CGI/Logica - Can We Deliver and Be Brilliant Together?

Looking through yesterday’s press comment on the proposed CGI/Logica deal leads me to believe I am the only analyst to express surprise that Logica attracted a trade bidder. Indeed, we even received a comment from a UKHotViews reader who proffered that because I got this so very wrong (see Will Logica run Canada dry?), perhaps I should look again at my fundamental assumptions.

The prevailing sentiment in the analyst community seems to be that because Logica is so ‘cheap’ then it was sure to attract a bidder. Well, I don’t know about that. I was always brought up to believe that just because something is ‘cheap’, that doesn’t necessarily mean you should rush out and buy it. Indeed, that is often the very reason you wouldn’t touch it with a bargepole!

So, I spent a few happy hours poring over the 59-page announcement letter, looked at lots of pretty slides, and listened to the investor concall, to try to understand why Michael Roach, President & CEO of CGI (strapline: We Deliver) thought it was a jolly good idea to acquire Logica (strapline: Be Brilliant Together), and what’s more make it work for all concerned, clients, employees and investors.

And finally I twigged.

He thinks he’s buying one company.

In fact, not only does Roach think that, but so do the sell-side analysts in the eminent North American investment banks who track CGI’s stock and who, judging from the concall, have little idea who Logica is, let alone what they do. They all seem to believe that Logica is simply a ‘European CGI’ – so ‘of course it will fit’.

Well it isn’t. Logica operates in no fewer than 24 European countries and 19 others worldwide. Each has its own culture, language, sales and delivery processes, regulatory environment and economic head- and tail-winds. CGI isn’t trying to buy one company – you could argue it is in effect trying to buy 43!

And does the deal make financial sense? Investors seem to think so, pushing CGI’s stock up 14% yesterday, though part of this would be accounted for by the simple addition of Logica’s earnings. Roach claims that the deal will generate “annual integration benefits totalling £125m by the end of the third FY at a one-off cost of £165m over 3 years” (by the way, how do you have a one-off cost that lasts 3 years?). These ‘benefits’ exclude the proverbial ‘revenue synergies’ and seem based mostly on back-office and related non-operational savings.

Well, I’m sorry, that’s not the place to be looking. It’s not Logica’s back-office that needs fixing (I am assuming CGI’s looks pretty clean and smart). It’s the pointy end of the business.

And please don’t get blinded by the brilliance of CGI’s 14.7% ‘adjusted’ EBIT margin. Its European operations enjoy an ‘adjusted’ EBIT margin of just 6.1%, pretty much in line with Logica’s 2011 ‘adjusted’ margin. Do they think that if they add the two companies together then European margins will double? In fact Europe (including the UK) would comprise almost 60% of the combined businesses – you can do the margin calculations for yourselves.

Folks, if this deal does go ahead, then ‘acquisition indigestion’ won’t even begin to describe the pain.