Chain Bridge Investing’s (“CB” or “we” or “our”) evaluation of Computer Sciences (CSC 46.45 ↑2.47%) Corporation (“CSC”, “Computer Sciences Corp.” or the “Company”) is based primarily on fundamental factors such as past, current and potential operating performance, as well as the Company’s current competitive environment. There is no guarantee that the market price of the Company will eventually reflect its implied value as derived from fundamental factors. This post, along with the others in this series, does not analyze the technical aspects of the Company’s stock price and its volume patterns. Furthermore, the reader should note that this post is one of multiple posts by Chain Bridge Investing regarding CSC.
CSC was founded in 1959 and provides information technology (“IT”) services, outsourcing, and professional services to its commercial and government clients, globally. The Company delivers its services through three segments.
North American Public Sector (“NPS”)
NPS provides a broad range of IT services to various agencies in the U.S. federal government. Such services include systems integration, enterprise modernization, telecommunications, training, and outsourcing. NPS accounts for approximately 39% of CSC’s revenue with nearly 70% of NPS revenue allocated for defense contracts and the remaining 30% allocated for civilian contracts.
In fiscal year 2010, NPS grew its revenue 4.1% from $6.0 billion in fiscal year 2009 to $6.2 billion in fiscal year 2010. NPS was the only segment to record positive growth for fiscal year 2010. Nevertheless, some market participants fear that this segment faces headwinds from efforts to: (1) reduce the deficit and cut federal spending; and (2) in-source more of the government’s functions.
Regarding the government’s budget for fiscal year 2011, there remains a healthy demand for IT services and the budgets for Defense, Homeland Security, and Intelligence remain intact. Furthermore, CSC has been repositioning itself to better service high growth areas such as healthcare, cybersecurity, logistics, and training and simulation. CSC has already developed an expertise in these high growth areas, which will help it offset or mitigate any future budget reductions. For instance, CSC has several years of experience implementing healthcare IT solutions for both the public and private sectors in both the U.S. and Europe. CSC has received various awards since 2008 recognizing its commitment and expertise in implementing various healthcare IT solutions. It would be a very unlikely that CSC failed to pick up profitable work in the healthcare IT sector.
Moreover, recent results from both Accenture and IBM, CSC’s competitors, have demonstrated that government spending continues to be strong – at least at the federal level. Accenture recently stated that it continues to see growth in its outsourcing business led by increased volumes at existing clients in U.S. federal and health practices. Also, IBM reported on July 19, 2010 that the revenue from its federal clients has increased 5%, while state and local government clients experienced more adverse cutbacks and reductions.
As far as in-sourcing, CSC has few acquisition support contracts so its exposure to in-sourcing efforts is limited. The in-sourcing movement appears to be more of a threat against small business contractors, than the large contractors. Simply, the volume of the in-sourcing contracts is not large enough to significantly hurt CSC’s NPS revenue.
In our opinion, NPS will continue to face headwinds, but remains well positioned to benefit from the aforementioned high growth markets, which will mitigate or more than offset any negative impact from the headwinds.
Managed Services Sector (“MSS”)
MSS provides information systems outsourcing services to clients in many industry verticals. MSS accounts for approximately 40% of the CSC’s revenue.
MSS revenue declined from $6.9 billion in fiscal year 2009 to $6.5 billion in fiscal year 2010, a decline of approximately 6.8%. The decline appears to be primarily due to a reduction in the scope and volume of work at large clients, however, such declines were – in part – offset by the continued growth of CSC’s client base.
While MSS currently experiences some setbacks as clients seek to reduce their discretionary spend, CSC continues to position itself to be a significant player in the cloud, cybersecurity, and IT outsourcing markets. These three markets all represent strong potential growth for the Company and play to previous established strengths. One should note that CSC is not new to any of these high growth markets, allowing it a good probability of growing MSS as the markets grow.
Although, at this time, some of MSS’ services are viewed by clients as discretionary, such perceptions are likely to change as companies continue to seek to improve profits and compete with each other. TPI, an outsourcing consultant, reported on July 20, 2010 that cost-cutting and cloud computing are becoming increasingly more important factors in persuading companies to implement outsourced solutions. As more companies accept MSS’ services as necessary and not discretionary, the markets will most likely grow and increase the long-run growth potential for MSS.
Business Solutions and Services (“BSS”)
BSS provides industry specific consulting, systems integrations, software solutions, and business process outsourcing (“BPO”). BSS’ clientele is very diverse and spread across multiple industry verticals. BSS accounts for approximately 22% of CSC’s revenue.
BSS revenue declined from $3.9 billion in fiscal year 2009 to $3.6 billion in fiscal year 2010, a decline of approximately 9.8%. The decline appears to be primarily due to a reduction in contract work, various delays and cutbacks on the National Health Services contract, and the sale of a business in Hong Kong. BSS’ services are arguably the most discretionary of CSC’s total business. Consulting, as an industry has been taking hits, as IBM and Accenture have both recently stated that their consulting businesses are in decline.
Although BSS does not appear likely to improve until the global economy begins to fully recover and clients feel better about discretionary spending, CSC is trying to increase the profitability of BSS through increased offshore delivery as well as consolidation of facilities and data centers. Furthermore, the Company continues to try to position BSS into emerging economies to benefit from the high growth opportunities, which still remains a relatively small portion of the Company’s revenue.
Moreover, long term, we believe the BPO market will continue to grow as companies focus on increasing profitability. Our logic is that a company usually reinvests its earnings and cash flow into its core functions and not necessarily its administrative activities and support functions. Companies like CSC, whose primary function is to provide such support functions/services, invest in these activities allowing them to offer better services at a cheaper price than what the companies would most likely be able to achieve if the services were kept in house. Basically, one obtains more for less.
CSC's Global Presence
CSC is a global company, which derives approximately 63.2% and 27.3% of its revenue from the U.S. and Europe, respectively. Latin America and Asia account for the remainder of its revenue. We consider a globally diversified client base to be a positive for CSC. Such diversification will help the Company to eschew and offset some of the negative headwinds that could be occurring in one location. Nevertheless, in regards to diversification, we would like to see more Latin America and Asian exposure in the future. At present, the Company is positioning itself for exposure to the growth from the emerging economies in both Asia and Latin America, but as seen in Exhibit 2 such actions have not yet shown results in the Company’s operations.
Disclosure: Long CSC