October 17, 2015 - 12:02am EST by
2015 2016
Price: 72.00 EPS 5.51 5.96
Shares Out. (in M): 103 P/E 13.1 11.4
Market Cap (in $M): 7,423 P/FCF 17.7 15.6
Net Debt (in $M): -354 EBIT 855 893
TEV (in $M): 7,069 TEV/EBIT 8.3 7.5
Borrow Cost: General Collateral

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  • IT Services
  • Secular headwinds



Investment Thesis

  1. Atos will face structural growth headwinds in Managed Services over the next 12-18 months due to outsourcing deflation as IT Infrastructure outsourcing contracts come up for renewal, driven by the cloud threat and offshore competition.  This is in dramatic contrast to management’s and the Street’s expectations for a growth acceleration over the next few years.

  2. The gradual shift to cloud-based services in Europe will increase pressure on Atos’ Managed Services organic growth, free cash flow, and ultimately its terminal multiple.  HP and IBM are case studies for the obsolescence risk and terminal multiple pressure that Atos could face as investors shift focus from Atos’ adjusted EPS to its low-quality, structurally declining free cash flow.

  3. Management’s “Ambition 2016” targets are aggressive and may be at risk, as its margin and FCF targets depend on a return to organic growth, which I believe is unlikely given Atos’ weak competitive position amidst the gradual industry-wide shift to the cloud.

  4. At 17.5x CY16 EV/ULFCF for core Atos (incl. pension), ATO does not price in the major risks facing its legacy ITO business - vs. the U.S. peer group which trades at ~10x.  In my base case where the Managed Services segment (58% of sales ex. Worldline) returns to shrinking organically and de-rates, core Atos should be valued at 12x CY16 EV/ULFCF, for a target price of €54/share (~25% upside from my target €72/share entry price).  A bull case re-rating to 18x EV/ULFCF would have 18% downside. 1.4x up/down to the short.


Street Bull Case

  1. Organic growth should improve to ~1% in 2H15 due to better Consulting & Systems Integration growth and to 1-2% in 2016 with improvements in all service lines.  The European outlook is improving and North America should be a growth driver with Xerox ITO (organic growth target of 3-5%).  Cloud is a secular headwind, but not in the near/medium term, and Atos does have private cloud exposure.  With gradual top-line improvement plus cost synergies from acquisitions, ATO should grow EBIT and EPS at a 15-20% CAGR over the next three years.

  2. FCF quality should improve as restructuring and M&A integration costs normalize beyond 2016, and there is significant optionality relating to further value creation from a potential near-term Worldline M&A deal as well as longer-term Atos acquisitions.

  3. At ~11x CY16 P/E on my target €72/share entry price, ATO is trading slightly below its all-time historical average (11.4x) and at a sizable discount (~30%) to IT Services peers, even though Atos is performing better than U.S. peers like HP and CSC.  Atos should trade at a more reasonable 13x CY16 P/E, for a bull case price target of  €85/share (18% upside for the long at my  €72/share entry price).


Company Overview

Atos SE (ATO FP) is a European IT Services company specializing primarily in data center infrastructure outsourcing, with lesser exposure to business process outsourcing (BPO), consulting & systems integration (CS&I), cloud, big data & cyber-security, and payment services.

  • Founded in 2000; headquartered in Bezons, France

  • 2014 pro forma revenue of  €10bn and 93,000 employees in 72 countries (post-Xerox ITO acquisition which closed on 6/30/15)

  • Serves mostly the Public & Health, Transportation, and TMT sectors, as well as Manufacturing, Retail, Utilities, and Financial Services

  • Has made several acquisitions & divestitures in the past few years:

    • Acquired Siemens Information Services (SIS) in July 2011

    • Acquired Bull (French cloud/big data/security company) in May 2014

    • Divested 26% of its stake in Worldline (WLN FP), its payment processing unit, in June 2014 via IPO and still retains a ~70% stake

    • Acquired Xerox IT Outsourcing (ITO), a former subsidiary of Xerox, in June 2015


What does Atos do?

  • Atos generates most of its revenue from Outsourcing (60-65% of total revenue; 65% of Managed Services revenue; 35-40% of IT Services revenue)

  • Within Outsourcing, Atos focuses primarily on Data Center & Desktop Outsourcing (50-55% of Outsourcing revenue; 30-35% of total revenue), the businesses most at risk from the growing cloud & automation threats in Europe


Data Center Infrastructure Outsourcing 101:

  • Many organizations have realized that outsourcing their data centers is the best way to align IT and business in the most cost-effective manner

  • Benefits from DC outsourcing include:

    • Lower financial and operational overheads

    • Ability to stay focused on core business areas and leave IT management to the experts

    • Maximum freedom and flexibility in daily IT operations

    • Protection of IT infrastructure from technology obsolescence

    • Proactive monitoring and management of their hosted IT infrastructure


Atos Business Mix:

  • Atos generates most of its revenue from Managed Services, especially from the Public & Health sectors

  • The business is concentrated in continental Europe, with heaviest exposure to France, Germany, UK, and Benelux & The Nordics

  • With its  €811mm acquisition of Xerox ITO in June 2015, Atos increased its U.S. revenue mix from <10% to ~20% (on PF 2014 #s)



What Else is Getting Outsourced?

  • Typical areas delegated to managed and outsourced data center providers include:

    • Full functionality and support of all elements within their data centers

    • Troubleshooting and help desk

    • End-user support and infrastructure operations

    • Hardware maintenance and network operations

    • Monitoring and management (server, systems, etc.)

    • Security

    • HVAC

    • Disaster recovery, storage management, and backup (power, data)


Global IT Services Industry Overview

  • IT Services was a $955bn industry globally in 2014 (+1.9% growth, +3.5% ex-FX), projected to decline -3.7% to $919bn in 2015 due to currency headwinds (+3.8% ex-FX) per Gartner

  • IT Services is expected to grow at a 4.3% CAGR from 2015-2019, driven by broader IT spending growth and supplanted by a shift from broader IT spending growth and supplanted by  shift from traditional IT infrastructure outsourcing to digital & cloud-based services

  • With outsourcing contributing more than half of market growth in constant currency, the global IT Services market is expected to reach $1.1bn in 2019



  • The forecasts for Infrastructure Outsourcing (Atos’ core Managed Services business) and Implementation services (each growing at 2.6% from 2015-19) are weaker than the overall IT Services market (4.3% CAGR)

  • Increasingly, buyers prefer solutions that minimize time and cost of implementation, driving demand for more efficient delivery methods, out-of-the-box implementation, and lower-cost solutions

  • This trend benefits Business Process as a Service (BPaaS) and Cloud Services (9.6% and 28.2% CAGR from 2015-19) at the expense of Infrastructure Outsourcing (the primary business in Atos’ Managed Services segment)


  • For Atos’ other primary segment, Consulting & Systems Integration, research analysts expect MSD growth through 2019

  • Gartner expects 7% growth in spending on IT consulting through 2019, driven by vendors who have demonstrated their ability to stimulate new demand from buyers looking for help with navigating business and technology complexities, particularly related to building a digital business

  • IDC expects the global System Integration market to grow at a 3% CAGR over 2014-19


IT Services Market Outlook

Atos’ core business, Traditional IT infrastructure outsourcing, faces increasing secular headwinds over the next five years.

  • Gartner expects continued pricing pressure and secular challenges in ITO spending as the market moves from traditional, on-premise, asset-heavy outsourcing models to virtual, asset-light, more-agile delivery models

  • Increased adoption of offshoring in geographies, such as continental Europe, will exacerbate negative pricing trends

  • 70% of CIO survey respondents indicated a desire to change sourcing vendors over the next 2-3 years (as of 3Q15)



Competitive Landscape

  • The IT Services market is the most fragmented market of the technology industry, due to the segment’s low barriers to entry

  • The U.S. is a more competitive market than Europe, where the global IT Services bellwethers have a stronger foothold and execution is key to remain competitive in that landscape

  • The top two providers, IBM and HP, have continued to lose market share since 2011, struggling to both drive growth and maintain margins due to secular challenges and a hypercompetitive marketplace undergoing major digitalization shifts



  • Although Atos has gained market share from 2011-14, Europe is becoming increasingly competitive as IT Services customers begin to focus on the substantial benefits offered by shifting from traditional to cloud-based outsourcing

  • Increased penetration of offshore pure-plays in Europe (e.g. Indian competitors such as Tata/TCS) who are well-equipped with these cloud-based services also poses a rising threat to prices and margins for traditional ITO companies like Atos


Historical Financials

Atos’ organic growth has been muted over the past five years due to structural headwinds for its legacy IT solutions – while reported revenue growth and margin/EPS growth have been driven by acquisitions and their associated cost synergies, respectively.

  • 2H11: Atos acquired Siemens Information Services (SIS), which had a major positive impact to EBIT margins in Managed Services and C&SI segments.

  • 2H14: Atos acquired Bull (French company, primarily Big Data & Cyber-security), which created the Big Data & Cyber-security segment. Atos acquired this low-growth low-margin business for its cost synergy opportunities and its exposure to "all things digital” (e.g. Cloud, Big Data, Cyber-security)



Recent Stock Performance

  • Atos’ stock price is trading near its last 10-year high and its forward P/E multiple trades in line with its last 5-year average, on increasing optimism from the Street around the company’s gradual top-line improvement (on company-adjusted organic growth figures after backing out recent contract losses) and margin expansion from acquisition cost synergies



Overview of the Cloud Threat

Gradually increasing threats from cloud trends in Europe should create a secular headwind for Atos’ core ITO market.


General Cloud Themes:

  • The interrelated themes of cloud and automation are driving a transformation in Atos’ core market of infrastructure outsourcing (ITO) – significantly lowering price points, revenue visibility and – most importantly – labor intensity, while driving up capital intensity

  • Over time, cloud applications reduce the demand for customized implementation and development, as well as infrastructure maintenance

  • The average deal size for a cloud implementation is typically smaller than traditional on-premise systems integration work (often 25-50% of the size of an equivalent on-premise implementation)

  • Today the high volumes of deals are offsetting the lower values, but this does not appear sustainable given increasing competition from offshore Indian pure-plays and given that Atos is lacking on the technological innovation front

  • Cloud also reduces the tail of follow-on services, which would have historically accompanied on-premise applications


Cloud Challenges Driving Outsourcing Deflation

  • Almost all European CIOs surveyed are expecting pricing declines on existing IT outsourcing contracts

  • While an element of deflation is typically built into outsourcing contracts, the largest outsourcing providers face additional challenges from public and private cloud and the break-up of monolithic contracts into “multi-tower” contracts shared amongst multiple suppliers

  • Given the threat of public cloud, CIOs have gained negotiating leverage with their outsourcing suppliers and are using this to put pressure on suppliers’ pricing even though large-scale shifting of legacy workloads to public cloud infrastructure-as-a-service (IaaS) is not a serious prospect near-term in most cases

  • However, these threats are not idle – some CIOs have reduced outsourcing fees as a result of Office 365 and ServiceNow deployments, for example

  • Given overall momentum behind the Cloud and increasing maturity of SaaS and IaaS offerings, IT services vendors are being compelled to offer pricing concessions to maintain existing contracts

  • These trends are aligned with overall dynamics within the Outsourcing market, with most of the major listed vendors seeing flat to declining revenue over the last couple of years

  • Only Accenture among the major Western vendors appears to be bucking the overall trend, likely based in large part on its high mix of BPO within its outsourcing business (supposedly ~1/3 of the outsourcing business per Accenture IR), which is relatively insulated from pricing pressure on IT since most of the value of the service is not tied to specific tech components in the majority of deals





Offshore Competition is Intensifying...

India-based ITO competitors are the lowest-cost providers and are finally starting to take market share in Europe.

  • Indian competitors are pushing into the European outsourcing market and are increasingly involved in a large portion of final selection rounds for outsourcing deals, causing Atos to face increasing pricing pressure and competitive threats related to deal wins

  • Although at a slower pace than in past years, India-based vendors continue to grow above the market average, making incremental market share gains

    • In a market that grew 3.4% in 2014, the top five India-based vendors collectively grew~15% (and are poised to grow even higher in 2015), yet still represent only ~4% of the total market