Logica buries old rivalry to secure CMG

1,400 jobs to go in move to create Europe's second-largest IT service company

The IT services firms Logica and CMG fleshed out their planned merger yesterday, saying around 1,440 jobs would go as a result of the marriage, representing around 6 per cent of the combined workforce.

The deal makes LogicaCMG the second largest European quoted IT services company behind Cap Gemini Ernst & Young, it reckoned, but will put it ahead of the number three player Atos Origin. The merged business, worth £1.2bn at yesterday's closing prices, will be headquartered in London and have operations in 34 countries, with annual sales of around £2bn and some 24,000 staff before redundancies.

With little overlap in terms of customers, which apparently came as a surprise to Logica and CMG, and ample room for cost-cutting, the logic of the deal seems pretty compelling.

The reality, though, is that the tie-up is a defensive one. Both companies historically enjoyed massive growth driven by major IT projects like the year 2000 computing issue but are now faced with a serious slow-down with the IT services market characterised by customers cutting IT budgets and taking longer to sign deals.

"We had a business that, for eight years, grew earnings per share at an average of more than 40 per cent. In that sort of environment, you've got so much going for you, you don't need to consider mega mergers really," Martin Read, Logica's chief executive, admitted. "But the market we're in now is radically different and ... in this type of situation, consolidation is the right thing to do," he said.

While analysts saw the logic, they warned that the integration of the two businesses might not be as straight forward as Logica and CMG would have you believe. "We continue to believe that the merger is being entered into for the wrong reasons and that bringing together two struggling companies will only result in one larger struggling company with a huge integration headache," Jonathan Imlah, an analyst at Dresdner Kleinwort Wasserstein said. "Moreover, we maintain that the cultures of the two companies, which have spent the past few years badmouthing each other, will be difficult to integrate."

Even Mr Read, who insists the two businesses are culturally very similar, admitted yesterday that some of his workers had jokingly asked whether the deal meant they would have to start wearing CMG ties. Every CMG worker is given a company tie or scarf on joining with special ones awarded to staff who have been with the company for periods of five years and longer. CMG also has a policy of openness that might not sit well with Logica. Every CMG worker has access to the personal details, including pay and assessment records, of all of their colleagues.

Nevertheless, it was hard to see the deal not coming together given that, very early on in the merger talks, the pair had already sorted out the kind of issues that often cause discussions to collapse.

When Logica and CMG confirmed they were in talks in early October, they said any deal would see Logica shareholders end up with 60 per cent of the pie with Dr Read getting the top job. Cor Stutterheim, executive chairman at CMG, is to be non-executive chairman of the new group. The pair said yesterday that shareholders in CMG would get 0.4827 Logica shares for each CMG share they hold and said the other senior management positions had now been ironed out. Alistair Crawford, CMG's chief executive, will be chief executive of operations in mainland Europe while Seamus Keating, Logica's finance director, beat his counterpart at CMG, David Robbie, to the position of group finance director.

Logica and CMG expect the merger to be "substantially" earnings enhancing next year and predict they could get around £60m of cost savings a year – with around half coming through next year and all the year after.

Those savings, including the 1,440 or so redundancies, are expected to cost around £80m. Logica said yesterday it had put in place a new £350m banking facility to cover the exercise and give it extra flexibility. The biggest area of overlap is likely to be the UK where Logica employs around 4,600 and CMG has around 3,100 workers although there will be hefty cuts in the group's wireless networks business, which sell text messaging software to telecoms firms.

"Of the combined company's turnover, 21 per cent will be wireless networks but one third of the savings to be made will be made there," Mr Read said. Logica has around 1,000 staff in this sector while CMG has around 1,500.

Surprisingly, he said, there was little overlap in the customer base with only four customers – Vodafone, Shell, Network Rail and the Dutch Ministry of Finance – featuring on each company's list of top 20 customers.

And LogicaCMG will certainly have an excellent position in the UK and Benelux markets which, taken together, will make up nearly 60 per cent of combined group sales. To preserve CMG's Dutch culture, the merged businesses will continue to be listed in London but will also apply for a listing on Euronext Amsterdam.

But the news is not all good. The pair warned yesterday that they might have to take a further writedown to cover the fall in value of past acquisitions.

Together, they have already made write-offs of around £700m, mainly for Logica's acquisition of the German firm PDV and for CMG's purchase of the UK business Admiral, and there will be around £826m of goodwill sitting on the combined balance sheet.

Then there are the integration issues with some analysts suggesting that Logica has a poor track record of assimilating acquired businesses. "Logica's track record on acquisitions for scale is not good in our view," analysts at Credit Suisse First Boston pointed out.

While Mr Read admitted there have been "one or two" difficult acquisitions, he thought this accusation was unfair since Logica has made around 20 acquisitions over the past six years.

Combining the Logica and CMG text messaging businesses, which are facing increasing competition from Nokia and Ericsson among others, may not reverse those business' fortunes.

And, of course, the market for IT services remains tough – both say they continue to trade "in line" but admit the environment remains difficult. The research house Gartner predicts that the IT services market will see growth next year but that it will remain "in the toughest environment it has seen since the early 1990s".

And the merger, of course, still needs shareholder and regulatory approval to get off the ground although completion is expected toward the end of 2003.

In the meantime, it is not inconceivable that a counter bidder might emerge. But even if that doesn't happen, Logica and CMG have kicked off a consolidation process that looks set to accelerate across the sector given the ongoing tough trading conditions.