Atos And DXC Technology Deal ‘Not For The Faint Of Heart:’ Analyst

MoffettNathanson anticipates that the combined entity could see about $300 million in cost synergies, but would not be able to increase revenues in the first year beyond one percent.

The potential $10 billion deal between DXC Technology and French IT services company Atos is “modestly attractive” but Atos is not much better off than the company it is eyeing for acquisition, longtime DXC analysts MoffettNathanson said.

“Like DXC, Atos’s service portfolio is heavily weighted toward traditional datacenter services – Atos does not have a large portfolio of high-growth digital and cloud services that would be obvious upsell offerings into the DXC base,” the company warned. “ So, while there would certainly be some tactical opportunities to cross-sell, or leverage the global reach of Atos+DXC to expand wallet share with multi-nationals, we don’t anticipate these revenue synergies to be significant.”

French IT services company Atos – which Ellis said has flat to negative revenue growth -- announced it had made an offer of more than $10 billion for DXC, according to Reuters. DXC confirmed the bid and said its board was considering the offer.

“This stock is not for the faint of heart: DXC’s core business (~50% of revenues) is in long-term structural decline,” Ellis wrote, “and DXC has so far made limited progress transitioning to new, higher growth service lines in Digital and Cloud.”

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Ellis anticipates that, if merged, the combined entity would see about $300 million in cost synergies, but would not be able to increase revenues in the first year beyond one percent.

“We believe that the combination of DXC and Atos would be modestly attractive for the two firms – incrementally enhancing the customer value proposition of the two standalone firms and creating an opportunity for optimization of SG&A expense base,” analyst Lisa Ellis wrote in the firm’s report last week.

She said DXC is improving under the leadership of CEO Mike Salvino, who has eliminated many of the destructive policies that ex-CEO Mike Lawrie employed such as price concessions and rapid head count reductions that led to customer churn. She said the company is battered, but thanks to its deep relationships with enterprises is “recession resilient,” and on track to stabilize revenues by late 2021.

“We believe much of DXC’s recent deterioration in performance was driven by execution errors by the prior management team … which have since been halted or reversed. Although DXC’s core business is in structural decline, it is sticky, highly-recurring, and reasonably recession-resilient; we expect DXC can, over time, stabilize revenues at ~ flat, and, with revenue stability will come margin stability and better FCF generation.”

Whether the deal benefits DXC shareholders depends on how much higher than $10 billion Atos is willing to go. MoffettNathanson said at $11 billion DXC’s shareholders would receive $29.7 per share – about a 15% premium to the Dec 31 close, but still 7% below the company’s 12-month target price for DXC. At $12 billion evaluation, DXC’s shareholders would receive $33.7 per share or about a 30% premium to the Dec 31 close, and 6% above the analysts 12-month target price for DXC.

“We tested a range of purchase values from $10 billion in enterprise value to $12 billion in enterprise value,” she wrote. “We estimate that at $10 billion deal value, DXC’s shareholders would receive $25.8 per share – no premium to the Dec. 31 close and 19% below our 12-month target price for DXC.”

Ellis said the value of the buy for Atos – which is currently sitting on $5 billion in debt -- is to grab DXC’s list of Fortune 500 clients which the French solution provider cannot match. Additionally, she said DXC’s offerings through its Luxoft acquisition could help Atos win share among European customers seeking digital transformation.

“With DXC, Atos would gain immediate access to DXC’s enviable client list of large U.S. enterprises,” her report states. “The combined firm would be moderately better positioned than standalone DXC to grow share of wallet with these larger customers by leveraging its global footprint (many of these clients are multi-nationals) and offering a broader portfolio of Digital & Cloud services (including DXC’s digital offerings acquired with Luxoft and Atos’ OneCloud offering).”