2023-10-04 02:13:17 ET
Summary
- Atos has suffered a vicious selloff on the heels of a massive capital raise announcement.
- Debt issues could be on the horizon as well, particularly with the company needing to execute an ambitious mid-term plan.
- The stock has seen its relative discount widen, but the persistent gap likely won’t be closing anytime soon.
French IT services roll-up Atos SE ( AEXAF ) has made further steps in its long-term plan to split off its core businesses, with management now engaged in a sale process for the slower-growth legacy outsourcing portfolio (Tech Foundations) to Czech businessman Daniel Kretinsky via his EP Equity Investment vehicle (EPEI). The catch is the rather unfavorable deal terms that will see Tech Foundations fetch an implied negative equity value (EUR 2bn enterprise value); to make up for a EUR1bn working capital shortfall in the remainco, Atos will follow through with a dilutive EUR900m equity raise.
This probably won’t be the end of Atos’ financial troubles either - group net debt/EBITDA is on track to cross its 3.75x covenant, and any amendment negotiations could entail a steep increase in its debt servicing costs. Also concerning is the governance, which is led by Bertrand Meunier, continues to come under pressure from activists following substantial turnover (four management teams in less than four years per Sycomore ) and numerous financial mishaps (qualified accounts in 2021).
So, while the Group laid out an encouraging transformation plan at this year’s Tech Foundations investor day , ongoing concerns around the company’s strategic and financial directions justify the low relative valuation vs. peers like Capgemini (CGEMY). The upcoming Eviden-focused investor day (i.e., the higher-growth business exposed to tailwinds like digital, cloud, and cybersecurity) presents a key catalyst, along with further developments on the Tech Foundations sale and equity raise.
Ambitious Mid-Term Plan Raises the Bar
Following a positive first look at the Tech Foundations entity where Atos will house its legacy IT services businesses at last year’s investor day event, the company raised the bar this year, citing a larger global addressable market of EUR705bn (+40% vs. the EUR490bn market size presented last year). Total market growth has also been upgraded to +3-5%/year through 2026, implying an encouraging shift to ‘GDP-plus’ (vs. the GDP-minus -1%/year market growth outlined previously). The latest split indicates management is pinning its hopes on several new engines, including expanded hybrid cloud & infrastructure (EUR415bn; +3-5%) and technology advisory & customized services (EUR180bn; +5-7%) categories, as well as an incremental EUR40bn from a new ‘digital business platforms’ category. In tandem, revenue (ex-deconsolidated operations) growth is now targeted to flatline earlier in 2024 at EUR5.0bn before recovering one year earlier in 2026.
As ambitious as the new sales targets might seem, Atos’ new margin targets are perhaps even more so, with operating margins expected to hit 6-8% of revenue in 2026 - well above the 0.7% last year. To get there, management will need to unlock a massive EUR1.2bn of gross run-rate benefits, mainly from delivery modernization projects (EUR680m) still in the pipeline. And while management cited that ~66% of underperforming accounts had been addressed, a large portion (~30%) of contracts had been terminated, with the remainder likely set for challenging repricing/renegotiation that may not yield sufficient P&L gains. In the meantime, management will have to work with a ~10% lower transformation cost budget (previously at EUR780m). Thus, I wouldn’t be too quick to underwrite the updated margin and free cash generation targets (positive in 2025) pending better visibility into the turnaround progress.
Tech Foundations Sale is Not All Good News
The promise of carving out both of Atos’ key assets had underpinned this equity story over the last year. But the post-H1 Tech Foundations sale disclosure was hardly confidence-inspiring. On the one hand, a full disposal of the slower growth Tech Foundations business helps de-risk the Atos remainco and removes significant EUR1.9bn of provisions, pension deficits, and other lease liabilities. Yet, the EUR2bn enterprise value also means Atos is only receiving EUR100m of cash, hardly enough to compensate for a EUR1bn working capital shortfall at Eviden post-sale. So net of cash, Tech Foundations is being sold for an implied -EUR900m equity value, which management plans to fund via a dilutive capital raise (EUR720m ex-EPEI). Contrast this with Atos’ current ~EUR720m market cap post-announcement. While activist investors are pushing back on the deal ( “the current shareholders of Atos (soon to be renamed Eviden) are being completely robbed” per CIAM ), the deal appears to have support from the Board and the French regulators/government, so I don’t expect a different outcome at the EGM later this year.
Beyond the massive equity dilution, the debt implications of this deal are worth considering as well. The EUR900m raise will probably address any working capital financing shortfalls without compromising on the current BB credit rating. But post-deal, the remainco will be standalone Eviden, where net debt/EBITDA leverage ratio is at risk of breaching its 3.75x covenant. Any amendments would likely entail refinancing in a significantly higher cost of debt regime. Over the mid-term, it also puts Eviden’s leverage ratio target of 2x at risk, particularly with the plan dependent on ambitious mid-term growth and profitability targets (high-single-digits % organic revenue growth; low-teens % operating margin) with limited margin for error. Alongside the uncertain macro environment right now, any incremental financial flexibility constraints could keep Atos stock trading at a relative valuation discount for a while.
Cheap for a Reason
Atos always seems to be moving from one controversy to the next, and this year has been no different. While the decision to unlock value by splitting the portfolio (low-growth Tech Foundations/high-growth Eviden) had initially seemed promising, the terms of the Tech Foundations sale (negative implied equity value) indicate there wasn’t a lot of value to begin with. Shareholders seem to agree, with the most recent rebuke by activist fund CIAM coming on the heels of a previous (unsuccessful) proxy fight with another activist, Sycomore Asset Management, earlier this year.
Still, any deviations from the current disposal of Tech Foundations to EPEI seem unlikely, and thus, a pending EUR900m dilution event is likely on the cards to rightsize the Eviden capital structure. Even if the equity raise has been priced in, I’m not sure the impact of a potential covenant breach (net debt/EBITDA of 3.75x) and a resulting increase in the company’s cost of debt has been fully accounted for. Having also outlined an ambitious mid-term financial plan in line with its strategic transformation, the probability of a future downward revision is concerning. The stock may look cheap relative to its European peers, but given the many underlying issues here, I would hold off for now.
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Atos: Cheap For A Reason