Turnaround… or bust
“A moment on the lips, a lifetime on the hips.” Such is the lament of many a weight-watcher, but the adage is equally applicable to many, if not most, of South Africa`s listed IT groups. As sweet as their acquisitions may have tasted during the late nineties boom, their buying binges have left them with excess fat and an unsatisfied hunger for sustainable profits.Over the past three months, IT groups have swamped the investment community with profit warnings that indicate that the sector is some way off a recovery, even after several years of upheaval, consolidation and restructuring. Among the most notable are trading updates from companies profiled in the pages that follow – AST Group, Global Technology (Glotec), MGX Group and Faritec.The technology industry has evidently not yet paid in full for the excesses of the good times when IT companies chased revenue growth and market share at the expense of long-term profitability and balance sheet strength. There`s still too much competition and excess capacity in the market and not enough corporate discipline, a fatal mix in such a poor business climate.As much as the over-traded local IT industry is crying out for consolidation, most of the groups profiled here are in no shape to buy out other companies, embark on ambitious mergers or to be acquired themselves.Indeed, most of these companies are in varying stages of the process of divesting themselves of their own non-core and poorly performing assets. AST, MGX and Glotec are too big for any but the sector`s true giants (comparatively speaking) to even contemplate swallowing in their entirety.The giants in question, Comparex and Dimension Data, have enough troubles from their own boom-time acquisition sprees to be interested in taking one of these problem children into the fold. One wildcard is the Altron Group, which could afford to buy practically any company in the sector should it wish to.The two smaller companies, Faritec and Vesta, are further down the line in their turnaround strategies and could form attractive acquisition targets. Faritec has a strong balance sheet and is in good health after adopting a conservative approach to growth in the last financial year. Consolidation will start to happen this year, but only a small scale.One likely ingredient for any corporate action will be black empowerment. Those empowerment groups with money, good contacts in the government and experienced leadership will have their pick out of a range of businesses, fresh from a fitness regime, but still cheap.Exploding the services mythThe woes at AST and Glotec explode a myth that practically everyone has subscribed to: that ICT services make a lucrative, high-margin business that will prove to be the long-term salvation of the industry. The reality is that offering services is messy and complex, because it is all about managing people.It is desirable, of course, to build a stream of annuity income from services contracts, but these deals often require some upfront investment before they become profitable. Services businesses are also difficult to scale according to the needs of the market. Companies generally end up with either too few people to handle the work in their order books, or with too many expensive consultants and techies sitting around with idle hands.Trying to grow a sustainable and profitable services business on an accelerated timeframe is rather like two women trying to have a baby in four and a half months – as Pat Moffett, Glotec`s marketing director, colourfully describes it.Perhaps the most important challenge that each of these companies face lies in restoring the market`s confidence in their ability to deliver good returns. As the survivors of an extended shakeout, they are among the better companies to list in the 1997 to 1999 technology boom. It would be uncharitable to be too harsh on these battered companies, since the mistakes they made were common at the time and unlike many they are still around to fix them.Most of them have some sound underlying assets and good market share in their core businesses. They now have to prove that they can leverage these to produce the hard cash flow and dividend returns that investors look for in a bear market. When the centre cannot holdby Lance HarrisMGX`s new chief took the wraps off his tough plans to restore order at the troubled group in a progress update at the end of January. But he concedes that his steps may not be enough to save the group from liquidation.After a two month review of operations at MGX Group, Peter Flack, the company`s new executive chairman and interim CEO, had little good news to offer shareholders in a progress update.At best, Flack – who was appointed late last year to drive the group`s turnaround – will be able to turn the group into a more profitable but much smaller business. At worst, the group could still be wound up to pay off its creditors.The group`s problems had originated at its centre, where it had suffered from some serious reputational setbacks as well as a general lack of leadership, direction and control, says Flack. “All the underlying subsidiaries are cashflow-positive, but at the centre we found a lack of basic disciplines”, he says.Steps have been taken to tighten the lax accounting practices and financial reporting systems that MGX used in the past.The group has started negotiations that could result in the sale of its Business Continuity and Enterprise Solutions divisions. These two businesses are largely made up of interests that MGX gained along with its acquisition of CCH. The CCH deal was meant to move MGX into the IT mainstream as a major player, but has instead proved to be its undoing.Digital and physical content management business Metrofile will now form the bedrock of the restructured MGX. This business has a stable track record and an enviable list of long-term services contracts with public and private sector clients.“Ideally, we want to build a group that has a good mix of high-growth businesses and mature ones that produce a steady stream of annuity income,” says Flack.The most formidable problem that MGX faces is a R550 million debt pile, largely a legacy of its acquisition of CCH in 2000. The group will probably not be able to pay the debt in full from the proceeds of the planned disposals, says Flack, and will still battle to service its debt burden out of cash flow from the streamlined group.If that proves to be the case by June this year, MGX may have to consider a rights issue, or the disposal of more or even all of its remaining assets.The group has also suffered a serious knock to its reputation after a series of corporate governance snafus under its previous management, including former CEO, Chris Hills and former executive chairman, Ronnie Price.These included an acrimonious public split with empowerment partner Motswedi and a long-running battle with the Securities Regulation Panel after the panel ruled that MGX and Ronnie Price`s family trust had worked in concert to buy EC-Hold shares rather than making an offer to minorities.Restoring some faith in the group`s name among investors and analysts will be particularly important if MGX does decide to go to the market looking for more money later in the year.Flack has taken a more accommodating – some may say pragmatic – stand on the EC-Hold debacle than did his predecessors. They were determined to defend the SRP`s ruling in court. He says that MGX has approached the SRP to try and find a more amenable way of solving the dispute. “We are waiting to hear from them how we should settle, when and for how much,” he says.MGX has also announced that it has entered into negotiations to a sell a stake in three of its subsidiaries to black empowerment investors, which may help to make amends for the Motswedi situation.MGX`s results for the six months ended December 2002 are expected in the last week of March. The group has already cautioned shareholders that they are expected to be “significantly worse” than the numbers for the same period of the previous year.The group says this can be blamed on a difficult trading environment, once-off restructuring and retrenchment expenses, increased financing costs due to higher debt and interest rate levels, and operational disruption caused by the aborted sale of MGX`s wholly owned subsidiary Software Futures to Paracon Holdings.Strategic and action plans as well as budgets for a reconstituted MGX are due to be submitted to the board in June, by which time Flack hopes to have completed negotiations for the sale of certain assets and resolved the EC-Hold issue.By the time Brainstorm went to press on the day Flack issued his progress update, the group`s share price had plummeted from around R2.50 the previous day to R1.50.MGX faces either a dramatic turnaround, or going bust. And investors clearly aren`t too confident. Regrets, we`ve had a fewby Lance HarrisGlobal Technology has taken desperate steps to correct the excesses of the boom times.Global Technology has the dubious distinction of being the worst performing share on the IT sector of the JSE Securities Exchange during 2002, plummeting from 95 cents at the beginning of the year to 10 cents by the end. The group is now moving swiftly to restore investor confidence after a year of deep losses.For the six months ended 30 June 2002, Glotec, which is active in financial services and business intelligence software, development and related services, reported a net loss of R7.7 million on turnover of almost R220 million, compared to a net profit of R92.9 million for the same period in the previous year. A recent trading update informs shareholders that the group also expects to record a loss for the full year ended 31 December 2002.Higher interest repayments, disappointing performance from Swiss associate company Temenos and foreign exchange losses after the strengthening of the rand all conspired to turn 2002 into a rough year for the group, says Glotec`s marketing director, Pat Moffett.“We got caught with our pants down when a number of things happened in relatively quick succession,” admits Moffett. “We probably didn`t react quickly enough – there are lot of excesses and inefficiencies that one doesn`t notice in a business as long as the good times last.”In mitigation, Moffett points out that 80 percent of Glotec`s costs lie in its people because it is a software development and services group that depends on its intellectual capital. “We couldn`t hack costs willy-nilly because we could have ended up cutting away at our lifeblood,” he says.Nonetheless, the group has put all of its expenses under close scrutiny and hopes to save R30 million in costs in the next financial year. Glotec has reduced its headcount to 600 from 700 a year and a half ago, streamlined processes and focused on customer satisfaction with the aim of making every site referenceable. It has also increased its focus on selling its locally developed insurance and banking software, particularly into international markets.Headaches have emerged at Glotec`s Australian subsidiary, which is listed on the Australian stock exchange and accounts for around 15 percent of the group`s profit and turnover.Although Glotec management has tried to downplay the troubles in the region, the Australian business is also expected to report a loss for 2002 because of its failure to secure a major tender. The company will tighten its control over the business and restructure it to avoid a repeat performance.Glotec is also exploring the possibility of buying out the minorities that hold a 30 percent stake in the business, although Ray Leonard, Glotec`s executive chairman and CEO, stresses that no decisions have been taken yet.In Temenos we trustWhile Glotec has taken steps to correct the problems in the operations under its direct control, its future is closely linked with that of its associate company, Temenos.Not only does Glotec own a 15 percent stake in the Swiss-listed group, it is also a major reseller of Temenos` suite of financial services software into Africa and Australasia. For the first half of 2002, the contribution of Temenos to Glotec`s profits was only one twentieth (R692 000) of the R15.8 million figure for the same period the year before.Temenos listed on the Swiss bourse in July 2001 at CHF23 (Swiss francs) and saw its share price hover at around CHF15 for a while before plunging down to CHF1. At the listing price, Glotec`s stake in Temenos was worth around R1.2 billion, but it is now valued at somewhere close to the R120 million Glotec paid for it at the current share price around CHF2.40.Given Glotec`s high gearing, one would imagine that it would make sense to sell Temenos shares to strengthen the balance sheet rather than embarking on another rights issue, as planned. In addition, some investors have long been anxious to see Glotec unlock value from Temenos, and their flight from the share when it became clear that this would not happen anytime soon has contributed to the weakness of the counter.But Glotec plans instead to hold onto its stake in Temenos in the hope that its value will eventually rise, says Moffett. The group`s patience with Temenos may yet be rewarded since the software company is in better health than its financials for last year indicate.Although Temenos` financial performance was less than stellar for most of 2002, the company was one of the star performers in the global banking software arena in the late nineties. Globus, the flagship Temenos product, was rated as the world`s top selling in its class for the fourth consecutive year by the International Banking Systems Review, and Temenos indicated in a January trading update that it took a stream of new orders for the fourth quarter of 2002.Even without this improvement, the cost cutting and restructuring should put Glotec back in the black for 2003.“I`m glad that 2002 is behind us. It was a disastrous year for IT, but for all that, the company is in better shape than it has ever been,” says Leonard. The pipeline for 2003 looks strong, with hopes that many of the deals that were postponed last year should come through, he adds. Glotec`s share price was stuck at around 16 cents at the time of writing, indicating that investors still need to be convinced by the group`s story.“If we were following a script, if what we had done had been done before, it would have been much easier. Instead, we`ve been doing it our way – us and Old Blue Eyes,” says Moffett. There`s one importance difference, though: despite regrets, of which it has a few, Glotec is not yet ready to face the final curtain. Vesta chooses survival over hypeby Jeff DelaneyConsolidation, rationalisation and a return to key business principles are turning the tide at embattled software developer, service provider and e-learning company Vesta Technology Holdings.Vesta`s CEO Frederick Morrison has watched the micro cap`s share price plunge from 30 cents a year ago to a paltry two cents as we go to press.The company is a fairly typical casualty of the dot com period. It built up capacity, banking on the future of e-commerce, e-enablement and e-business, and saw this investment go down the tubes (to use Morrison`s words).A few injudicious acquisitions, including the Fund Mator group of companies, did little to help the cause.The trick now is to recover this cash, which is difficult when the original basis no longer exists.Vesta`s dismal performance is not unique in the local and international IT sector, however, and the company appears to have been relatively prompt in taking remedial action.“The last couple of years have been tough in the market and many companies have been through the pressure cooker,” concedes Morrison ruefully. “What we have realised is that you cannot change the underlying principles of good business. Hits and eyeballs don`t translate into cash and that`s something the ‘dot bomb` period brought home.”Vesta, he adds, is fortunate in that it was founded before the boom period, cutting its teeth in a buyer`s market, enduring longer sales cycles and focusing on the need to build lasting relationships with customers. All this went out the window as the IT bubble inflated and companies profited on a wave of unrealistic hype and expectation.“In a way, perhaps, Vesta did not capitalise as much on the hype of the period as we could have, but there was always the nagging feeling that something was missing. That`s with the benefit of hindsight and, in saying that, there`s little doubt that a lot of people sacrificed their business integrity for quick profit at the time. In my experience, the dot com era saw IT ethics sink to their lowest ever,” Morrison says.The reversal of the market had far reaching implications for the sector as a whole, and survival as opposed to mega growth became the overriding concern of most companies.“By the end of 2001, we realised we had to make some tough decisions – take a close look at our company and restructure. We also realised that in the prevailing market it was impossible to do anything to counter a falling share price. There is just no way a micro cap is able to change world sentiment.”Tough medicineVesta`s solution was severe. The company cut back on staff from a peak of 120 to around 60-odd today, but Morrison believes it achieved the optimum swing that will allow it to avoid further rationalisation going forward.“In addition, we took a conservative look at our figures and our projections. Ad hoc sales were discounted completely, the idea being to ensure that contractual business at least equalled the running costs of the company. We have achieved this through returning to our traditional business model of focusing on margins as opposed to revenue.”That said, Morrison is wary of making growth projections, stressing that Vesta is still in a consolidation phase.“We release our interims at the end of February, which will give us an indication of how successful the turnaround has been and I`m optimistic they will show us moving from the loss making situation of last year. I`ll be happy if we can show a positive balance by year end,” he says.The last year has seen a rash of de-listings of small caps, and Morrison is ambivalent about Vesta`s future as a listed entity.Open options“I don`t believe any company in our sector, from the Didatas to the small caps like ourselves, is generating shareholder return at present. The reality remains: how can you fight negative world sentiment and institutional disinterest? The fact is that our listing is not core to our survival as a company.“Also, de-listing purely as a means of avoiding public scrutiny cannot be a good thing. But the JSE is not returning value at the moment, and, if that is your only criteria, then being listed is worthless. We`re keeping our options open.”What is not an option, stresses Morrison, is a management buy-out concentrating on retaining the best and discarding the rest. Management, he says, is stable and committed to the turnaround. “I believe the shake-out the market has undergone is a good thing. There is no doubt the industry was both overvalued and overtraded. There`s no such thing as funny money any more. The key is hard work that translates into real returns.Vesta has endured and appears to have survived its shake-up, and while Morrison concedes it could have been done a couple of years earlier, it`s now over.Has the company really turned the corner? Given the vagaries of the market, that`s anyone`s guess. Only the numbers will tell. A twist of sobrietyby Lance HarrisIt`s a familiar tale: company hits cash crunch after growing too quickly and greedily for its own good. But AST`s new management team hopes it can provide a happy ending for the group`s saga of corporate excess.The AST Group`s share has long been priced for outright disaster, despite repeated assurances from its management that everything was under control. During 2002, the counter went into free-fall, from R2.30 at the outset of year to less than 30 cents by the beginning of December. Only then did the group finally admit that it was in trouble.In a profit warning issued then, AST informed shareholders that the group expects to record an attributable loss for the six months ended December 31 2002 and fingers once-off restructuring charges, a tight competitive environment and high interest costs as the reasons for its difficulties.Although the IT services firm issued a trading update in October to tell the market that it was suffering because of poor market conditions, it underestimated how deep its troubles were and how expensive it would be to correct them.Non-executive directors at AST and at Kumba Resources (which is a major shareholder in the group) instigated a set of sweeping changes to the company`s strategy and operations, starting with an overhaul of its board of directors that was announced in early December.Jan van Zyl stepped down as CEO, apparently in a negotiated resignation – although he was said at the time of his departure to have been struggling with a personal injury. John Miller, AST`s sales director, took the reins of the group as CEO, and executive chairman Gerrie de Klerk`s position was moved to a non-executive position.Miller, a 62 year-old veteran of ICL and Unisys, says that the market can expect to see a more conservative approach from AST than it was accustomed to in the past. He promises that his focus will remain on increasing margins and profitability rather than on chasing revenues – which stood at a formidable R2.2 billion for the financial year ended June 2002.Miller`s sober approach is a stark contrast to that of De Klerk, the gregarious eternal optimist who engineered the group`s rise from a tiny software reseller into an IT services giant. Although De Klerk succeeded in his goal of growing AST into one of South Africa`s largest ICT services groups, his strategy took a heavy toll on the balance sheet, which reflects high debt levels.AST has two immediate priorities: strengthening its balance sheet and improving its liquidity. To those ends, the group has announced a set of far-reaching initiatives and strategies, ranging from simplification and restructuring of its operations through to a business improvement programme designed to hike margins and increase efficiency.AST has acquired numerous companies over the past few years, straying from its core focus and introducing complexity into its structure, says Miller. The group also didn`t act quickly enough to integrate these businesses and reduce the overheads that they brought with them. “You don`t need as many HR directors and FDs and MDs as we took on with our acquisitions,” Miller says.Around 90 percent of AST`s business is fundamentally healthy and continues to generate cash each month in line with expectations, he adds. The group has a solid base of annuity revenues from outsourcing contracts and joint ventures with the likes of ABSA. Recently, it secured a two-year extension of its outsourcing contract with flagship customer Iscor – a deal that is currently worth more than R240 million a year.“The good bits need to remain very focused on what they are doing. The bits that are performing badly or that are non-core will be disposed of over time,” says Miller.Shedding skinMiller declines to name the operations that AST plans to get rid of, but says that the process will involve the sale of certain businesses and the closure of others.In some cases, AST has started negotiations with potential buyers and has offers on the table. Miller hopes that the group will benefit from a cash injection from some of those planned transactions.Costs and efficiencies at the core businesses are also under the microscope because cost inflation is running ahead of price increases in the current operating environment.AST has already laid off some 250 staffers, and plans to retrench a further 150, or possibly more, in the coming months. AST has wielded its axe in every department, sparing only those divisions that produce billable work.AST has not given up on its plans to bring a black economic empowerment partner on board to strengthen its position in the public sector market and hopefully inject some capital into the business. Miller says that AST has identified some potential partners who have money on hand, although it has yet to receive a cheque.The group says that it is solvent despite its current woes and expects the full year to show a profit before amortisation of goodwill for past acquisitions. The new management is realistic enough to note that its drive to improve margins and contain costs will be a slow process that will only bear fruit in financial 2004.At the time of writing, AST`s share price hovered at around 25 cents. Investors, too, seem to believe that the road to the turnaround will be a long one for AST. Back against the ropesby Lance HarrisFaritec Holdings has shown that it can claw its way out of a tight corner. Now it needs to convince the market that it is on track for long-term sustainable growth of both profits and revenues.Faritec Holdings impressed the IT industry with a dramatic turnaround during financial 2002, but a combination of investments in new businesses and tough market conditions are expected to take their toll on the bottom-line in the first half of the new financial year.In a trading update in November, the group informed shareholders that it expects its results for the six months ended December 2002 to be below those for the same period in 2001. The main culprit for the disappointing performance is the group`s Enterprise Solutions subsidiary, which suffered from slow hardware sales during the second half of calendar 2002 as South African companies continued to hold back on infrastructure investment.This product-oriented business, largely made up of IBM server and storage sales, currently accounts for more than half of Faritec`s revenues. However, Faritec is also emerging as a significant IT services player with an outsourcing business worth more than R100 million a year.Like many of its peers, the group sees services as its long-term future.CEO Simon Tomlinson tells Brainstorm that a decision last year to decentralise Faritec`s operations and create three autonomous subsidiaries has positioned the group to grow its services businesses more aggressively.The three new companies are Faritec Enterprise Solutions, Faritec Inter-Company Processes (a B2B e-commerce initiative) and Faritec Strategic IT Services.The new structure is just about bedded down and will hopefully stimulate growth by giving each business more flexibility in setting strategy and pursuing opportunities.“In the past, we had a small base of decision-makers. Now, we have three subsidiaries with their own boards of directors and control over their budgets, HR, IT and marketing,” Tomlinson says.Surprisingly, the reorganisation has brought costs down slightly rather than increasing them. Faritec now runs a lean head-office structure with only five full-time employees, including an HR director who will most likely take up a post at one of the subsidiaries.Faritec`s big focus for the coming months is on growing its high-value services business with the goal of lifting its operating margin from the 6.3 percent of the last financial year to 10 percent or more in three years time. As part of that strategy, Faritec has invested heavily in creating new business intelligence, security and business process outsourcing initiatives.Faritec is a late entrant into these already fiercely contested markets. However, Tomlinson hopes that the group`s approach of offering business intelligence and security solutions as a managed service will set it apart from the pack.But this strategy carries risk and is only likely to yield results in two or three years time. The South African market has yet to warm to the concept, whether it is labelled as managed services or application service provision or hosted services.Empowerment credentialsTomlinson lays at least some of the blame for slow sales in the Enterprise Solutions division at the door of the group`s lack of a black economic empowerment (BEE) partner.The right empowerment credentials are critical for doing business not only with the government – a market segment where Faritec has never been particularly active – but increasingly also with the larger blue-chip corporations, as Tomlinson notes. After a long search, Faritec has identified a suitable empowerment partner and hopes to conclude its negotiations with this party by the end of March.“I`ve spent the last 12 months looking at BEE and we`ve spoken to a number of potential partners. A number of problems keep arising – particularly with initiatives and investments that conflict with our business,” says Tomlinson.With a share price that languished at 36 cents at the time of writing, Faritec seems like an attractive acquisition target or a prime candidate for a delisting from the JSE. The group is open to both of these possibilities, althoughh it will only consider proposals that enhance shareholder value, claims Tomlinson.“There will be some degree of consolidation in the next 12 to 24 months. The market is over-traded,” says Tomlinson. “There are two ways that we could participate in the process – we could merge with or acquire one or two of the other parties out there, or we could be acquired by another company.”Faritec`s board has also debated the possibility of delisting from the JSE, but for now that is not an attractive option because many shareholders bought into the group at higher levels.“I don`t see this as a strategic decision – business goes on either way. However, it [delisting] doesn`t make sense at a share price of around 40 cents because of the premium we`ve had to pay for the shares,” says Tomlinson. “At around R1 or R1.50, it may become attractive and if the right proposal comes along, we`d consider it.”Tomlinson says that the group has kept a lid on its costs and hopes to see a recovery in IT spending during calendar 2003, although he warns that he expects trading conditions to remain difficult for some time yet.Still, the challenges that Faritec faces today are relatively minor compared to the problems of two years ago when the group called off two major acquisitions, retrenched 10 percent of its staff and battled with free-falling margins and revenues. Among the groups profiled in this feature, it is one of those best positioned to bounce back when the market turns.
