Capita has agreed to acquire Northgate Managed Services (NMS) in a £65m deal.
At first glance, this appears to fit in with Capita’s strategy of making mid-sized acquisitions to beef up its IT services business, Capita IT Services (CITS), with the added bonus of a new ‘nearshore’ delivery centre in Newtonabbey, Northern Ireland.
The move also seems to mark the beginning of the expected break-up and sale of Northgate’s three divisions by private equity owners KKR as it seeks to cash-in on the £1.1bn they invested back in 2008.
However PAC believes that, in both cases, there are grander schemes at play.
Capita’s Motivation for Acquiring NMS
Capita has a long tradition of growth through acquisition, but this has tended to focus on its heritage focus area of BPO. It has made some niche forays into IT services, such as the purchase of testing specialists Mission Testing back in 2002. But it was only really with the acquisition of Carillion IT Services in 2009 that Capita moved into IT outsourcing (ITO) in a big way.
The acquisition of Carillion IT Services provided a foundation for the division now known as CITS, with core capabilities around IT and network infrastructure management. CITS’ portfolio of offerings has since been expanded via ‘bolt-on’ acquisitions. These have included Ramesys (education VAR) in 2010, and Smiths Consulting (SAP services) in 2012.
However, there has been a noticeable gap in Capita IT Services’ offering that has prevented it from realising its stated aim of becoming a major player in the UK IT services scene. That is the ability to provide cloud computing services, which is an important aspect of NMS’ offering. Of particular note are private cloud IaaS and ‘virtual desktop’ offerings, for which it has been steadily building a set of references (e.g. Department of Education Northern Ireland, NSPCC, Scottish Heritage).
The jewel in the crown is last year’s £170m win with the Department of Education Northern Ireland (DENI). This will see NMS develop, implement and manage a ‘cloud environment’ for Northern Ireland’s schools.
The NMS deal adds to Capita’s vertical specific capabilities, notably in the education sector. This is particularly the case in Northern Ireland, where the cloud environment win was just the latest step in the ‘Classroom 2000’ (C2k) initiative to improve ICT in schools.
With Capita having acquired education-focused VAR Ramesys, as well as leading schools information system SIMS way back in 1994, the addition of a managed services ‘wrap’ could be a means of generating cross sales that would significantly expand the value of existing education relationships. With local government SITS peers such as Advanced Computer Group (through its acquisition of Serco Learning) and Civica (through its libraries information system) considering similar moves within the education sector, it is clear that there are opportunities to be had.
As an added incentive, NMS would also bring Capita some added capabilities in the health sector, an area where PAC expects new opportunities to emerge in the aftermath of NPfIT. Although Capita does already have some references in the sector, these have largely been focused on network integration and BPO. The acquisition of NMS will add a portfolio of managed services developed specifically for the NHS, and with existing references in Northern Ireland and Scotland. There are two key aspects:
- A clinical portal offering, providing the infrastructure that enables a unified view of patient records.
- A virtual desktop infrastructure offering tailored for health trusts.
Northgate’s Motivation for Divesting NMS
Following the £257m acquisition of Arinso in 2007, Northgate has operated across three divisions:
- NorthgateArinso (NGA) – an international provider of HR software and BPO services.
- Northgate Public Services (NPS) – a provider of sector-specific software and services, based on proprietary offerings and IP, focused on the UK public sector.
- Northgate Managed Services (NMS) – a provider of infrastructure-related IT services to the UK mid-market.
The architect of this organisational structure was Northgate’s former CEO Chris Stone, who turned around the loss-making McDonnell Douglas Information Systems into profitable Northgate, and then over the next decade developed the group around its three pillars of growth.
However, once Stone departed Northgate in 2011, it became clear that KKR was approaching the end of a five-year ownership cycle with a view to divesting what were in reality three very different business units in order to gain a return on its initial investment.
For many years PAC has pondered the logic of maintaining these three divisions. In particular, the potential for achieving synergies through a merger of NPS and NMS is clear: the two divisions overlap in that they both have a strong public sector focus and are UK-centric. However, they diverge in terms of the propositions with which they address this market.
Reports emerged in September last year that NMS was on the market, with a price tag of £100m, but no-one was willing to meet this valuation. Capita has now stepped in at the lower level of £65m, but it is important to note that only £22m of this will come in cash. The rest will come from a combination of assuming NMS’ pension deficit (£17m) and equipment leasing (£26m).
With terms for a divestment of NMS agreed, there is little hope of achieving synergies between NPS and NGA given that there is very little common ground between them. Therefore, KKR clearly aims to divest these two divisions at a premium following the sale of NMS that seemed to be dragging down the value of the Northgate ‘portfolio’.
In paying £65m for NMS, and only £22m of that in cash, Capita seems to have a bit of a bargain on its hands. Although there is a sizeable pension deficit, this must be balanced against pro-forma figures for FY 2011/12 of £141.6m revenue and operating profit of £10m. By applying Capita’s trademark operational discipline, it can reasonably expect to improve NMS’ operating margins.
Beyond the simple maths of the transaction, the acquisition of NMS will allow Capita to enhance its ITO proposition in two ways. First, it has made a ‘defensive’ move by gaining a cloud computing practice, increasingly a pre-requisite in the UK IT services market, including for the public sector. However, as pointed out on the PAC blog this week, it is important to understand that this is not a means to an end in itself. Rather, the ability to offer services on a ‘cloud’ basis is must be just one way of providing access to a service that meets a specific customer need.
This is where the addition of NMS’ vertical offerings to the education and health sectors, including on a cloud basis, come into play. This will provide two new growth drivers for CITS, in areas where PAC expects growing activity as the organisations in this sector seek new approaches in order to meet their budgetary challenges.
For the rest of the Northgate group, and particularly for its owners KKR, it remains to be seen whether the ‘divide to profit’ approach is the right one. There should be interested suitors for the two divisions, with the public sector and HR services both remaining interesting, if not red-hot, markets. But Northgate and its backer will look to make sure that they squeeze out as much value as possible, having been forced to lower their sights this time round.