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DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST
CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do
business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a
conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in
making their investment decision.
This document is being provided for the exclusive use of JACOB BRAHMS at ARTEMIS INVESTMENT MANAGEMENT LLP
10 July 2014
Table of contents
Investment View 3
Executive Summary 3
Investment Thesis 3
Opportunities for Growth 3
Financial Inflection 4
Valuation 4
Key Risks 4
IT Services Trends Positive 5
1) Economic Trends 5
2) Technology Trends 8
3) Micro Indicators Healthy 10
What it means 11
Build and Buy is Building Value 12
Reaching Global Scale 12
Buying - Surfacing M&A Returns 14
Builders not just Buyers 16
A view from HOLT® 17
Building and Buying Can Drive Further Market Share 19
Accounting for FCF Growth 20
Accounting Issues Raised by the Logica Acquisition 20
Assessing Accounting Quality 20
What it Means 24
Key Outlook Issues 25
Europe Outsourcing an Opportunity 25
U.S. Federal Government IT Trends 27
Canada: Stability at the Core 30
Balanced Delivery Network 32
Summary 33
Capital Structure 34
Capital Priorities 35
Financial Assumptions 37
Valuation 39
Key Risks 44
Appendix A: Company Overview 45
Appendix B: Balance Sheet & Cash Flow Forecasts 47
Appendix C: Management and Board of Directors 49
Appendix D: Compensation & Governance 50
Compensation 50
Governance 50
Appendix E: Peers Map 51
Investment View
Executive Summary
We are initiating coverage of CGI with a $48 target price and an OUTPERFORM rating. We are initiating coverage of
CGI has grown organically and through M&A to become one of the larger independent CGI with a $48 target price
global IT service firms. In our view, CGI is well positioned to continue to grow market and an OUTPERFORM
share and free cash flow as it leverages its larger European platform, benefits from cyclical rating.
and secular spending trends, and makes select acquisitions.
Investment Thesis
Constructive on IT Services
From a macro perspective, we are constructive on the IT services sector. In our view, CGI CGI is well positioned to
is well positioned to benefit from improving macro trends in Europe and U.S, which has benefit from improving
historically led to higher discretionary corporate IT spend. Additionally, recent corporate macro trends in Europe and
surveys indicate that technology spending, and IT services in particular, remains one of U.S.
the top priorities for U.S and Europe corporations. Overall, we believe these industry
tailwinds provide support to our expectations for CGI's revenues to recover, with revenues
expected to grow 3% y/y in 2015E up from -2% y/y in 2014E.
Build and Buy Strategy is Building Value
We believe CGI is an attractive investment within the sector. Using its Build and Buy CGI is an attractive
model CGI has quietly become one of the larger global IT service providers, with over 80% investment within the sector
of revenues now generated outside of Canada. Throughout its expansion, CGI has based on strong execution
demonstrated a recurring ability to integrate acquisitions effectively into its operations and of its Build and Buy strategy
a capacity to instill strong operating processes into its growing platform. The result of and opportunity for further
CGI's execution has been rising ROIC in a range of economic and revenue cycles, with its market share growth.
current ROIC reaching 13%. A HOLT® analysis suggests the market continues to
underestimate the future return potential of its assets, consistent with our own forecasts.
Over the long-term, we believe CGI is positioned to grow share in the relatively
fragmented IT service sector by continuing to execute on its build and buy strategy. In the
near-term, CGI should realize further returns from the recent Logica acquisition, as we
expect overall operating margins to rise to 13.1% in 2015E from 10.7% in 2013E.
Accounting for Free Cash Flow
Since the Logica acquisition, CGI's working capital has become more volatile and its cash CGI has a relatively healthy
conversion has declined owing largely to higher restructuring payments. We believe this accounting track record, and
volatility has contributed to some concerns over CGI's accounting quality and recurring that cash conversion trends
FCF potential. Our historical analysis highlights a healthy and relatively stable accounting will improve.
track record, consistent with peers. As we discuss, many of the recent working capital
adjustments appear specifically related to the large and complex acquisition of Logica. We
expect cash conversion trends to recover in 2015E, contributing to free cash flow growth
of over 40% to $3.38 per share and also providing scope for further stock re-rating.
model, provide it with the necessary flexibility to offer high-end services and cost efficient
options as customer demands evolve.
Financial Inflection
In our view, CGI's financials are approaching an inflection point as revenue headwinds The company's revenues
moderate, operating margins show further improvement, and cash conversion returns to and cash conversion metrics
normalized levels. In fiscal 2014E we forecast revenues to decline -2% y/y due to are reaching an inflection
European contract pruning and near-term U.S. Federal funding pressures, but as these point.
headwinds moderate and European revenue accelerates, we expect revenue to grow +3%
y/y in 2015E. Margin improvement is expected to remain a key financial driver, and we
forecast operating margins to rise to 13.1% in 2015E from 10.7% in 2013 as CGI
continues to leverage its European platform. Overall, we estimate CGI's consolidated EBIT
increases 24% y/y in 2014E and 7% y/y in 2015E. Importantly, we also assume
restructuring costs and working capital swings are largely cycled by 2015E, providing a
basis for FCF conversion ratios to return to more normalized levels.
Valuation
The success of CGI's Build and Buy strategy has been reflected in its strong price Our $48 target, which is
performance over the past decade with its stock price rising at a CAGR of 16%, well above based on a DCF model,
both the S&P and TSX at 6%. Despite the strong stock price performance, CGI continues assumes an 8.5% WACC
to trade at a reasonable 12.1x forward P/E, and in-line with its average U.S. peer discount and 1.0% terminal growth
of 1.5x. We have historically found adjusted earnings to be one of the more important rate.
stock price drivers, and with adjusted EPS expected to rise to $3.15 in 2015E from $2.30
in 2013, a 2-year CAGR of 17%, we are constructive on the upside potential of the stock.
CGI also continues to support a healthy FCF yield of 9% in 2015E, a slight discount to
industry leader Accenture, to which it has historically tracked. Our $48 target price is
based on a DCF model that assumes an 8.5% WACC and 1.0% terminal growth rate.
Key Risks
Key risks for CGI include: (1) The risk of lower IT service demand due to cyclical or Key risks include lower IT
secular shifts, (2) Competitive pricing pressures on bids that could impact future margins service demand,
or revenue growth, (3) Lack of execution on existing contracts that could affect financials competition and contract
or stock sentiment, (4) M&A activity that is dilutive to earnings, and (5) Negative non-cash execution.
working capital changes that do not improve as expected.
1) Economic Trends
An improving economic cycle should be supportive of corporate IT service spend, a U.S. IT service spend tends
portion of which is discretionary. We have historically found that U.S. IT service spending to lag GDP by 2-4 quarters.
tracks GDP momentum on a two-to four- quarter lagged basis, with information processing
equipment and software investment (a sub-segment of the BEA's GDP number) the best
leading indicators. For some industry perspective, we highlight the growth trend of this
GDP sub-segment against industry leader Accenture's revenue growth in the Americas
(see Exhibit 1), as well as global IT service spending against Global GDP. (See Exhibit 2.)
Exhibit 1: U.S. GDP – Information Processing Equipment Exhibit 2: Global GDP vs. Global IT Service Revenues
& Software vs. Accenture C/C Revenues
25.0% 12.00%
20.0% 10.00%
15.0% 8.00%
10.0%
6.00%
5.0%
4.00%
0.0%
2.00%
-5.0%
0.00%
-10.0%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
-15.0% -2.00%
-4.00%
-6.00%
GDP - Information Processing Equipment & Software
Accenture CC Revenues Y/Y Global GDP Y/Y Global IT Services Y/Y
Source: Thomson Reuters, Credit Suisse estimates Source: Thomson Reuters, Gardner, Credit Suisse estimates
As such, continued stability in the U.S. and rising corporate prospects in the UK and Improving macro trends in
Europe should be supportive of global IT service spend. According to our Credit Suisse the U.S. and Europe should
economic team global GDP is expected to rise to 3.2% in 2014E from 3.0% in 2013 led by be supportive of IT services.
developed markets in particular, and further accelerating to 3.9% in 2015E.
10 8.8
8.3 8.2
7.5 7.3
8 6.4
6.1
5.5 5.3
6 4.5 4.9 4.7 4.5
2.7
4 4.8 5.0 5.2 5.2
4.5
3.6 3.9 3.9
2 2.6 3.0 3.1 3.0 3.2
2.6 2.8 2.4 2.6 2.4
2.0 2.4 2.0
0 1.4 1.5 1.4 1.2
-0.1
-2 -0.8
-4
-3.7
-6
02 03 04 05 06 07 08 09 10 11 12 13E 14E 15E
European economic prospects, from which CGI now derives over 50% of its revenues, are
particularly encouraging. For example, after a very long recovery period, European
domestic demand is finally starting to show signs of improvement, which could be a
positive catalyst for improving corporate profitability.
104
Euro area
102 US
Japan
100
98
96
94
2008 2009 2010 2011 2012 2013 2014
Source: Thomson Reuters
More specifically, European PMI data, a leading indicator for GDP growth, are also Key European markets are
showing signs of improvement in CGI's key European markets, including UK (~13% of showing PMI improvement.
consolidated revenues) and Sweden (~9%). Other key markets such as France are
showing less improvement but stable trends.
65.0
60.0
55.0
50.0
45.0
40.0
35.0
30.0
7/1/2011 11/1/2011 3/1/2012 7/1/2012 11/1/2012 3/1/2013 7/1/2013 11/1/2013 3/1/2014
Exhibit 6: U.S. CFO Outlook vs. CGI North American and Accenture America Revenues
25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
Source: Duke/CFO Business Outlook survey, Company data, Credit Suisse estimates;*CGI is excluded
between Q4.10-Qq.11 owing to the Stanley acquisition
Technology spending was above all other discretionary spending items with the exception
of general capital spending.
7.0%
6.0%
5.0%
4.0%
4.0%
3.0%
3.0%
2.3%
2.0%
1.0%
0.0%
Capital Technology R&D Advertising & Marketing Wages & Salaries
Source: Duke/CFO Business Outlook survey, Company data, Credit Suisse estimates
A recent Credit Suisse report highlighted similar spending outlooks in Europe. In Richard A CS survey highlights
Kersley's April 2014 report, titled, (Credit Suisse Executive Panel - Changing up a similar corporate spending
gear), 60 European corporates were polled on their spending plans. As highlighted in intentions in Europe.
Exhibit 8, the net balance of companies that were looking to raise spending in the next six
months vs. those planning to decrease, rose to 27% from 16% last Fall, its highest reading
since the September 2011 survey.
40%
20%
0%
-20%
-40%
Nov '10 May '11 Sep '11 Jan '12 May '12 Nov '12 Jun '13 Oct '13 Apr '14
Europe
Just as importantly, European respondents also indicated that IT spending was one of
their highest priorities, behind only employment and wages.
20%
0%
Employment & Wages Advertising budget
-10% Building & Plant
expenditure
-20%
Travel budget
-30%
Cars & Commercial
Vehicles
-40% Apr-14 Survey Oct-13 Survey
2) Technology Trends
Within the technology sector, there is an accelerating shift in corporate spend toward a Corporate spend is
confluence of digital technologies commonly referred to as SMAC (Social, Mobile, increasingly shifting to
Analytics, Cloud). Working together, these emerging technologies are creating new ways SMAC digital technologies.
for companies to interact with consumers, collaborate across the firm, and increase data
analytic capabilities to become smarter and quicker.
For some context on the magnitude of the shift, a recent KPMG report titled, 'The SMAC
Code, Embracing new technologies' for future business, reported that in 2012:
"SMAC contributed approximately 20% of the total (world) information and
communication technology spending…growing at about 18% y/y year-on-year, i.e.
around six times the rate of the rest of the IT industry. At this rate it is expected
that these technologies will become 80% of the total spending by 2020.
As these trends accelerate there is some debate on the impact on traditional IT service We believe these
providers, particularly as more processes move into the cloud replacing some of the technology shifts will remain
traditional large-scale IT systems integration. In our view, we believe these changes will supportive of IT service
generally be supportive to the IT services sector in the mid-term, for the following reasons: spend.
(1) Change Provides Opportunity: We believe a substantive shift in technology
represents an opportunity for innovative IT service providers to help companies make
the necessary transitions and pull-through other services. In addition, in our opinion,
customization provided by IT service firms will remain an important requirement for
most mid-to-large companies based on specific corporate demands, security needs,
and challenges inherent in integrating a mix of software across the firm.
(2) A Shift in IT Spend: We believe any corporate savings gained from shifting legacy
spend to the cloud are likely to be re-invested in other areas. As such we expect a
shift in IT service spend, not necessarily a reduction.
(3) New Opportunities: Finally, IT service providers are in a position to leverage their
own proprietary IP and software to benefit from opportunities in the cloud. We estimate
roughly 16% of CGI's revenues are IP based, although it had reached 25% prior to the
acquisition of Logica.
The ongoing demand for IT services was evident in a recent Credit Suisse IT survey,
summarized in a report by Credit Suisse Analyst Kulbinder Garcha and his team, titled, IT
Hardware & Global Communications Technology: 2014 Outlook: Spending
muted, with Cloud shift to boot. The survey highlighted how the demand for IT
services is rising and remains one of the highest priorities for Enterprise IT spend.
Exhibit 10: Respondents asked for view on top priority Exhibit 11: Respondents asked for view on expected
spend in IT – Service demand remains strong growth in major IT segments
70% 7.0%
60% 6.0%
5.0%
50%
4.0%
40%
3.0%
30% 2.0%
20% 1.0%
10% 0.0%
PCs
Storage
Printing
Software
Networking
Services
x86 Server
-1.0%
0%
-2.0%
-3.0%
2014 vs. 2013 2013 vs. 2012
2014 2013 2012
As such, while our IT Hardware & Global Communications Technology team expects IT service spend should
Enterprise IT spending to increase at a four-year CAGR of 4% y/y, IT services are outpace overall Enterprise
expected to increase at a CAGR of 5%, and above its historical CAGR of 2% from 2008 to IT spend.
2012.
0.00%
-0.80%
-2.00%
-4.00%
-3.90%
-6.00%
Services Total IT Hardware Storage Enterprise Printing Servers
Switching &
Routing
120%
100%
80%
60%
40%
20%
0%
Q1.07 Q3.07 Q1.08 Q3.08 Q1.09 Q3.09 Q1.10 Q3.10 Q1.11 Q3.11 Q1.12 Q3.12 Q1.13 Q3.13 Q1.14
More specifically, there are already signs CGI is having success in re-accelerating Booking trends are
revenues in Europe with the region at an estimated book-to-bill ratio of 114% on a LTM improving in Europe.
basis. Encouragingly, CGI is seeing particular bookings momentum in regions that were
under pressure at Logica prior to the acquisition, including the UK, Sweden and Benelux.
1,000.0 m
500.0 m
Bookings Revenues
Owing to the mix of longer-term outsourcing agreements in overall bookings (outsourcing Consulting Book-to-Bill is
represents ~55% of CGI's revenues) we caution that book-to-bill doesn't always provide the better leading revenue
perfect visibility into near-term revenue trends. Consulting book-to-bill is often a better indicator, and also positive.
indicator due to its shorter contract lengths. CGI has only recently started to provide
disclosure of this metric, but it is currently tracking at a LTM ratio of 107%.
What it means
In summary, we are constructive on the overall IT service sector, as it should CGI's larger IT service
disproportionately benefit from improving macro trends and any increase in corporate platform is well positioned to
discretionary spend. Additionally, while there is an ongoing shift in technology spending, benefit from macro and
we believe the demand for IT services is still healthy, with expectations for above average secular trends.
demand over the mid-term. CGI's larger platform is well positioned to benefit from these
trends, and it is already starting to show some momentum in its key European region.
$2.5 B
$2.0 B
$1.5 B
American
Stanley
$1.0 B Management
Systems
$0.5 B
-
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
$(0.5 B)
Following the Logica acquisition, Canada represents only 17% of its revenues but owing to Europe now represents over
its high margin, still generates 30% of the company's EBIT. The European region now 50% of revenues.
represents over 54% of CGI's revenues and roughly 40% of EBIT, followed by U.S. at 25%
and 26%, respectively.
Canada
17%
Canada
30%
Europe
39%
U.S.
Europe 25%
54%
U.S.
26%
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
CGI has quietly climbed the ranks of global IT service providers. Although CGI does not CGI is now one of the larger
have the reach of some of the largest players, it now has the scale and growing expertise independent IT service
to provide a global solution that multinational companies are increasingly demanding from firms.
often fewer vendors. We'd note the sector remains somewhat fragmented, with IBM
Services the largest firm at only 6% of global revenues.
$50.0 B $46.8 B
$40.0 B
$30.4 B
$30.0 B
$23.5 B
$20.0 B
$15.0 B $13.8 B $13.2 B
$11.8 B
$9.5 B $8.8 B
$10.0 B
-
IBM Fujitsu Accenture HP CSC Capgemini NTT Data Atos CGI Group Cognizant
Services Services Services
As we highlight in Exhibit 19, scale itself does not necessary lead to higher operating Operating leverage is limited
margin percentages, as cost of goods often represents over two-thirds of IT service in IT services – operating
revenues, limiting underlying operating leverage. Margin performance is also a reflection processes are important.
of the type of work and region in which the firm operates, as well as a reflection of the
firm's overall operating processes and execution.
16%
14% Accenture
12%
CGI
10%
Cap Gemini
8%
Atos
6% CSC
4%
2%
0%
- 5,000 10,000 15,000 20,000 25,000 30,000
Within this dynamic and fragmented IT service market we believe that CGI can gain further CGI is well positioned to
share by continuing to execute successfully on its Build and Buy model. gain share as it executes on
its Build and Buy model.
20%
0%
-20%
-40%
-60%
-80%
CGI has also been successful in integrating acquired assets to drive strong returns. For CGI has been a strong
some perspective, we provide a timeline of some of the key events in CGI's U.S. integrator of acquired U.S.
expansion in Exhibit 21. Despite acquiring larger companies with lower margins, CGI has assets.
had great success at integrating the U.S. acquisitions while maintaining strong margins.
Exhibit 21: CGI U.S. Timeline – Revenue and Margins of Key Acquisitions
3,500 m 14%
Despite adding margin dilutive business, CGI has
3,000 m 11% successfully maintained U.S. margins 11%
12%
2,582 m
2,500 m 9% 10%
2,000 m 8%
1,500 m 6%
962 m 4%
1,000 m 885 m 4%
500 m 315 m 2%
- 0%
CGI US 2003 Ams 2003 Stanley 2010 CGI US 2013
(Est)
With its acquisition of Logica, CGI has again demonstrated an ability to effectively It has also significantly
integrate assets. For example, CGI has grown Logica's margins from 6.3% at the time of improved Logica's margins.
the acquisition to 10.6% as of Q2.14, even after adjusting for provisions. Relative to its
major European peers and expectations for 2014, the early results are impressive.
5%
4%
2012 2013 2014E
Importantly, we believe these savings are sustainable as the bulk of the savings to-date In our view the European
are from headcount reductions. We estimate CGI reduced Logica's legacy headcount by costs savings are
5,000 (a 12% reduction), representing savings of over $300 million, or equivalent to a 6% sustainable.
margin improvement.
CGI's ability to leverage acquired assets to drive rising returns over-time is evident by CGI has been able to
reviewing its ROIC performance. While acquisitions have often led to an initial step-down leverage acquisitions to
in ROIC (2004, 2011) the company has a track record of leveraging the expanded platform grow ROIC.
to accelerate ROIC, reaching 13% in 2013, above our estimated cost of capital of 8.5%.
6%
4%
2%
0%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Q1.14 Q2.14
-2.00%
-4.00%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E
Accenture CGI
The margin performance is despite having acquired a larger amount of lower margin CGI has generated
Federal Government revenues, and an increased level of M&A activity that has driven comparable FCF per
higher amortization of intangibles. CGI's ability to drive improving margins is due in part to employee to industry leader
its pricing discipline, a focus on higher-end (and higher margin) contracts, strong operating Accenture.
processes that allow for cost levers to be quickly pulled, and a balanced use of delivery
centers. The net result is that CGI has generated comparable FCF per employee to
industry leader Accenture.
Exhibit 26: FCF (Operating Cash Flow – less Capex) per Employee
$25,000
$20,000
$15,000
$10,000
$5,000
$-
2007 2008 2009 2010 2011 2012 2013 2014e 2015E
Accenture CGI
The operating performance has also allowed CGI to deliver strong FCF per share, rising at CGI has delivered a FCF
a CAGR of 19% y/y over the last decade. per share CAGR of 19% y/y.
$3.50 $3.38
$3.00
$2.50 $2.35
$2.00 $1.75
$1.61 $1.63
$1.48
$1.50 $1.35
$1.22
Risk
Probability of Default 0%
Average Credit Rating NA
Accounting Quality Poor
Mom entum
6m 3m 1m
CFROI Revisions -0.54 0.44 0.00
Price Change % 8.90 9.49 2.73
Source: HOLT®
A more practical way to interpret the HOLT® results is that the market essentially assumes The market is assuming
CGI will grow revenue at a CAGR of only 2% y/y with no further margin or asset growth. limited revenue growth with
Given the potential to accelerate revenue over the mid-term with its new European no margin improvement.
platform and improving macro environment conditions, along with Management's track
record at both margin improvement and asset turns, we think such a forecast is quite
conservative.
One other key finding from Exhibit 28 is that the large investments made in the early Asset growth has historically
2000's (i.e., high asset growth) led to a period of solid CFROI increases from 2005 to led to improving returns.
2010, a period in time in which there was limited acquisitions or asset growth. It reiterates
CGI's ability to integrate various assets into its platform and its success as a long-term
operator of those assets.
Successful throughout various cycles
Using HOLT®, we also reviewed the financial drivers of CGI success in more detail, CGI has used a mix of
summarized in Exhibit 29. As previously discussed, while organic revenue growth has not levers to drive returns,
always been achieved, CGI's has been able to grow returns by focusing on margin including revenues, margins
execution and driving higher asset turns. Again, this track record reflects positively on and asset turns.
Management's operating processes and ability to execute in different cycles.
Exhibit 29: HOLT® Key Drivers – Sales, Operating Margins, Asset Turns
Source: HOLT®
■ Contract Provisions: CGI took two provisions, mostly related to expected losses on
revenue generating contracts and write-offs, totaling £173 million (or ~C$275 million).
The provisions were in addition to £39 million of charges Logica that had taken six
months earlier as part of a review of its contract profitability. If CGI was too
conservative in its contract review, it could re-release these provisions through the
P&L in future periods.
Source: HOLT®
140%
120%
100%
80%
60%
40%
20%
0%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E
Even on a recent three-year cumulative basis, a time period in which CGI has had Cash conversion has been
significant restructuring expenses and adjustments from the Logica transaction, it ranked mid-pact among peers
mid-pact among select peers. despite the Logica
acquisition affecting recent
Exhibit 32: Three- Year Cash Conversion years.
120%
111%
108%
100%
88% 88% 86%
80% 75%
71%
60%
40%
20%
0%
Accenture Booz Allen CGI CSC Cognizant Atos Capgemini
hamilton
Since the acquisition, we note that deferred revenues have increased to 8% (before Deferred revenues have
dropping to 7% in 2013); however, on a longer-term basis, it has been very steady increased after the Logica
averaging 3-5%. acquisition but CGI has a
steady historical record.
6%
5%
5%
4% 4% 4%
4% 4%
4% 3%
3%
3% 3%
2%
1%
0%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Deferred revenue/revenue
A broader metric that is useful to measure balance sheet quality for long-term contracts is CGI's revenue recognition
the spread between deferred revenues (a more conservative accounting approach in metrics suggests good
which cash is recognized ahead of revenue) and work in progress (a less conservative balance sheet quality.
approach in which revenue is recognized before the client is billed). If deferred revenues
are greater than work in progress, it should signal a more conservative revenue
recognition approach and more limited contract risk.
CGI's performance on this metric is not quite as strong as the industry leader Accenture,
but has historically been relatively stable in the -1% to -3% of sales range. The exception
was in 2010/2011 after it acquired Stanley, a reflection of higher work –in -progress
brought on by a larger mix of Federal contracts.
Accenture CGI
Although there was a decline in 2013, relative to its IT service peers, CGI's performance Revenue recognition metrics
on this metric remained well within its peer range as we highlight in Exhibit 35. compare favorably with its
peers.
2.0%
1.0%
0.0%
-1.0% -0.5%
-2.0%
-1.8%
-2.0%
-3.0%
-3.0%
-3.3%
-4.0% -3.6%
Accenture Cognizant CGI Cap Gemini CACI Atos CSC
Overall, while change in non-cash working capital has fluctuated year-over-year when Working capital as a
viewed on a long-term basis it has been relatively steady, averaging just 1% of revenues. percentage of sales has
historically been stable.
Exhibit 36: Change in Working Capital as % of Sales
6%
4%
4%
2%
2% 2%
0%
0% 0%
-1% -1%
-2%
-2% -2%
-3% -3%
-4%
-4%
-6%
-6%
-8%
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E
As restructuring payments roll-off we assume net working capital to remain roughly 1% of We assume net working
revenues, including some negative net change in working capital as deferred capital to remain roughly 1%
revenue/sales moderates to more historical levels. of revenues.
What it Means
Although there has been some recent working capital volatility and cash flow uncertainty We expect that cash
around the recent Logica acquisition, we believe these issues will not impact the long-term conversion will ramp back to
sustainability of CGI's free cash flow. By the end of 2014E, we expect most of the its historical averages in
restructuring payments related to the Logica acquisition will have cycled and that cash 2015.
conversion will ramp back to its historical averages in 2015E. This trend would provide
scope for an acceleration in FCF, reaching $3.38 per share by our estimates, or 40% y/y
growth, and the potential for a further stock re-rating.
Canada
17%
Canada
33%
U.S.
Europe 25%
54%
U.S.
57%
Canada U.S. Europe Asia Pacific Canada U.S. Europe Asia Pacific
Since the acquisition, European constant currency revenue trends have declined, although CGI is shifting its attention
according to Management it is due to unprofitable contracts being wound down or sold. from cost savings to
regaining revenue share in
Europe.
Exhibit 38: CGI Europe Constant Currency revenues Y/Y (excluding Logica comp Y/Y)
30.00%
25%
19%
20.00%
12%
9% 10%
10.00%
5% 4% 3%
0.00%
-1% -2% -1% -2% 0% -1%
-10.00% -7%
-9%
-14% -14%
-20.00%
-22%
-30.00%
Q4.08 Q2.09 Q4.09 Q2.10 Q4.10 Q2.11 Q4.11 Q2.12 Q4.12 Q2.13 Q4.13 Q2.14
Since the start of 2014, with a majority of the cost restructuring efforts behind it, CGI has Growing outsourcing
shifted its attention to regaining revenue share momentum in the region. Successful bid demand represents an
announcements may act as positive catalysts over the next few quarters, as it often takes opportunity for CGI.
9-12 months before contracts are awarded. We are constructive on the upside potential for
CGI in Europe, in part as there is a rising demand for Outsourcing sources, which is a
good match for CGI's expertise.
Outsourcing has been a rising trend for many years in Europe, although until recently it
has generally been more common in English-speaking countries such as the UK. For
some perspective on how the pace of these trends has evolved regionally, the larger India
IT service providers generate ~60% of their revenues from the U.S. and only 25% in
Europe. However, there are indications from the Indian-based firms that outsourcing
trends are gaining momentum more broadly across Europe. (See Exhibit 40.)
Exhibit 39: Top Five Indian IT Service Firms - Revenues Exhibit 40: Top Five Indian IT Service Firms - Recent Y/Y
by Region Revenue Trends
70% 50%
61%
60% 40%
50%
30%
40%
20%
30% 25%
10%
20% 14%
10% 0%
FY08 FY09 FY10 FY11 FY12 FY13
0% -10%
Americas Europe Others Americas Y/Y Europe Y/Y Others Y/Y
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
We believe greater interest in outsourcing is an opportunity for CGI to gain share as it has
significant experience in facilitating large-scale outsourcing agreements and gradually
shifting contract work into longer-term contracts across its delivery network. For example,
CGI took a prominent role in shifting leading Canadian companies to an outsourcing model
as the trend started to accelerate in that country, including the $4.5 billion Bell Canada
Exhibit 41: Revenue Mix prior to Logica Acquisition Exhibit 42: Backlog Duration prior to Acquisition
100% 4.50
90% 3.85
4.00
32%
80%
3.50
70% 56%
2.99
60% 3.00
Revenue years
50% 2.50
40%
2.00
68%
30%
44% 1.50
20%
10% 1.00
0% 0.50
Logica CGI
-
Outsourcing Consulting CGI Logica Outsourcing
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Importantly, CGI has a track record in shifting revenues to longer-term recurring revenue CGI has a track record in
streams. Following its acquisition of AMS in 2004, CGI shifted recurring revenues from converting shorter projects
approximately 20% of AMS' base, to roughly 55% six years later. to recurring revenue
streams.
Exhibit 43: AMS Recurring Revenue Shift
60%
55%
AMS acquisition has shifted recurring
50% revenues from 20% to 55% over six years
40%
30%
20%
20%
10%
0%
2004 2010
the fallout of the troubled Healthcare.gov website in the fall of 2013. Despite this back-drop
we remain constructive on the mid-term opportunities owing to CGI Federal's long-term
relationships, its valuable IP, and the prospect for improving federal funding in the mid-
term.
Background
Since 2010, the Federal Government IT budget has stalled at roughly $80 billion per Federal IT spending has
annum, and despite some recent clarity on overall Government funding, there has been been under budget and
uncertainty on how specific projects will be funded, with shorter contract durations and an funding pressures.
inclination toward extension of existing contracts.
Exhibit 45: CGI Federal Gov't Billings and Estimated Market Share
1,600,000 2.0%
1.8%
1,400,000
1.6%
1,200,000
1.4%
1,000,000
1.2%
800,000 1.0%
0.8%
600,000
0.6%
400,000
0.4%
200,000
0.2%
- 0.0%
2009 2010 2011 2012 2013
Relative to its Government service peers, CGI Federal has also delivered a relatively CGI has also delivered a
strong financial performance, with one of the higher two-year revenue CAGR's from 2011 strong financial performance
to 2013 and one of the higher operating margins (although we include CGI's non-Federal relative to peers.
business in its IT margin owing to lack of better disclosure, which may impact
comparisons).
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Importantly, based on recent contract tenders as disclosed by the Federal Government, CGI continues to gain
there also does not appear to be any near-term backlash from the Healthcare.gov issue, Federal bookings.
with bookings on a LTM relatively steady.
$500 m
$400 m
$300 m
$200 m
$100 m
While we assume softer near-term revenue trends, we believe improving Federal funding But Federal funding should
over the mid-term may be a positive catalyst for shorter-cycle Government service improve over the mid-term.
providers such as CGI, owing to:
■ IT spend cannot be ignored: Our Channel checks suggest that while the overall
Federal IT budget may remain muted in fiscal year 2015 there is expected to be some
uptick in spending (i.e. 2016/2017) to preserve and secure critical systems.
■ Still pockets of Growth: There are still areas of growth within the Federal IT budget,
particularly in areas such as Cyber, Intelligence, Veterans, Health Care, and Tax
Collections, verticals in which CGI has expertise. Conversely, CGI has very limited IT
exposure to specific war efforts, which have been under particular revenue pressure.
■ IP and Long-term agreements provide downside protection: CGI also has long-
term agreements leveraging proprietary IP within the sector, including its Momentum
Enterprise Solution, a specifically designed Federal ERP system implemented at more
than 50 Federal agencies.
While we believe improving Federal funding can be a mid-term catalyst, CGI has
momentum with State/Local and Enterprise to help offset any near-term pressures.
Exhibit 49: Canada constant currency revenue vs. nominal GDP growth
40%
35%
30%
25%
20%
15%
10%
5%
0%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
-5%
-10%
We attribute some of the slower revenue growth to a relatively weak IT spend environment Revenue impacted by
As Exhibit 50 highlights, Canadian hardware and software expenditures (a potential proxy weaker IT spend
for IT service spend) has been relatively modest since the great recession, often tracking environment.
below nominal GDP trends.
15.00%
10.00%
5.00%
0.00%
-5.00%
-10.00%
-15.00%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Center for the Study of Living Standards, Credit Suisse estimates
Larger competitors also remain active in Canada, keeping the market competitive. For Competition also remains
example, both IBM Canada and Fujitsu Canada, have recently built new data centers in active; however, we still see
the country. As a market leader there may naturally be fewer large scale opportunities for growth opportunities.
CGI although we believe there are still pockets of growth by potentially expanding further
into new markets (Resources), deepening relationships with the country's large banks, and
leveraging its broader global scale and IP portfolio from Logica. Recent booking results
suggest Canadian revenues may start to modestly pick-up.
Despite a softer revenue environment in Canada, CGI has effectively managed margins, In slower market, CGI still
another example of its strong operating processes. As highlighted in Exhibit 51, margins delivered strong margin
rose from 14% in 2007 to 19%, despite that, in 2007, corporate costs ($63 million) were performance.
reported in a separate line item, whereas in 2014 they were consolidated into divisions.
$350 m 18%
16%
$300 m
14%
$250 m 12%
$200 m 10%
$150 m 8%
6%
$100 m
4%
$50 m 2%
- 0%
2007 2014
Shifting work offshore to lower-cost regions has been an ongoing trend in IT services, as Shifting work offshore has
evident by success of the five major Indian-based IT service providers. been a long-term trend.
Exhibit 53: Major Indian IT service Firm Revenues– Nine-Year CAGR of 23%
$ 45,000 m 45.0%
$ 40,000 m 40.0%
$ 35,000 m 35.0%
$ 30,000 m 30.0%
$ 25,000 m 25.0%
$ 20,000 m 20.0%
$ 15,000 m 15.0%
$ 10,000 m 10.0%
$ 5,000 m 5.0%
- 0.0%
FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13
Diversified global IT service firms have also been pushing a greater percentage of Diversified IT service firms
headcount to lower cost centers such as India, with Accenture and Capgemini now having have also been shifting
over 33% of their respective headcounts in the region. headcount to offshore
locations.
34%
35% 33%
30%
26%
25%
20%
15% 14%
10%
5%
0%
CapGemini Accenture CSC CGI
Summary
Overall, we believe CGI's global platform has a number of opportunities to drive revenue
growth, including rising interest in European outsourcing, a U.S. Federal IT funding
recovery and potentially some renewed momentum in its key Canadian market. Its local
and global delivery model should provide sufficient flexibility as client demands evolve.
Capital Structure
Despite the recent acquisitions, CGI has a relatively strong balance sheet. Net debt to Despite acquisitions, CGI
LTM EBITDA is currently at 1.6x, as it has focused on paying down debt since the Logica still has a healthy balance
acquisition. Going forward, its strong balance sheet and free cash flow generation should sheet.
continue to support investments and acquisition, as well as a mix of share repurchases.
Debt Overview
CGI currently has $2.8 billion in short and long-term debt made up of U.S. senior CGI currently has $2.8
unsecured notes and revolving and term loan credit facilities, mostly related to the billion in short and long-term
acquisition of Logica in 2012. The majority of CGI's debt matures over the next five years, debt.
with CGI's term loan due in two payments in 2015/2016 and scheduled repayments on its
~$480 million U.S. senior notes starting in 2016. CGI's $1.5 billion credit facility also
matures in 2017, which had $211 million drawn as of Q2.14 plus a subsequent $487
million following the quarter. While 2016 represents the largest near -term debt maturities,
we do not see any pressure points owing to its modest leverage and free cash flow
generation.
Exhibit 55: CGI Net Debt Exhibit 56: CGI Debt Repayment Schedule
$3.5 B $1,200 m
$3,105 m $1,090 m
$3.0 B $2,740 m
$1,000 m
$2.5 B $2,181 m
$800 m
$2.0 B $698 m
$1.5 B $600 m
$1,094 m $494 m
$1,013 m
$898 m
$1.0 B
$400 m
$341 m $257 m
$0.5 B
$200 m $144 m
$-
$(60 m) $(48 m)
$(0.5 B) $-
2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E
Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates
Despite some relatively large acquisitions, CGI has historically had limited leverage, often
building cash positions ahead of a deal. A lower leverage range is consistent with many of
its IT service peers that typically operate in net cash positions.
2.1x
2.0x
1.6x
1.5x 1.3x
1.2x 1.2x
1.2x
1.0x
0.6x
0.5x 0.5x
0.5x 0.4x
0.0x
0.0x
(0.1x)
-0.5x
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E
Common Equity
CGI has two tiers of equity authorized and issued: 276 million of Class A subordinate CGI has two tiers of equity.
voting shares with one vote per share, and 33 million Class B shares with ten votes per
share. Insider shareholders consisting of founders Serge Godin, André Imbeau, and the
Caisse de dépôt et placement du Québec control roughly 15% of the combined Class A
and B shares but ~64% of votes. The multi-voting class B shares are primarily controlled
by Mr. Godin and Mr. Imbeau who own 86% and 13% of the class B shares, respectively.
CGI's current short interest is ~8% of its float, in-line with its average trading range. It has
declined from recent highs as we believe investors have gained increased confidence in
the Logica opportunity.
% of Float
25m 10%
Shares
20m 8%
15m 6%
10m 4%
5m 2%
- 0%
Capital Priorities
Historically CGI's capital priorities have been on acquisitions, as it views itself as a growth CGI's historical priorities
company with an opportunity to expand the depth and reach of its global platform. have been on M&A and
However, when M&A conditions are not attractive CGI has also returned capital to share buybacks.
shareholders via share repurchases. We estimate share repurchases (net of some
issuance) have accounted for roughly 3% y/y per annum in share price growth.
$3.0 B
$2.5 B
$2.0 B
$1.5 B
$1.0 B
$0.5 B
-
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
$(0.5 B)
Future Priorities
We believe acquisitions will remain CGI's near-term priority, and, in the absence of any We believe acquisitions will
such opportunities, share repurchases. As CGI views itself as a growth company with a remain CGI's near-term
unique opportunity to grow scale in IT services, we believe a dividend is unlikely in the priority to grow its global
near-term. platform.
For acquisitions, CGI appears to be focused on building depth in existing regions such as
the U.S. vs. further expanding geographic reach. We believe it is also placing emphasis on
growing its IP portfolio. Valuations may be higher for higher-growth software/IP assets and
in turn more difficult to drive accretion, although CGI's larger scale may provide
incremental opportunities to distribute across the platform.
Financial Assumptions
Our model is based on the following key financial assumptions: Our model assumes a
recovery in revenues and
■ We assume constant currency revenue growth of -2% y/y in 2014E as we assume FCF conversion.
some ongoing revenue pruning in the European region, but rising to +3% y/y in 2015E
as it gains renewed momentum in Europe, in particular.
■ We estimate EBIT margins rise to 12.5% in 2014E from 10.7% in 2013 owing to
ongoing cost management, particularly related to the European integration. We
assume further margin improvement to 13.1% in 2015E based on ongoing
restructuring in Europe, overall cost management, and higher value revenue in the
mix. Overall we estimate EBIT increase 24% y/y in 2014E and 7% y/y in 2015E.
■ We also assume CGI starts to cycle its heavy Logica related restructuring costs, and
as such that cash conversion returns to more normalized levels. We note that in 2014
YTD there has also been about $20 million of provisions released through the P&L
related to the Logica acquisition, which we adjust in our 2015 estimates. Over the mid-
term, we forecast a ~1% negative change in non-cash working capital as a percent of
sales, in part as we model for deferred revenues to moderate. This range is consistent
with its long-term historical average.
■ In 2015E we forecast free cash flow grows over 40% to just under $1.1 billion, driven
by the roll-off of most Logica restructuring payments, as well as EBIT growth.
Evidence of revenue acceleration and cash conversion returning to more normalized
levels would be positive catalysts for the stock. Detailed Balance Sheet and Cash Flow
forecasts can be found in Appendix B.
Basic Weighted Average Shares Outstanding 263,432 307,900 309,807 310,339 311,963 313,563
Diluted Weighted Average Shares Outstanding 273,644 316,974 319,118 319,434 321,058 322,658
Adjusted EPS
Adjusted EBT 555,223 966,061 1,221,188 1,361,763 1,418,780 1,461,568
Adjusted Income taxes 153,891 238,396 280,050 354,058 368,883 380,008
=Income tax expense prior to Adjustments 401,332 727,665 941,137 1,007,705 1,049,897 1,081,560
Valuation
Historical Valuation
The success of CGI's build and buy strategy has been reflected in its strong stock price Over the past 10 years CGI
performance. Over the past ten years CGI has averaged a 16% CAGR in its stock price, has averaged a 16% CAGR
slightly below Cognizant but above Accenture and well above the S&P and TSX at 6%. in its stock price, well above
the S&P and TSX at 6%.
Exhibit 61: 10 –year CAGR Stock Price Change for select Diversified IT service providers
25% 24%
20%
16%
15%
13%
10%
6% 6% 5%
5% 4% 3%
0%
Cognizant CGI Accenture S&P TSX S&P 500 Cap Gemini CSC Atos
Cognizant CGI Accenture S&P TSX S&P 500 Cap Gemini CSC Atos
P/E Analysis
As we highlight in Exhibit 62, forward P/E has historically been an important indicator of Forward P/E has historically
CGI's stock price. We remain constructive on the stock's upside potential based on our been an important indicator
expectations for adjusted EPS to rise to $3.15 in 2015E from $2.30 in 2013, a 2-year of CGI's stock price.
CAGR of 17%.
250.00 $2.50
200.00 $2.00
150.00 $1.50
100.00 $1.00
50.00 $0.50
- $0.00
7/1/1999 12/1/2000 5/1/2002 10/1/2003 3/1/2005 8/1/2006 1/1/2008 6/1/2009 11/1/2010 4/1/2012 9/1/2013
On a price-to-adjusted earnings basis, CGI's forward P/E remains in-line with its historical CGI's forward P/E remains
average, as the stock price increase has been proportionate with its earning accretion. in-line with its historical
Relative to select U.S. peers, its trading ratio is roughly in-line with its historical discount of average.
1.5x.
Exhibit 63: CGI Historical Forward P/E Exhibit 64: Forward P/E vs. Select U.S. peers
14.0x 3.00
13.0x 2.00
12.0x 1.00
11.0x 0.00
-1.00
10.0x
-2.00
9.0x
-3.00
8.0x
-4.00
-5.00
1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014
CGI Group Average
+2 Std. Dev -2 Std. Dev Average Vs. US
Source: Thomson Reuters, Company data, Credit Suisse estimates Source: Thomson Reuters, Company data, Credit Suisse estimates
EV/EBITDA
On an EV/EBITDA basis, CGI is now trading at a forward EV/EBITDA of 7.1.x, on the high- Forward EV/EBITDA of
end of its more recent average of ~6.0x and slightly above its 1.25x historical discount to 7.1x, on the high-end of its
select U.S. peers. The higher EV/EBITDA reflects in part its higher leverage following the historical average of 6.0x
acquisition compared with peers that typically run net cash balances.
Exhibit 65: CGI Historical EV/EBITDA FY2 Exhibit 66: CGI Fwd EV/EBITDA vs. Select U.S. peers
1.00
9.0x
0.50
8.0x
0.00
7.0x -0.50
-1.00
6.0x
-1.50
5.0x -2.00
4.0x -2.50
-3.00
3.0x
1/31/2008 1/31/2010 1/31/2012 1/31/2014 -3.50
1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014
CGI Average since 2008
+2 std dev -2 std dev Average Vs. US
Source: Thomson Reuters, Company data, Credit Suisse estimates Source: Thomson Reuters, Company data, Credit Suisse estimates
While industry EV/EBITDA multiples are high relative to post-recession multiples, they are Industry EV/EBITDA
mid-range when viewed over previous mid-to-late cycles. multiples are mid-range on a
longer-term view.
12.0x
10.0x
8.0x
6.0x
4.0x
2.0x
0.0x
1/1/2003 2/1/2004 3/1/2005 4/1/2006 5/1/2007 6/1/2008 7/1/2009 8/1/2010 9/1/2011 10/1/2012 11/1/2013
US Average
FCF Yield
One of the most important valuation metrics we track for CGI is related to FCF. Over the FCF yield on 2015E remains
past four years, CGI has traded at an average FCF yield of 9-10% y/y and the stock is healthy at 9%.
currently trading in that range. On a relative comparison basis, CGI is trading a slight
discount to Accenture, a stock that it has typically tracked on a FCF yield basis. (See
Exhibit 69.) In our view, we believe a 9% FCF yield remains attractive relative to CGI's
potential long-term growth profile and that, as the stock re-rates, it has the potential to
trade at the lower-end of its historical FCF yield range of 6-7%.
Exhibit 68: Historical FCF Yield Exhibit 69: FCF Yield Historical – CGI & Accenture
14% 20%
13% 18%
16%
12%
14%
11% 12%
10% 10%
8%
9%
6%
8%
4%
7% 2%
0%
6%
4/1/2011 10/1/2011 4/1/2012 10/1/2012 4/1/2013 10/1/2013 4/1/2014
Source: Thomson Reuters, Company data, Credit Suisse estimates Source: Thomson Reuters, Company data, Credit Suisse estimates
Relative Comparison
On a relative basis we believe CGI screens attractively against a basket of global CGI screens attractively
comparisons, including IT service providers in the U.S., Europe and India. For example, in against a basket of global
2015, the global group is forecast to grow EBITDA at a two-year CAGR of 10% y/y, with comparisons,
an EV/EBITDA of 8.8x versus CGI at 12% y/y and 7.1x, respectively. Similarly, CGI is
trading at a P/E multiple of 12.1x versus the group at 15.1x, despite a growth rate of 17%
y/y versus the group at 13%.
North American
CGI Group $38.02 $13,291 $10,085 $10,628 $10,911 4% 1.3x 1.2x $1,493 $1,776 $1,864 12% 7.5x 7.1x
Accenture Plc $80.64 $48,511 $28,563 $29,876 $31,878 6% 1.6x 1.5x $4,660 $4,871 $5,178 5% 10.0x 9.4x
Computer Sciences Corp. $63.30 $9,692 $14,993 $12,998 $12,998 -7% 0.7x 0.7x $1,683 $2,038 $2,189 14% 4.8x 4.4x
International Business Machines Corp.
$188.42 $219,718 $99,751 $97,397 $98,004 -1% 2.3x 2.2x $26,127 $27,196 $28,677 5% 8.1x 7.7x
Hewlett Packard $33.65 $73,395 $112,298 $112,035 $109,158 -1% 0.7x 0.7x $13,689 $14,438 $14,302 2% 5.1x 5.1x
Average -1% 1.3x 1.3x 7% 7.0x 6.6x
Europe
Capgemini € 53.41 € 7,897 € 10,092 € 10,264 € 10,620 3% 0.8x 0.7x € 1,065 € 1,112 € 1,192 6% 7.1x 6.6x
Atos € 59.38 € 5,038 € 8,615 € 8,637 € 8,718 1% 0.6x 0.6x € 974 € 1,001 € 1,052 4% 5.0x 4.8x
Average 2% 0.7x 0.7x 5% 6.1x 5.7x
India Based
Cognizant Technology Solutions Corp.$50.37 $28,435 $8,843 $10,397 $12,124 17% 2.7x 2.3x $1,993 $2,274 $2,613 14% 12.5x 10.9x
Tata Consultancy Services ₹ 2,398.15 ₹ 4,538,289 ₹ 629,895 ₹ 818,094 ₹ 940,697 22% 5.5x 4.8x ₹ 180,870 ₹ 251,322 ₹ 284,678 25% 18.1x 15.9x
Infosys ₹ 3,310.35 ₹ 1,604,982 ₹ 403,520 ₹ 501,330 ₹ 535,581 15% 3.2x 3.0x ₹ 115,280 ₹ 134,150 ₹ 147,641 13% 12.0x 10.9x
Wipro Ltd ₹ 545.30 ₹ 1,214,552 ₹ 374,256 ₹ 437,549 ₹ 483,228 14% 2.8x 2.5x ₹ 80,807 ₹ 100,460 ₹ 111,851 18% 12.1x 10.9x
HCL Techno ₹ 1,473.20 ₹ 960,190 ₹ 255,811 ₹ 330,448 ₹ 373,207 21% 2.9x 2.6x ₹ 57,057 ₹ 86,398 ₹ 93,714 28% 11.1x 10.2x
Average 18% 3.6x 3.2x 21% 13.3x 12.0x
North American
CGI Group $38.02 $13,291 $1,076 $1,332 $1,428 15% 10.0x 9.3x $2.30 $2.95 $3.15 17% 12.9x 12.1x n.a. 7%
Accenture Plc $80.64 $48,511 $4,067 $4,264 $4,578 6% 11.4x 10.6x $4.21 $4.53 $4.93 8% 17.8x 16.4x 2% 6%
Computer Sciences Corp. $63.30 $9,692 $607 $1,020 $1,136 37% 9.5x 8.5x $2.18 $3.91 $4.49 44% 16.2x 14.1x 1% 12%
International Business Machines Corp.
$188.42 $219,718 $21,449 $22,813 $24,267 6% 9.6x 9.1x $16.35 $17.87 $19.95 10% 10.5x 9.4x 2% 8%
Hewlett Packard $33.65 $73,395 $9,078 $9,971 $9,935 5% 7.4x 7.4x $3.35 $3.75 $3.84 7% 9.0x 8.8x 2% 12%
Average 13% 9.5x 8.9x 17% 13.4x 12.2x 9%
Europe
Capgemini € 53.41 € 7,897 € 857 € 922 € 1,002 8% 8.6x 7.9x € 2.96 € 3.61 € 3.98 16% 14.8x 13.4x 2% 6%
Atos € 59.38 € 5,038 € 645 € 671 € 722 6% 7.5x 7.0x € 4.32 € 4.39 € 4.74 5% 13.5x 12.5x 1% 6%
Average 7% 8.0x 7.4x 10% 14.2x 13.0x 6%
India Based
Cognizant Technology Solutions Corp.$50.37 $28,435 $1,821 $2,079 $2,389 15% 13.7x 11.9x $2.19 $2.54 $2.91 15% 19.8x 17.3x n.a. 6%
Tata Consultancy Services ₹ 2,398.15 ₹ 4,538,289 ₹ 170,079 ₹ 238,079 ₹ 259,279 23% 19.1x 17.5x ₹ 71.23 ₹ 97.63 ₹ 108.85 24% 24.6x 22.0x 1% 3%
Infosys ₹ 3,310.35 ₹ 1,604,982 ₹ 104,290 ₹ 120,410 ₹ 131,034 12% 13.3x 12.2x ₹ 164.87 ₹ 186.35 ₹ 205.59 12% 17.8x 16.1x 2% 5%
Wipro Ltd ₹ 545.30 ₹ 1,214,552 ₹ 69,972 ₹ 89,354 ₹ 100,329 20% 13.6x 12.1x ₹ 26.98 ₹ 31.66 ₹ 36.01 16% 17.2x 15.1x 1% 4%
HCL Techno ₹ 1,473.20 ₹ 960,190 ₹ 50,689 ₹ 79,027 ₹ 85,554 30% 12.2x 11.2x ₹ 57.20 ₹ 87.87 ₹ 99.82 32% 16.8x 14.8x 1% 5%
Average 21% 14.5x 13.3x 21% 19.1x 17.0x 4%
CGI's EV/EBITDA multiple and EBITDA growth relative to its peers is highlighted visually
in Exhibit 72.
20%
2-year EBITDA CAGR (%)
15%
CGI
10%
North America Based
Europe Based
5% U.S. Government
Services
0%
4.0x 5.0x 6.0x 7.0x 8.0x 9.0x 10.0x 11.0x 12.0x 13.0x 14.0x
EV / EBITDA
Within Canada we note there are few useful comparisons, owing to the relatively small
size of the sector and mix of constituents. Given this context, however, CGI may
disproportionately benefit from any demand for Canadian technology stocks.
Constellation Software Inc Soffware $265.29 $5,995 $11.64 $11.90 $12.16 2% 22.3x 21.8x 1.6% 5%
Celestica Equipment Mfr. $13.26 $1,624 $0.98 $1.00 $1.02 2% 13.3x 13.0x n.a. 6%
BlackBerry Telecom Hardware $11.40 $5,677 ($1.04) ($0.97) ($0.90) -7% n.a. n.a. n.a. 47%
Computer Modelling Group Ltd Software $14.70 $1,084 $0.37 $0.37 $0.38 1% 39.6x 39.1x 2.5% 3%
Open Text Corporation Software $51.60 $6,369 $3.30 $3.33 $3.37 1% 15.5x 15.3x 0.3% 5%
Average 0% 22.7x 22.3x 1% 13%
Source: Thomson Reuters, Company data, Credit Suisse estimates
Our $48 target price is based on a WACC of 8.5% and a Terminal growth rate of 1.0%. We Our $48 target price is
highlight the sensitivities to our target price in Exhibit 74. Our target price implies a NTM predicated on a WACC of
FCF yield of ~8%, implying some modest multiple appreciation that we believe is 8.5% and Terminal growth
achievable as the company's revenue and cash conversion outlook improves. rate of 1%.
Key Risks
Key risks for CGI include, but are not limited to, the following:
Market Share
CGI competes with many strong international firms and its future business is contingent on CGI competes with many
maintaining and growing its current market share within this ecosystem. Over the long- international and regional
term, CGI may also face increasing competitive pressure and pricing deflation from Indian- firms.
based IT service firms that are seeking to move up the value chain. Finally, CGI is also
dependent on hardware/software partnerships within the IT sector and any adverse
change in relationship could have an impact on its growth potential.
Acquisitions
CGI's continued ability to identify potential acquisition targets and execute on transactions CGI may make dilutive
both large and small is a key pillar of CGI's growth strategy. If CGI is not able to make acquisition or be unable to
further acquisitions or acquires companies that do not fit well with its existing business, it find new opportunities.
could have a material impact on long-term growth prospects. Additionally, with recent
acquisitions, CGI is now large enough in size that future acquisitions will likely have
smaller impact. We believe CGI's strong M&A track record helps mitigate this risk.
Contracts
CGI's revenues may be at risk if any ongoing work or contracts in backlog are cancelled or CGI may experience
there are performance issues. Additionally, the majority of CGI's contracts are performed execution risks.
on a fixed-price basis. If CGI does not accurately estimate costs associated with these
contracts, there could be potential profit shortfalls. In our view, CGI has very strong
contract bidding and operating processes to help limit the overall risks.
Client Concentration
The company derives a large portion of revenue from the U.S. Federal government and its CGI has some client
agencies. If the U.S. government agency, or other key clients, were to materially decrease concentration risk, namely
the business that does with CGI, it may be difficult to replace these revenues. the U.S. Federal
government.
Economic Sensitivity
CGI's business is driven by the level of business activity of its clients, which can be CGI's business is sensitive
affected by current economic conditions. Any slowdown in the current economic recovery to economic trends.
could lead to cancellation or deferral of existing contracts and delays in entering into new
engagements. CGI has demonstrated an ability to manage variable and fixed-cost levers
in periods of slower revenue growth, which would help offset economic risk.
FX Impact
CGI generates revenue and cost in currency other than CGI's reported currency of CGI has some FX exposure,
Canadian dollars. The company naturally hedges its profits as costs are matched with the although does have a
currency in which revenues are denominated, and it also employs some currency hedges. natural hedge.
If currencies weaken against the Canadian dollar, the company's consolidated financial
results could be affected.
Voting Rights
As of December 13, 2013, 55% of the aggregate voting rights are attached to the There is a risk that voting
Outstanding Class B shares. The multi-voting class B shares are primarily controlled by Mr. shareholders may conflict
Godin and Mr. Imbeau, who own 86% and 13% of the class B shares, respectively. To the with non-controlling
extent that the interests of the voting control group conflicts with that of non-controlling shareholders.
shareholders, there may be some risk to shareholder returns.
The company has a presence in 40 countries with over one-half its revenues now coming The company has a
from the Europe region. presence in 40 countries.
North America
42%
Europe
54%
The company has a strong market position in five verticals, including government, CGI has expertise across
manufacturing retail and distribution (a vertical that has grown in particular with the Logica five verticals.
acquisition), financial services, telecom & utilities and health care.
Telecommunications &
Utilities Health
16% 8%
Government
32%
Financial Services
18%
Manufacturing,
Retail & Distribution
26%
Government Manufacturing, Retail & Distribution Financial Services Telecommunications & Utilities Health
CGI competes against larger companies such as IBM, HP and Fujitsu that can combine CGI competes against a
Hardware and Software solutions, as well as large diversified IT service companies such range of global, regional and
as Accenture, Capgemini and CSC. Within the Federal IT service sector it competes with Indian based IT service
both large and small competitors Booz Allen Hamilton, CACI, and SAIC. Finally, CGI also firms.
competes against Indian It service firms, which are increasingly shifting their efforts to
provide more localized and high-value services.
CGI has a number of proprietary business solutions to help its market positions, including
Momentum, an ERP suite used by the U.S. federal Government, CGI Advantage, a
leading State and local ERP system, and strong credit service solutions for both
Government and businesses, including Collections360.
Total Liabilities and Equity 10,453,442 10,879,272 11,631,917 11,533,940 12,610,232 13,723,715
Financing Activities
Francois Boulanger Executive Vice-President and Mr. Boulanger was appointed as the successor to R. David
Chief Financial Officer (CFO) Anderson on July 9, 2014. He previously was Senior Vice-
(Current) president and Corporate Controller since 2006.
Jame Cofran Senior Vice-President and Mr. Cofran was appointed CMO in May, 2012 after serving as
Chief Marketing Officer Global Marketing Lead for the Financial Services industry since
2009. Mr. Cofran previously worked at American Management
Systems, Inc. (AMS), where we working in various management
and consulting positions.
Benoit Dubé Executive Vice-President and Prior to joining CGI, Mr. Dubé was head of the legal
Chief Legal Officer (CLO) department at Cognicase Inc., which was acquired by CGI in
2003. Mr. Dubé was previously an associate at McCarthy
Tétrault LLP and acted as legal counsel for BCE and Canadian
Bankers Association.
Source: Company data, Credit Suisse
Governance
CGI's authorized share capital consists of an unlimited number of Class A subordinate A number of governance
voting shares carrying one vote per share and an unlimited number of Class B shares rules apply to CGI's duel
(carrying ten votes per share, of which, as of December 13, 2013, 276,014,110 Class A share structure.
subordinate voting shares and 33,272,767 Class B shares, were issued and outstanding.
As of December 13, 2013, 45.3% and 54.7% of the aggregate voting rights are attached to
the outstanding Class A subordinate voting shares and Class B shares, respectively.
If a take-over bid, other than an exempt bid, for the Class B shares is made to the holders
of the Class B shares without being made simultaneously on the same terms and
conditions to the holders of Class A subordinate voting shares, each Class A subordinate
voting share shall become convertible into one Class B share.
Each Class B share may, from time to time, at the holder's option be converted into one
Class A subordinate voting share. The Company's articles of incorporation also provide for
pre-emptive rights in favor of holders of Class B shares.
Disclosure Appendix
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