Stock of the Week: Accenture

It's always a good sign when people who worked at a restaurant still go there to eat after they quit.

Full disclosure time. Before I started working here at the Fool, I worked at my "Stock of the Week" selection -- Accenture (NYSE: ACN  ) . I hope it's also a good sign that I would hire Accenture in a second if I were ever in need of the services they provide. Even for a premium.

Well, what services do they provide?
Many people still remember Accenture by its former name, Andersen Consulting. When Andersen Consulting severed ties with Arthur Andersen (fortuitously, in hindsight), it had to change its name as part of the deal (again, fortuitously).

Regardless of what you call Accenture, it's one of the world's largest providers of management consulting, IT consulting, and outsourcing. How large? Accenture has about 170,000 employees; in comparison, Coca-Cola has about 90,000.

Contrary to popular belief, Accenture isn't technically a U.S. company; it is headquartered in Bermuda and has offices in 49 countries. The United States -- Accenture's largest operating country -- makes up only 36% of total revenues.

Yo' momma's a consultant
Doesn't it seem as though everyone's a consultant these days? Well, they probably are. The competition in the consultancy space is fierce. Not only does Accenture have to wrangle with other large, multinational players like IBM (NYSE: IBM  ) , but it also has to compete against the "Big Three" Indian outsourcers Wipro (NYSE: WIT  ) , Tata, and Infosys (Nasdaq: INFY  ) ; accounting firms that provide consulting; and niche providers.   

Accenture's outsourcing business has grown out of its consulting business ("Hey, we just converted you to a new software system -- want us to run it, too?"), but a lot of the other players are reversing that process. The Indian outsourcers are swimming upstream to the high-margin consulting business, and the accounting firms are trying to straddle the line between remaining independent and selling you fries with that audit.

What separates Accenture?
With all this competition, what makes Accenture so special? First of all, its reputation is pristine. Although I'm sure IBM and EDS (NYSE: EDS  ) would beg to differ, I've always considered Accenture the Goldman Sachs (NYSE: GS  ) of the consultancies. What does that mean? It means that if all the companies were charging the same price for the same service, Accenture would be the one you'd pick.

I'm biased, of course. I saw firsthand how well Accenture's operation runs. Although it is now a public company rather than the partnership it started as, that partnership mentality has lingered. Smart young consultants work long hours for many years in the hopes of one day making partner.

Its corporate culture is imbued with a demand for uncompromising excellence. The effect of that is hard to quantify, but it's an x-factor that makes me comfortable that Accenture will effectively evolve, however the competitive and business environments may change.

Another advantage Accenture has on all but its largest competitors is its one-stop-shop capability. It's software agnostic -- it's not biased toward any particular software systems, as many of its competitors are, so the company has its hands in just about every kind of consulting and outsourcing you can think of. And if it doesn't, it's not afraid to figure it out.

It has to be a comfort to Accenture's clients that they can come to one company for so many of their third-party needs. That's the same advantage that Wal-Mart (NYSE: WMT  ) has over mom-and-pop shops. Sure, a boutique firm may do a certain type of consulting better (or cheaper) than Accenture, but there are large efficiency costs associated with managing and coordinating multiple vendors. The local hardware store may have a better selection of hammers, but is it worth the extra time you take to go there for that incremental gain?

Incidentally, Accenture can compete on price as well as quality. How? Through the company's self-proclaimed "global delivery network." Remember that Accenture is truly global, with offices in more than 150 cities. It can have local people on the ground at client sites all over the world. But how does it compete with the low-cost Indian providers? Accenture supports the on-site client teams with massive delivery centers in low-cost areas like India, the Philippines, China, and Eastern Europe. The combination of the two allows it to provide a local feel and knowledge at a competitive price.

Risky business
For me, the primary risks Accenture faces are:

  • Margin compression -- This could come from chasing lower-margin work (for example, increasing the percentage of outsourcing vs. consulting work) or from competitive pressures (being a premium provider only has so much pricing power). Note that as Accenture has grown and as it has increased its outsourcing business to around 40% of revenue the last few years, it has been able to keep margins fairly steady.
  • People -- I kid you not: Accenture actually claims, "Our most important asset is our people" in its latest 10-K. Gag. But it's true. If Accenture fails to recruit people who will help it keep its current standards or lets its corporate culture slip, the music will die.
  • Reputation risk -- In a service industry, reputation is everything. Arthur Andersen disintegrated once its reputation was tainted. Granted, public accounting is more reputation-based than consulting, but clients would still switch to Accenture's competitors if they felt their good name was being sullied in association.

At what price, love?
Check out how Accenture compares to the other multinational big boys:

Company

TTM Revenue
(millions)

Trailing P/E Ratio

Return on Capital

Accenture

22,388

16.5

64.1%

IBM

98,785

15.7

16.1%

EDS

22,134

12.1

6.6%

All data from Capital IQ, a division of Standard and Poor's.

You'll notice that Accenture is priced comparably to IBM and EDS, but with a huge return-on-capital advantage. Add the other advantages I've talked about, and Accenture is looking attractive.

Let's see how Accenture looks on a discounted cash flow basis. In my model, I assume a 13% earnings growth rate for the next five years (which is what analysts estimate and below Accenture's guidance for the upcoming year) and half that growth rate for the second five-year period. Assuming a terminal growth rate of 3% and a discount rate of 11% values Accenture's shares at around $43, a 23% premium to its Thursday close of just under $35.  

Accent on the Future  
At today's prices, I believe we can purchase a great company at a good price. If that price slips a few dollars further, we can upgrade that good price to a great price.

Previous Stocks of the Week:


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