Harry You, 46, a former investment banker with Morgan Stanley, is unusual. He likes to join the companies he IPOs. First it was Accenture (NYSE:ACN), as CFO. Now, it's BearingPoint (NYSE:BE) as CEO. And he moves fast, spending just nine months as CFO of Oracle.
BearingPoint is the offspring of the KPMG accounting firm, with annual revenues greater than $2.6 billion. Its 15,400 consultants have a reputation for industry expertise and a distaste for the conceptual head-banging of their peers. The firm offers a "third way" to client enlightenment, a path between global players IBM (NYSE:IBM) and Accenture, and the high-growth, high-valuation Indian IT firms, such as Wipro (NYSE:WIT) and Infosys (NASDAQ:INFY).
A recent Business Update call sounded like a runner showing up for a 10K -- only to find a marathon. Since taking over, You has overhauled the company's clubby culture by dropping 150 managing directors (steadying BearingPoint's consulting business); nursed overdue 2005 financial statements; and worked to inspire his footloose staff (turnover, though torrid at 24%, is 4% better than when he took over a year ago) -- but many painful miles remain.
Consider the $100 million expense on auditing 2005 financial statements and Sarbanes-Oxley compliance. Compared to competitors, BearingPoint has twice the selling, general, and administrative costs (measured as a percentage of sales and including the finance charges). In addition, BearingPoint is underweight internationally, especially in offshore skills. (It has 300 staff members in India, with more in China.)
Consulting quandaries
Fixing the traditional business of counting cranky consultants is great. Is it enough? Why is a You-turn, so to speak, required?
First, the traditional consulting business costs too much. Recruiting and exiting 4,000 staff each year means more than 60,000 interviews a year. Assume 25% turnover, a candidate-to-hire ratio of 5:1, three interviews each, and an exit interview for each departing employee. Result: An exhausting trawl through the recruiting markets for me-too hires. Returns evaporate from large investments in training when the hires don't stay. In addition, there's a huge loss of chargeable management time and attention. Fixing the problem will require higher cash salaries -- the main choice, given a promiscuous history of issuing options on a stagnant stock -- and substantial investments in recruitment and retention programs.
Admittedly, there are still some big savings left in BearingPoint's traditional business. The company should be focusing on its "core" -- and for a consulting firm, that means brand, client relationships, quality employees, and intellectual property. BearingPoint should outsource everything else, and quickly.
Second, it's a volatile, exposed business model. Most of BearingPoint's revenue comes from projects. These are hard to win, easy to lose, and swing up and down with client demands. IT consulting is both seasonal -- new projects are rare in the summer -- and cyclical, driven by recession-sensitive IT spending. With countries from India to Russia offering their best graduates at discount prices, the long-term pricing trends are dismal. BearingPoint's economic protection of intellectual property is limited to two patents.
Industry trends further undermine the traditional model of finding complex software integration projects (and staying as long as possible). Software-as-a-service, where software is rented, saves licensing fees and means no work for consultants. Leaders include Salesforce.com (NYSE:CRM) and RightNow Technologies (NASDAQ:RNOW). Both are in customer relationship management, but the model is spreading. Next, there's IT as a utility. Technology contrarian Nicholas Carr argues that IT looks like the power industry 100 years ago. It will move from being built by each company to being purchased as a utility, like electricity or water. With 80% of projects overdue or over budget, it's an irresistible force.
Third, the stock market offers BearingPoint's current business model a low valuation. Based on forecasts for 2006, BearingPoint is trading at a price-to-sales ratio of 0.7. Blue-chip Accenture trades at 1.5 times sales. Indian outsourcer Cognizant, with recent quarterly revenue growth of 47%, has a boisterous price-to-sales ratio of 10. It will be hard to catch Accenture, and as a U.S.-centric company, the offshore growth premium is, well ... offshore.
What does the You-turn mean?
BearingPoint can't be like a doctor who smokes -- advising on best practices and talking about results, then ignoring its own advice. It needs to commit to delivering results to clients. Two suggestions:
First, build business processing services. This is where an outsourcing firm takes over the running of a process and commits to improvements, sharing the value created with the client. It's where best practices get proven (or broken). BearingPoint's industry expertise gives it an advantage here over the Indian IT firms and Accenture.
Second, invest in the utility trend. This means delivering services and committing to results for a set of industry clients. It takes a blend of consulting, investment banking, and technology skills, and the deals look like project financings (think bridges and toll roads). Financing can be kept off the balance sheet -- helpful to BearingPoint's strained credit rating -- yet the company deepens relationships with clients by becoming their business partner. It's also a patent-rich area, which helps the economic moat.
Spicing BearingPoint's revenue with transaction-processing businesses will increase its valuation significantly. Transaction processors with utility business models enjoy forward price-to-sales ratios between 2.4 and 5.6 -- many times BearingPoint's skinny 0.7 ratio. Large processors include Automatic Data Processing and First Data, with Checkfree, Euronet, and Total System Services rounding out the list of smaller processors. Other advantages include reduced dependence on hyperactive hiring and lower revenue volatility from fixed, annuity-like cash flows.
Mr. You has many of miles ahead of him in this consulting marathon. This advice could help him make it to the home stretch.
Consult with further Foolishness:
- BearingPoint's Troubled Books
- IBM: A Very Small Bright Light
- Foolish Forecast: Salesforce.com Calling
- 3 Stocks That Blew the Market Away
Take stock of BearingPoint's competitors on our Accenture and Salesforce.com message boards.
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John Finneran is a consultant, investment analyst, and writer specializing in the financial value of technology. He does not own any of the shares mentioned.
