What future now for Logica's once fast-growing text messaging service?

Shares in Britain's leading software house plunge 17 per cent after 'modest growth' forecast

The IT services group Logica upset the market for the second time in less than three months by again lowering expectations for its key mobile phone text messaging business.

The warning sent its shares sliding 16.9 per cent to 409.5p, making it the worst performing stock in the FTSE 100 index yesterday.

The fall puts Logica, with a valuation of around £1.83bn, in serious danger of being ejected from the index and its shares are now at their lowest point since the end of 1998.

But the company also upset the investment community with its statement that it would produce overall earnings growth "at least in line" with the current market consensus.

Analysts said that was "misleading" mainly because yesterday's alert forced most of them to downgrade their earnings expectations substantially for the current year. "Logica's approach to guiding analysts is extraordinary. It's chaos, in fact. They say they're comfortable with consensus knowing full well the consensus is about to decline," one said.

Up until recently, however, Logica had an excellent reputation in the investment community thanks to its solid IT services business and the higher growth prospects its mobile division offered.

The mobile networks division sells software to mobile phone operators which enables them to provide text messaging services as well as the technology that allows them to monitor pre-pay mobile phones.

But analysts now fear the mobile division is faltering and have concerns over its future. They also point out that market conditions for Logica's IT services business remain tough.

Logica said it now expected sales growth in its mobile networks business in the second half to be "modest", at best, thanks to a slowing in Japan.

Analysts interpreted Logica's new guidance to mean the division would manage 0 to 5 per cent growth in the second half, which, when added to the 28 per cent growth seen in the first half, means the unit might produce as little as 14 per cent growth for the year.

Martin Read, Logica's chief executive, said he now regrets publishing a specific growth target for the division. "It's quite difficult to pick a number and get it right. Obviously it's frustrating to get it wrong and people find it unsettling," he said.

Just over two months ago, the company said it expected sales growth to be around 30 per cent. Before that, analysts had pencilled in 40 to 50 per cent growth compared to the 80 per cent growth seen in the previous year.

"The [mobile] business is still growing, albeit slower than it was, and is delivering good profits," Dr Read says.

Still, analysts are concerned the company has still not won any next generation, or multimedia messaging service, contracts although it is trialling its technology with 15 operators. "They have 150 customers [in mobile] and they're trialling with only 15. It doesn't sound like they're out there talking with enough people," said Michael Tyndall, an analyst at Nomura.

MMS is an extension of the current text messaging systems on mobile phones and will allow users to send and receive messages that include text, pictures and video clips. Hutchison recently awarded its MMS contract to one of Logica's rivals, CMG, while Vodafone chose Ericsson. Logica had been in the bidding for both contracts. Other competitors in the MMS space include Nokia and Comverse.

Dr Read, however, remains unfazed, saying MMS is more an "evolution" rather than a "big bang" and that the market has focused too heavily on the two deals when many more deals have yet to be announced. "We'd have preferred to have logged some names. But this is a long game and the prizes will go to those who've got the most reliable product," he said.

Logica has also been heavily criticised for not spending enough on research and development. In the six months to 31 December, it spent around £13m, or around 8 per cent of the mobile unit's turnover. By contrast, its rival CMG spends around 40 per cent of its Wireless Data Networks' turnover on R&D – a figure expected to total around £60m in 2001.

Analysts point out, however, the comparison is one of "apples and pears" since CMG's mobile division contains other software products such as billing software. Dr Read is "confident" Logica is spending enough.

Moreover, analysts note that CMG's mobile unit is still loss-making. They predict it will have made an operating loss in 2001 of around £20m, on turnover of around £145m. Logica's unit recorded an operating profit of £39.7m in the first half, on turnover of £161.7m.

The fall in Logica's shares, however, means the company is now valued at its end of 1998 level, before it even had a mobile networks division. Dr Read said: "It's disappointing that a business that is well positioned as this in the medium and long term, is attracting such a low valuation."

The rest of Logica's business, IT services, is holding up well under tough conditions, he points out, and Logica forecasts a "solid" performance there in the second half. "They've managed to steer that business [services] through what has been a very rocky time in the market in general," Mr Tyndall said. In addition, Logica announced that Andrew Given, its deputy chief executive and finance director, would retire at the end of 2002. The company promoted Seamus Keating to the role of finance director.

In the first half, Logica recorded a pre-tax profit, before the amortisation of goodwill, of £78.5m, up from £64.8m. Sales were up 19 per cent at £600m. Logica's order intake rose 34 per cent to £807.1m and it has around £115m of cash.

For now, however, that performance seems irrelevant since the market is only interested in seeing Logica winning MMS contracts. Until it does, all investors have to go on is Dr Read's optimism.

Despite the recent setbacks, he is credited with the business's transformation. When he joined the group in 1993, Logica was worth around £130m while annual sales were in the order of £180m. Still, the pressure is firmly back on. Winning over a now angry and sceptical audience could be harder than Dr Read believes.