ACN - Accenture PLC

[Palantir]

I'm considering starting a position in here. My rationale here is not very exciting or creative - solid firm with good growth and cash flow, and a nice return of capital program. What I'm trying to decide right now is what their customers' switching costs are like.

[MYDemaray]

I'm guess they are pretty high...like IBM.  Many of these are deeply embedded, long-term projects.  Some, like the gov't work, I'd imagine have to go through bid processes...so the customers erect their own switching costs.

[Phaceliacapital]

Don't know a lot business related but they always turn up in my Cannibals screen as very high buyback guys

[bmathews03]

Accenture consultants work very closely with clients, learn a lot about the clients’ businesses, and, over time, consultants become indispensable.  Of Accenture’s top 100 clients, 92 have been clients of Accenture for at least 10 years.  And, outsourcing contracts typically last 5-10 years, and it's pretty difficult to switch from an entrenched provider, even when the contract comes up.

[bmathews03]

I'm considering starting a position in here. My rationale here is not very exciting or creative - solid firm with good growth and cash flow, and a nice return of capital program. What I'm trying to decide right now is what their customers' switching costs are like.

 

THESIS

The company is awash in cash, generating a nice free cash flow yield with 10% of market cap in net cash. It is in a growing market with a strong competitive advantage. It has quality management, and it regularly returns most of its cash to shareholders. If you buy this stock, you can ignore it for five years, and you'll end up with a double or better.

 

BUSINESS DESCRIPTION

Accenture performs system integration, management consulting, and outsourcing for large corporations.  The target market is the Global 2000 (the 2,000 largest companies in the world).  Currently, Accenture serves 94 of the Fortune Global 100. Accenture has 244,000 employees in 54 countries.

 

1.      Systems Integration:  Implementing business software.  This requires large teams with expertise in specific in software, such as Oracle or SAP, the industry, and business processes.  Engagements are typically a few months to a year.  Project-level margins vary from 20-50%, depending on the specifics.  The delivery teams often include a blend of local, high cost staff and offshore, low-cost staff.  It's a highly-fragmented market.  According to Gartner's IT Professional Service data, market shares are: IBM (7%), HP/EDS (4%), Accenture (4%), Fujitsu (3%), CSC (3%), Capgemini (2%), Deloitte (2%), TCS (1%), Infosys (1%), and Wipro (1%).  Competitors include IBM, Infosys, TCS and Wipro.

 

2.      Management Consulting: Improving client processes and strategy.  Engagements are typically 2-6 months.  Project-level margins are high -- typically over 40%.  Competitors include Deloitte, McKinsey, Capgemini, and numerous small-specialist firms.

 

3.      Outsourcing: Performing a back office function, such as payroll processing or application development,  for a client in exchange for a fee.  Typically, the work is done in a "Global Delivery Center," which is Accenture-speak for an office in a low-cost location, such as India. These are "big deals" (over $50 million) that take place over 5-10 years.  Competitors include IBM, HP (EDS), Infosys, Wipro, TCS, CSC, and Cognizant.

 

MARKET GROWTH

Accenture is well-positioned to benefit from two major market trends: increased spend on IT and increased business outsourcing.  These are both generational-length trends that will cause massive shifts, although not in any particular year.  Over the past 10 years, Accenture has generated top-line growth of 8% annually, regardless of the macro environment.  I'd expect that same growth to continue for the next 5 years.

 

1.      IT Drives Productivity: We are in the age of transformation driven by information technology.  Technology, in the form of improved analytics, increased automation, and productivity enhancements catalyzed by mobility, the cloud, and big data.  Investments technology drive improved productivity, higher revenue, reduced costs, and better capital efficiency.  For this reasons, Gartner is forecasting 5-10% spend in IT over the next five years -- more than double global GDP growth.  Accenture is particularly well-positioned because Accenture works on multiple platforms, i.e. it integrates for the major software and hardware vendors.  Accenture is just as capable installing a Salesforce.com system as an Oracle system.  In that sense, you don't need to worry about technological change or obsolesce.  Regardless of what is the new hardware or software technology, it won't fit perfectly to the incredibly complexity of a Global 2000 Business.  Thus, system integrators will be necessary.

 

2.      Outsourcing Reduces Costs: Businesses that have traditionally handled all their internal back-office functions are increasingly looking at opportunities to outsource.  Two key structural factors are driving this trend.  First, management wants to strategically focus on their core competency, which doesn't include back office functions -- it's not their expertise.  Second, tactically back-office functions can be done more cheaply by specialist providers.  Here's why: typically, outsourcers, such as Accenture, have process expertise (i.e. experience curve), the ability to implement technology and amortize the costs over bigger volumes, and expertise in labor arbitrage, (i.e. hiring and managing knowledge workers India, Eastern Europe, Latin America, South Africa, China and other offshore locations).

 

MOAT

Warren Buffett's quick-and-dirty test for a moat is high returns on equity with no debt.  Accenture's return on equity has averaged 65% over the past ten years.  This is significantly above the average 8-9% returns on equity for the stock market (source: Aswath Damodaran, NYU-Stern).  This high-level of return on equity results from: sticky client relationships, economies of scale, intellectual property, economies of scope, and brand.

 

1.      Client relationships tend to be sticky.  Accenture consultants work very closely with clients, learn a lot about the clients’ businesses, and, over time, consultants become indispensable.  Of Accenture’s top 100 clients, 92 have been clients of Accenture for at least 10 years.  These client relationships are also crucial as "reference clients" when bidding for new business.

 

2.      Scale: Accenture is the world’s largest consulting firm, and it serves the world’s largest organizations, the Global 2000.  These clients operate globally and at a huge scale, and they need partners to operate at the same level.  For instance, a typical systems integration project or outsourcing deal might require putting 50 or more experienced consultants on site, in addition to another 50 developers off-site.  Only a handful of firms have the ability to operate at this scale, which generates pricing power for those handful of firms.

 

3.      Intellectual property: Accenture has multiple delivery methodologies, playbooks, offerings, etc... This is a codification of past work, which makes it easier and quicker to deliver new, similar work.  As such, Accenture consultants don't walk into a new engagement empty handed -- they will be armed with an instruction-manual.  This allows the firm leverage intelligent, hard-working, junior people that tend to be inexpensive and high-performers.

 

4.      Scope: Accenture has the broadest offering of any professional services firm -- from up-front McKinsey-type strategy consulting to back-end EDS-type outsourcing.  Thus, Accenture can honestly offer clients a "one-stop shop" to improve their business.  In Accenture-speak, it's called "transformation," which is a holistic approach to solving business problems.  No other firm has Accenture's broad scope of capabilities to go from development of a business solution through to implementation, including expertise in business processes, industry issues, technology and back office functions.

 

5.      Brand: The Accenture brand was ranked 45 on Interbrand's Global Brands Study, and the Financial Times ranked it as 49 on its 2011 Top 100 Most Powerful Brands Study.  The brand conveys three distinct advantages.  First, it offers downside-protection to CTOs/CIOs that hire Accenture.  If an engagement goes wrong, they're not likely to take flack for hiring a no-name.  If an Accenture engagement goes wrong, the CIO/CTO has the automatic out ("I hired the premier global firm, they messed up, not my fault").  Second, as a global brand, purchasing officers will seek out Accenture.  As part of their job, they want to know someone at Accenture, and if an RFP is going out, Accenture will be included in the list.  Third, and perhaps most importantly, Accenture's brand is a differentiator in the recruiting process.  Junior-level hires want a brand-name on their resumes to start their careers, and senior-level hires, rain-makers which exist in small numbers, want to be selling a premier service.

 

MANAGEMENT

Accenture trains and sells business professionals as its core-business.  This results in a deep roster of management talent, which is mostly internally generated.

 

1.      Core of experienced, internally generated Managers.

a.        Deep Management Bench: Accenture's management team is internally generated, and the typical member of the management team has 20 years or more working with clients, learning and implementing best practices, and developing business acumen.

b.        Experienced Management: Of the 18 key executive officers mentioned in the 10k, 16 are Accenture-lifers with 20 to 30 years experience with the firm.  The exceptions are the Chief Counsel and BPO Group Executive, who have been with Accenture for 10 years and 19 years, respectively.

c.        Dynamic, Young Team:  And, don't think that long-tenure of experience has resulted in group of elderly holders-on -- all of management are in their late 40s or early 50s.  The oldest executive is Bill Green, 58, the Chairman of the Board, after retiring from 6 years as CEO.

 

2.      Results indicate both operational skill and financial stewardship.

a.        Operational Results: Management has a strong track record in both generating growth and maintaining profitability.  Accenture has grown the business 8.5% annually over the past ten years, including both the dot-com collapse in IT spend the general malaise of "Great Recession."  Across the same period, operating margins never fell below 10%, and ROIC never fell below 47%. 

b.        Financial Stewardship: Accenture's management has a proven track record of generating cash and returning it to shareholders via dividends and repurchases.  In the past five years, Accenture generated $13.5 billion in free cash, 80% of which was returned to shareholders via dividends and repurchases.  In the previous 10-year period, Accenture generated $21 billion in free cash and 75% was returned to shareholders.  In the same periods, only $900 million and $1.4 billion, respectively, was spent on acquisitions.

 

VALUATION

Accenture is a cash-generating machine.  Accenture's business model doesn't require investment, and it generates large amounts of cash.  Over the past 10 years, free cash flow has averaged 10.4% of sales.

 

1.      80% Cash Returned to Shareholders:  Accenture returned 80% of cash generated in past 5 years to shareholders through net repurchases and dividends.  The company has increased its dividend every year since initiating it in 2005.  That equates to nearly 4x growth in 6 years -- from $0.30/share in 2005 to $1.13/share in 2011.  The forward yield, which doesn't include a likely 2012 dividend raise, is 2.3%. 

 

2.      $100/share in 2016: Using simple, conservative assumptions for revenue growth, margins, share count, and P/E multiple, my estimate of the share price in 2016 is about $100.  I'll quickly lay out my assumptions.  First, Accenture's revenue has grown 8% annually over the past 10 years.  Second, during that time, operating margins have remained relatively constant, ranging from 10-13% with an average of 12%.  Third, over the past five years, the share count has fallen by an average of 3.7% per year.  Fourth, over the past 10 years, the P/E multiple has ranged from 16x to 48x; today, it's about 18x, calculated with diluted shares.  Thus, if I assume 8% revenue growth, constant margins, 3.7% annual share reductions, and an 18x P/E multiple, the share price should be $103 in 2016.

 

3.      17% Annual Returns: Leon Cooperman, formerly of Goldman Sachs Asset Management and currently head of Omega Advisors, has a simple and effective rule-of-thumb to estimate equity returns.  The formula is free cash flow yield plus growth equals return.  Applying that simple math, i.e. 9% yield plus 8% growth, results in expected annual returns of 17%.

 

 

*Note: This is mainly from notes that I've written going back 1-2 years, if a particular number is out-of-date, please forgive me. Hopefully, it won't distract from my overall message.

[LC]

Great post, thanks for sharing your notes & experience of following the firm.

[Palantir]

Yes, great post, and thanks for crystallizing that info in one piece. I like your Return = FCF Yield + Growth, I'm stealing that.

[LC]

My question with most services firms regarding their moat is...what is their differentiation factor? What does Accenture do that much differently from IBM/Infosys/McKinsey etc.? What comparative advantage do they have?

 

Does scale really matter on a structural level once you reach a certain size? Are there projects that ONLY Accenture can handle, which Infosys or IBM cannot? Does their scale really give them some cost advantage, that they can spread over more projects? I mean, how many projects can an employee really handle all at once? Is it that they offer a more comprehensive suite of services? If so, why are they the only one who does this? It seems like any other large consultant with the financial resources can integrate more services to challenge Accenture.

[no_free_lunch]

LC,

 

I think what he is saying is that while scale might  not matter once you reach a certain size, there are only a handful of companies that reach that size.  Hence you get weak monopolistic pricing, which is still much better than pricing with no monopoly.

[bmathews03]

LC,

 

I think what he is saying is that while scale might  not matter once you reach a certain size, there are only a handful of companies that reach that size.  Hence you get weak monopolistic pricing, which is still much better than pricing with no monopoly.

 

That is well said. I have "nothing to add."

 

Interesting enough, this thread and this company will never generate much interest on this board. It will continue beating the market and compounding at a high rate. Yet, everyone thinks they're a genius. They want to debate stuff and try for some rapid 30% 1-year gain by some fake catalyst. They want to be the first to figure something out or at least think they have (e.g. Sears). This company generates lots of cash relative to its market price, and it returns the cash to shareholders. There isn't much to figure out. You just go to sleep and watch it double every 5-7 years or so. If the price dips and you time it right (mostly by luck), then you'd probably get a better return.

 

Honestly, sometimes I get fed up with investors in general, but also the "value investing" cult. I have no problem with the basic principles (they're self-evident), but the groupthink and arrogance sometimes annoys me.

[bmathews03]

Honestly, sometimes I get fed up with investors in general, but also the "value investing" cult. I have no problem with the basic principles (they're self-evident), but the groupthink and arrogance sometimes annoys me.

 

Sorry... lest anyone be confused. This is a general thought, and it isn't meant towards anyone on this thread or boards. Generally, the Accenture discussion has been good, and COB&F is a great forum (mostly) with polite contributors.

[Palantir]

FYI - I am one of those people looking for stocks that can generate cash on autopilot for years, so ACN is exactly the type I am looking for. Regarding your E® formula:

 

Let's take it on a per share basis because ACN is buying back so much stock and yet diluting it at the same time via share compensation.

 

ACN's FCF is typically 3.27B, and out of that, they return about 1.8B in buybacks every year, so the adjusted FCF that accrues to shareholders is = 1.5 B

 

Backing the cash out of the firm, we get an EV of about 50B, and an ad-FCF/share Yield of 3%

 

On a per share basis, the growth over the past 5 years has been about 6% in FCF/share and about 7% in EBITDA/share.

 

Adding those two gives me an expected return in the 9-10% range.

[fareastwarriors]

I think some of the investors here are searching for the "deep value" stuff and not necessarily something more GARP-like. There are many good ideas posted and just because they don't get a lot of attention (posts) it doesn't mean they are not good investments.

 

Don't fret, no forum is perfect.

[no_free_lunch]

1250 views and counting.  People are definitely taking it in.

 

[LC]

I still don't quite know what distinguishes them from other consulting firms. If the investment hinges on the fact that the industry is an oligopoly that is fine...but in that case wouldn't an investment in ANY of the oligopoly firms prove a good one? So why Accenture and not IBM or another large player? Are they the only company that can offer the full suite of IT/systems, outsourcing, and management consulting to the largest global companies?

 

 

Honestly, sometimes I get fed up with investors in general, but also the "value investing" cult. I have no problem with the basic principles (they're self-evident), but the groupthink and arrogance sometimes annoys me.

 

Sorry... lest anyone be confused. This is a general thought, and it isn't meant towards anyone on this thread or boards. Generally, the Accenture discussion has been good, and COB&F is a great forum (mostly) with polite contributors.

Don't worry! I know this wasn't directed at me...I am just trying to play the devils advocate here and kill the investment idea. At the end of the day I take comfort in the common ground that we're all trying to make a good return!  ;D

[Palantir]

I still don't quite know what distinguishes them from other consulting firms. If the investment hinges on the fact that the industry is an oligopoly that is fine...but in that case wouldn't an investment in ANY of the oligopoly firms prove a good one?

 

Why do you think they need to be "distinguished" from other firms? I don't believe that is necessary among successful businesses.

[cayale]

What distinguishes them is their ability to do really large projects (an oligopolistic business of sorts) and their brand.  It's a good company and a cash flow machine.

[LC]

I still don't quite know what distinguishes them from other consulting firms. If the investment hinges on the fact that the industry is an oligopoly that is fine...but in that case wouldn't an investment in ANY of the oligopoly firms prove a good one?

 

Why do you think they need to be "distinguished" from other firms? I don't believe that is necessary among successful businesses.

I don't think they need to. I'm just curious if one has the option to invest in any of the oligopoly players in the large scale consulting business, why choose Accenture?

[Palantir]

I still don't quite know what distinguishes them from other consulting firms. If the investment hinges on the fact that the industry is an oligopoly that is fine...but in that case wouldn't an investment in ANY of the oligopoly firms prove a good one?

 

Why do you think they need to be "distinguished" from other firms? I don't believe that is necessary among successful businesses.

I don't think they need to. I'm just curious if one has the option to invest in any of the oligopoly players in the large scale consulting business, why choose Accenture?

 

Valuation? Profitability? Growth? Strength of business?

 

Now if I take your post to mean what Accenture's "economic moat" is, then I don't have an opinion as I don't look for moats.

[LC]

Take Infosys.

 

Higher margins, growing at a faster rate, and trading at 16x last year's earnings vs. 15.3x for Accenture.

However it's less levered (hence the lower ROEs vs. Accenture)

[Palantir]

I don't believe investing in ACN excludes you from investing in INFY. But anyways, my understanding is that they sell different services from ACN, but I will leave it to the more knowledgeable forumites to delve into that.

[cayale]

I still don't quite know what distinguishes them from other consulting firms. If the investment hinges on the fact that the industry is an oligopoly that is fine...but in that case wouldn't an investment in ANY of the oligopoly firms prove a good one?

 

Why do you think they need to be "distinguished" from other firms? I don't believe that is necessary among successful businesses.

I don't think they need to. I'm just curious if one has the option to invest in any of the oligopoly players in the large scale consulting business, why choose Accenture?

 

As I understand it, they do higher value (more complex, less commoditized) work than some of the outsourcers, and have a higher concentration of management consulting.  Outsourcing is growing more quickly but this is sticky business and it is easier to justify your prices/margins than, say, the work of HPQ, DELL, etc.  I view them as discriminating niche underwriters.  Because this is a long-term contract business, you want to enter into profitable business where you can justify the price you are charging.

[rpadebet]

I like these IT consulting companies. There is a moat around them i.e. the relationships are sticky.

 

From first hand experience I can tell you that once you hire one of these guys to outsource your IT work, it is very very difficult to transition away from them. Typically you have to hire all the consultants who work for you into your firm (sometimes there is explicit language in the contract prohibiting it or making it very expensive to do), then you have to get another consultant firm and transition the older consultants over. Also these companies enter into long term contracts, low initial price and usually have significant price escalations each year built in. So there is pricing power as well.

 

But you need to be careful with some of these Indian managed companies. Satyam comes to mind. They silently diversified into real estate transactions and screwed the shareholders. US Based and US managed companies are typically preferable IMO.

 

Also you would want companies here who do work for cost constrained, heavily regulated, bureaucratic, complex industries like the Govt, Financial firms, Healthcare firms where there is a long term trend towards cost minimization and the management incentive is to pay a few extra bucks to the consultants to manage the IT headache because they already might have too much in their hands. I like the clients to be bureaucratic because change doesn't happen easily and/or is slow when it happens. That is an ideal captive client for IT consulting companies.

 

I looked at a few of these. I prefer a pure play rather than have other software/hardware/other services mixed in. I also prefer the consulting company itself to be non-bureaucratic and simple because they have to adapt constantly to the changing landscape.

 

A few months back I narrowed my search to CTSH (Cognizant) when it was trading in the 60's (I think the price got depressed then because of the possibility of Immigration Law). They have much higher growth than the rest primarily because they are smaller. They are US based (but more comparable to INFY, Wipro and other indian firms rather than IBM or Accenture). They focus exclusively on Financial and Healthcare sectors (I hope they get some Govt contracts as well sometime). The management focuses on maintaining the high 20%ish operating margin (which is a good thing in an asset lite business). They have loads of cash and will probably use it to grow and diversify into other areas.

 

Now, it seems the stock has had quite a good rally, but given the growth prospects and the industry concentration, I still think it is cheap but the margin of safety isn't as pronounced as it once was.

 

I think investors might get another crack at these once Immigration Bill becomes front and center again. There is a fear that the bill would increase the cost structure for these firms. I think the fear is reasonable but a short term event. That's why you want a nimble firm here. All these firms have been hiring non H1-B visa employees and Americans over the years (usually driven not by law but by client demands to have onshore support). They will figure out a way to adapt to the law (in fact these guys are well represented in the lobbying landscape given that the Indian govt itself has a huge stake in their well being and India is a target market for American produced goods and services), so the final law that passes might not be as harmful as imagined.

 

Finally, I think these companies are very very easy to hold. Not many screw ups can happen (unless management really tries to). Also IMO the long term trend towards off shoring jobs to low cost locations, out sourcing hiring and firing decisions are not going to change overnight.

 

 

 

[Christopher1]

Just to give some insider info (I had a nice experience there) about the company:

- Financial discipline is #1 priority - every single project has a very high margin goal based on which the project executives are rewarded, everything is strictly monitored with some useful reporting tool. A project is approved for sale only if the forecast demonstrates the margin is achievable. In my experience, it's very rare to miss the target margin, and if so the executives recover it in the next project.

- All people are classified in a ranking for promotion/salary increase/bonus. The system is quite meritocratic. Each individual from the analyst level has a minimum profitability goal (called chargeability).

- Accenture has a different positioning compared to Mckinsey (lower price, different competencies)

 

[bmathews03]

Let's take it on a per share basis because ACN is buying back so much stock and yet diluting it at the same time via share compensation.

 

You can't exclude share repurchases from investor return. The company's repurchases dwarf its share issuance. The company spent $2.5 billion repurchasing stock and expensed options issues of $371 million. If you don't make that assumption, you'll probably be closer to the E® that I mentioned.