Keane: From Intrigue to Turnaround?

Looking for intrigue and a turnaround story? Try Boston-based information-technology services firm Keane (NYSE: KEA  ) .

Over the summer, a Ms. Fisk, the erstwhile VP of Marketing, alleged that CEO Brian T. Keane, son of the company's founder, had harassed her. The standard peekaboo arrangements were made -- the offending Keane accepted "poor judgment," and Ms. Fisk received $1.14 million cash as settlement.

Last Friday, things got worse for the company as Keane dismissed its president, Richard Garnick, for reasons related to compliance with the company's policy on travel expenses and "unauthorized communications."

How does Keane move beyond all this intrigue to become a turnaround?

More Bangalore than Boston
Garnick was already working on a plan to make Keane more Bangalore than Boston. Keane's staff of 9,360 employees are split 70/30 between the developed economies and India. Keane wants to change the split to 50/50. This means finding nearly 1,800 new hires -- an increasingly expensive path, with salaries for Indian IT staff rising 10% to 20% per year. And Keane must compete with brand-name Indian firms such as Infosys (Nasdaq: INFY  ) , along with the leading global firms, Accenture (NYSE: ACN  ) and IBM.

Garnick's plan was influenced by his past experience at Wipro, but a better model to imitate may be Satyam Computer Services (NYSE: SAY  ) . Both firms have total revenue close to $1 billion, but Satyam eschews the traditional IT-firm model of sending as much work as possible to India. Instead, it earns half its revenues by getting closer to its clients, working on-site or in "nearshore" (which means Canada, apparently) centers. This reduces margins, but has long-term benefits from increased client intimacy and satisfaction. Applying the Satyam model would allow Keane to leverage its existing U.S. operations and minimize employee disruption.

If Keane adds the 1,800 Indian staff, pushes gross margins from the current 29% to the Satyam model of 35%, and maintains revenue per employee of $130,000, the company would add $14 million to gross profit, an increase of 5%.

One Keane
Keane is at work on a transformation program called "One Keane." It aims to centralize common services and blend local offices into global practices. Again, taking Satyam as a model, if Keane can reduce its selling, general, and administrative expenses from 22% of revenue to Satyam's 17% ratio, it would save around $10 million a year.

Assuming all these savings can be dropped to the bottom line, at a tax rate of 35%, then Keane's transformation plan can increase pre-diluted earnings per share by $0.27 per year, a 40% increase on 2005.

There's also an opportunity to benefit from the spicy market multiples awarded to companies sitting on the Indian IT trend. Keane currently trades at a price-to-sales ratio of 0.9; meanwhile, Satyam trades at 5, and Infosys at a tongue-burning 11.

Missing acts
"One Keane" is missing a couple of acts, though. First, how will Keane distinguish itself in the fragmented, undifferentiated IT services marketplace? It's tough to offer the lowest-cost services when competing against the native Indian firms. Offering a wide range of services is also a losing idea against the global brands. Keane lays claim to the usual IT service goodies -- industry-specific value propositions, intellectual capital leverage, and a global delivery model. But these claims can be found in the marketing of every IT services firm. Execution is key, and the fate of other midsized IT firms should encourage Keane to be cautious. Sapient (Nasdaq: SAPE  ) lives on the edge of delisting, and a firm with origins similar to Keane's, called Headstrong, was acquired by Indian firm Techspan.

The business mix is also worrisome. Keane's "Other Services" segment contains some strong divisions, including consulting and project management, but a large component appears to be "supplemental staffing placements." This doesn't sound good, and it isn't -- it's a low-margin, dispiriting business, unaffectionately known as "body shopping" in the industry.

Help from Edgar
Despite a miserable year, Keane has some good news. Keane recently won part of the contract to overhaul the SEC's Edgar system, and the whole of Fooldom hopes they do a great job. In addition, Keane is already working on a 12-year, $367 million deal to build and operate a transport ticketing system for the state of Victoria, Australia.

Beware of debentures
Moving from operating to financing, Keane is carrying above-average levels of debt for this industry. Its debt-to-equity ratio of 1 to 3 is high; Satyam has no debt.

BearingPoint's (NYSE: BE  ) recent debt trauma and harassment by hedge funds should encourage Keane to play carefully with its debentures. That's not to say the company should abandon debt altogether, though. First, contracts such as the ticketing system, with payments (based on delivery performance) committed years into the future, may be matched with debt. Second, as a turnaround case, Keane has a high cost of equity - close to 15% in this Fool's opinion -- offering potential high returns (and risks) to equity investors, but also making lower-cost debt attractive.

Needed: A baggage-free CEO
The only good thing about turnarounds is their opportunity for value. Otherwise, they are scary for investors, concerning for customers, distressing for employees, and stressful for management.

Keane can take several logical steps to create significant value. The challenge lies in finding management that's more interested in execution than intrigue.

As an interim measure, the new chief financial officer will act as CEO while Keane is looking for a permanent candidate. To convince investors that its peekaboo games are over, Keane needs to look outside both its founding family and the Boston consulting world to find its next CEO.

Take a keen interest in further Foolishness:

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Fool contributorJohn Finneranwrites and advises on the financial value of technology for managers and investors. He does not own any of the shares mentioned. The Fool has a disclosure policy.


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