Government contracts, technology investments are among challenges

Tuesday, January 3, 2006

By CRAYTON HARRISON / The Dallas Morning News

For Affiliated Computer Services Inc., 2006 begins much as 2005 ended - with lots of bumps in the road.

The Dallas-based company must get its government work going again, continue to absorb its big acquisitions and make significant technology investments.

As if those weren't challenges enough, it's also still adjusting to a new chief executive, president Mark King, who took over after the abrupt resignation of predecessor Jeffrey Rich in October. And a group of private equity firms reportedly wants to buy ACS for about $8 billion.

The New York Times reported Monday night that Texas Pacific Group, Bain Capital LLC and Blackstone Group LP could reach a deal by the end of the week, according to people involved in the talks.

But ACS isn't commenting on the reports. Instead, it's talking about building its business.

"Mark King's charter over the next year is to return ACS to its core focus," said spokeswoman Lesley Pool. "As you get big and grow so fast, sometimes you have to remind yourself to go back to the basics."

ACS was founded in 1988 by Darwin Deason, who remains as chairman and controls 37 percent voting power.

Mr. Rich, a longtime executive, became CEO in 1999 and held the role until October, when he resigned to pursue other interests. He hasn't spoken publicly about his decision. Mr. Rich helped ACS focus on business process outsourcing, in which the company handles accounting, human resources paperwork and other routine tasks.

ACS' revenue grew to $4.4 billion in 2005 from $1.6 billion in 1999, and its stock price doubled under Mr. Rich's tenure.

But the growth slowed noticeably in the company's 2005 fiscal year. ACS' 2005 sales to government clients - about half of overall revenue - fell in 2005 from 2004, even excluding revenue from units the company divested.

In early 2005, rival Electronic Data Systems Corp. beat ACS in bids for key contracts to process state Medicaid payments.

In December, ACS asked North Carolina's state government to give it nine extra months to finish building and testing a Medicaid system.

Medicaid market

"We remain concerned about ACS' competitive positioning in this key growth market after recent losses and implementation issues," UBS analyst Adam Frisch wrote in a December note to clients.

Every technology services company will have a few problem contracts, but it was important for ACS to look good in the Medicaid market, he said.

ACS is investing in a new Medicaid information system, among other technological improvements, Ms. Pool said. And the company has been refining many of its internal operations to serve clients better, she said.

In June, the government group got a new leader, Tom Burlin, and its sales force has doubled, she said, to 54 senior-level sales people with deep background in government services.

Wall Street's judgment about the company changed markedly during the year.

At one point, ACS shares were off nearly 25 percent for 2005, falling to less than $46 in April.

Flat finish

But the stock rallied in late October, and closed the year at $59.18 - nearly flat with 2004's finish.

ACS has bought companies it believes will help it provide a larger set of services than competitors can offer. Its biggest deal of the year came in March, when it announced the $445 million purchase of the human resources consulting unit of Mellon Financial Corp. In August, it said it would buy the transportation services unit of Ascom Holding AG for $100 million.

Acquisitions

Some analysts have said the company is relying too heavily on acquisitions to increase sales.

Mr. King has said the company is doing its part to consolidate the outsourcing market, becoming one of the largest providers in a growing field.

Overall, its net income fell to $415.9 million for the year ended June 30, from $529.8 million as the company absorbed its acquisitions.

Despite stumbles in 2005, "ACS has generally performed pretty well," said Ben Trowbridge, chief executive of outsourcing advisory firm Alsbridge.

The entire computer services industry is coping with sweeping changes in technology and labor.

New competitors such as Hewlett-Packard Co. have entered the market from the hardware industry, and offshore companies in India are posing a threat.

If private equity firms buy ACS, it will probably be the first of several transactions this year as the industry adjusts to those trends, Mr. Trowbridge said.

"This deal is actually an indicator that you'll see more deals this year," he said.