. NYSE:CACI $111.91 $2,700 $4,113 0.0% 10.1x 10.2x 9.8x 15.8x 16.5x 15.9x 0.9x 0.9x 0.9x
International Business Machine NYSE:IBM $205.79 $203,400 $241,650 2.8% 7.7x 7.8x 7.6x 9.5x 9.3x 9.2x 1.9x 2.1x 2.1x
Infosys Ltd NYSE:INFY $44.99 $51,413 $44,938 1.7% 15.9x 14.6x 13.3x 23.0x 20.6x 19.0x 4.3x 4.0x 3.7x
Wipro Ltd NYSE:WIT $17.45 $42,825 $38,988 1.7% 14.0x 12.6x 11.4x 19.9x 17.7x 15.9x 3.2x 2.9x 2.6x
Cognizant Tech Solutions Corp. NASDAQ:CTSH $79.90 $48,700 $46,138 0.0% 14.7x 12.5x 10.8x 24.1x 19.6x 17.7x 3.0x 2.6x 2.2x
Cap Gemini SA EPA:CAP $104.46 $16,426 $14,837 1.7% 9.5x 9.0x 8.2x 18.0x 17.3x 15.2x 1.1x 1.0x 1.0x
Average 1.5% 11.9x 11.1x 10.2x 18.5x 17.0x 15.7x 2.3x 2.2x 2.0x
Median 1.7% 11.3x 10.8x 10.2x 19.5x 17.7x 15.9x 1.9x 2.1x 2.1x
CGI Group Inc. TSE:GIB.A $54.27 $16,930 $19,040 0.0% 11.4x 13.2x 12.7x 20.0x 16.6x 14.7x 1.8x 1.8x 1.8x
EV/RevenueP/EEV/EBITDA
Company Ticker
Share
Price
Market Cap
($ mm)
Enterprise
Value ($ mm)
Dividend
Yield
16
Valuations – Comparable Companies Analysis
Strictly Private and Confidential
Comparable Valuation Methodology: We gave 50% weighting on 2014A EBITDA multiple, 30% on 2015E, and 20% on 2016E.
Implied Valuation: (In Millions Except For Share Price and Multiples)
Comp Set is trading at 11.3 x 2014A EBITDA, 10.8 x 2015E EBITDA, 10.2 x 2016E EBITDA
50% * 11.3 * 2014A CGI EBITDA + 30% * 10.8 * 2015E EBITDA + 20% * 10.2 x 2016E EBITDA = $17,192.85
$17,192.85(EV) - $ 2,144 (Net Debt) = $15,048.85 (Market Cap)
$15,048.85 (Market Cap) / 280.7 (Diluted Shares Outstanding) = $53.61
18. 18
Valuations – DCF Output
Strictly Private and Confidential
Free Cash Flow Buildup
$mm Projected Annual Forecast
2010A 2011A 2012A 2013P 2014P 2015P
Period 1 2 3
Total Revenues $10,605.0 $10,817.1 $11,141.6
EBITDA 1,442.3 1,503.6 1,548.7
EBIT 996.9 1,049.3 1,080.7
Tax rate 25.0% 25.0% 25.0%
EBIAT $747.7 $786.9 $810.6
Depreciation & Amortization 445.4 454.3 467.9
Accounts receivable (61.1) (154.1) (431.4)
Inventories (48.5) (68.5) 46.2
Prepaid expenses 66.1 0.0 0.0
Accounts payable 9.5 (24.3) 13.8
Accrued expenses 35.0 (92.9) 26.3
Capital expenditures 2.4 2.4 2.4
Unlevered free cash flows $1,196.6 $903.9 $935.9
Discount Rate (WACC) 6.8% 6.8% 6.8%
Present value of free cash flows $1,120.1 $792.1 $767.8
Sum of present values of FCFs $2,680.0
Terminal Value
Growth in perpetuity method:
Long term growth rate 2.0%
WACC 6.8%
Free cash flow (t+1) 954.6
Terminal Value 19,791.5
Present Value of Terminal Value $16,236.1
19. 19
Valuations – DCF Output
Strictly Private and Confidential
WACC
Share Price $54.72
Diluted Shares Outstanding 280.7
Cost of Debt 3.0%
Tax Rate 25.0%
After-tax Cost of Debt 3.0%
Cost of Equity 8.9%
Total Debt ($) $2,679.7
Total Equity ($) 4,988.7
Total Capital $7,668.4
Debt Weighting 34.9%
Equity Weighting 65.1%
WACC = 6.82331%
Enterprise Value to Equity Value
Enterprise Value $18,916.1
Less: Net debt 2,144.0
Equity Value $16,772.1
Diluted Shares Outstanding 280.7
Equity Value Per Share $59.76
Implied Upside 9.210%
Implied Fair Value Share Price
Terminal FCF Growth Rate
WACC
59.8 1.50% 1.75% 2.0% 2.25% 2.50%
5.8% $ 68.14 $ 72.37 $ 77.15 $ 82.60 $ 88.87
6.3% $ 60.38 $ 63.72 $ 67.45 $ 71.64 $ 76.37
6.8% $ 54.07 $ 56.77 $ 59.76 $ 63.07 $ 66.77
7.3% $ 48.84 $ 51.07 $ 53.51 $ 56.19 $ 59.15
7.8% $ 44.45 $ 46.31 $ 48.34 $ 50.55 $ 52.97
SESITIVITY ANALYSIS
20. 20
Valuations – Base/Bull/Bear Cases
Strictly Private and Confidential
Base Case:
Using conservative growth rate estimates lower
than historical growth rates and lower than
expected forward looking projections, we have an
Implied Value Per Share @ $59.76
Bull Case:
Using anticipated growth estimates on par or slightly
higher than historical growth rates and using expected
forward looking projections, we have an Implied Value Per
Share @63.07
A strong recovery of the European macro environment
resulting in robust demand, driving mid-single-digit
revenue growth and margin expansion and an earlier
turnaround of the US federal business.
Bear Case:
Using growth estimates based on a worst case scenario
(slowdown in US, Canadian and European economy and
low terminal growth rate), we have an Implied Value Per
Share @ $50.96
The bear case is also based off of a slower recovery in
the European macro environment resulting in weaker
demand of consulting and professional services.
Furthermore, the base case is based off of a slower
turnaround in the US federal business. This will lead to
low single-digit revenue decline and flat margins.
Enterprise Value to Equity Value
Enterprise Value $18,916.1
Less: Net debt 2,144.0
Equity Value $16,772.1
Diluted Shares Outstanding 280.7
Equity Value Per Share $59.76
Implied Upside 9.210%
Enterprise Value to Equity Value
Enterprise Value $19,845.6
Less: Net debt 2,144.0
Equity Value $17,701.6
Diluted Shares Outstanding 280.7
Equity Value Per Share $63.07
Implied Upside 15.262%
Enterprise Value to Equity Value
Enterprise Value $16,445.4
Less: Net debt 2,144.0
Equity Value $14,301.4
Diluted Shares Outstanding 280.7
Equity Value Per Share $50.96
Implied Upside -6.878%
21. 21
Valuation – Final Valuation
Strictly Private and Confidential
Final Valuation
20% Comps and 80% DCF
EV (DCF)
20% Comps
+ 80%DCF
Less Net
Debt
EV (Comps)
Dil Share O/S
$18.92 Bil
$18.57 Bil
$2.144 Bil
$17.19 Bil
281 Mil
Valuation
Value/Share $58.46
Upside 7.72%
22. 22
Recommendations
Strictly Private and Confidential
BUY: GGI (TSE:GIB-A) @
Current Market Price
Hard-Stop
Target Exit
Target Entry
Position
$50.96
$60.00
$54.27
1.5%
overweight
100%
XIT.TO
Valuation Metrics
EV 18.57 CAD$Bil
EV/EBITDA 11.4 x
P/E 19.16 x
Market Cap 15.29 CAD$Bil
58%22%
20%
XIT.TO
Telus (T.TO)
CGI Group
(GIB.A)
SUMMARY
• CGI Group Inc. is among the world’s largest independent IT
consulting firms with potential to capture greater market share
through increased demand and strengthening economy
• Macro and micro environment creates a favourable environment for
CGI Group Inc. to grow its client base
• P/E 2014A of 20.00x and EV/EBITDA of 11.4x
CURRENT PROPOSED
24. 24
Appendix A.
Strictly Private and Confidential
Terms:
Industry Value Added (IVA): The value added of an industry, also referred to as gross domestic product (GDP)-by-industry, is the
contribution of a private industry or government sector to overall GDP. The components of value added consist of compensation of
employees, taxes on production and imports less subsidies, and gross operating surplus. Value added equals the difference between an
industry’s gross output (consisting of sales or receipts and other operating income, commodity taxes, and inventory change) and the cost of
its intermediate inputs (including energy, raw materials, semi-finished goods, and services that are purchased from all sources
Backlog: Revenue Backlog is the sum of the future revenue in the revenue schedules used to recognize revenue of the term of an
agreement. Revenue backlog is the amount of contracted revenue that has yet to be recognized.