Capita acquires key managed services supplier to UK public sector

OVUM VIEW

Summary

Capita has agreed to acquire Northgate Managed Services Limited (NMS) from Northgate Information Solutions for £65m (£22m in cash, an assumed pension deficit of £17m, and £26m in equipment finance leases). At £65m, for a business that had revenues of £141.6m in its financial year to 30th April 2012, Capita seems to have bagged a bargain.

Capita has a small IT managed services business in the UK that focuses on data center services. Capita’s customers include public and private sector organizations such as local councils and insurers, while NMS has a number of clients in the UK education sector and public sector. In addition to enhancing Capita’s IT managed services offerings, NMS will complement Capita’s strong education support services business and other public sector businesses.

As a result of the acquisition, UK IT managed services vendors now have a larger, more dangerous competitor to contend with.

The UK managed services market is ripe for consolidation

The UK managed services sector is currently an interesting place to be, but not a very comfortable one if you are a mid-sized player. 2e2 has gone into administration, and UK managed services suppliers Computacenter and Daisy Group recently walked away from acquisition discussions. In addition, although Northgate Information Systems seems to have a found a buyer for NMS after several months of looking, the agreement is for a deflated price.

Margins are tight for mid-sized players, and as cloud-based IT services start to gain a hold, investing in assets and resources (data center facilities and equipment) will sap the energy and finances out of these vendors (e.g. the £26m in equipment finance leases that Capita is taking on from Northgate). 2e2 and NMS are not the first and will not be the last examples of consolidation in the UK managed services market.

IT services underpin multiple Capita service lines, but NMS has the advantage of a strong education/public sector focus

Capita already has a data center/managed services business and data centers in five UK locations, a couple of them tier-3 (i.e., secure, resilient, and government security compliant), and its managed services customers include local councils (Birmingham, Harrow, and Southampton), government departments, and financial services clients, including a number of insurers. Many of its data center residents are also BPO customers, and here lies the justification for the acquisition. Data centers and IT managed services underpin most business processes, are a way in to new clients (start with managed IT, then sell higher value BPO), and provide an opportunity to upsell to existing clients.

NMS is attractive to Capita because it has been successful with its managed services business in UK sectors such as education and the National Health Service. Capita has been capitalizing on opportunities to sell support services to schools, particularly the new UK Academies. As such, NMS’s ICT-focused skills and services are a good match for Capita’s education support services.

Capita is growing its IT managed services business by acquisition in the absence of organic growth

NMS was hit hard by the cancellation of the Building Schools for the Future program in 2011. Until then, it had been doing well in looking after the IT needs of UK schools and colleges, but when the UK government spending cuts and caps started to bite in 2010, it had to spend and invest to differentiate itself. Other mid-sized managed services suppliers had to do the same, and much like these other vendors, NMS went in the direction of cloud, establishing itself as a cloud infrastructure and service provider. It was starting to gain traction, winning a £170m ($268m) contract in partnership with telecoms provider Eircom to design, implement, and manage a cloud-based IT infrastructure for schools in Northern Ireland, and even earning a modest profit of £10m in FY2012.

Although ongoing leasing and pension costs were no doubt a worry for NMS’s parent company, they are less of an issue for Capita with its £2.9bn of revenues in FY2011. Capita was already delivering managed services and utility hosting from its data centers, for both internal and external customers, but it was not achieving growth. Acquisitions such as NMS are a way for Capita to achieve growth and help spread the cost of its IT operations. Capita gets additional cloud capabilities and skills, and potentially gains NMS’s involvement in a very useful £170m cloud contract with the Northern Ireland Department of Education. This contract, NMS’s numerous existing managed services contracts with UK educational authorities, local councils, and NHS trusts, as well as its foothold in Academies, should just about pay for the deal. We think it is a good move on Capita’s part, though the fact that it has clearly been struggling to move up a level in the UK ICT managed services business for the past couple of years suggests that it has lacked direction.

IT managed services competitors will fear a more forceful UK competitor, but Capita must not smother NMS

The NMS acquisition is not going to turn Capita into a leading UK managed services provider overnight. It will have to integrate a mid-sized UK managed services provider (NMS) with its own smaller IT managed services business, and the sum of the parts is not going to make a Computacenter, an SCC, or a CGI/Logica. However, Capita is a big services machine, and the NMS acquisition will help it fill out the IT portion of its portfolio. With so many tentacles in the UK public and private sectors, the acquisition of NMS makes Capita a far more dangerous competitor to the ICT-only service providers and telcos that also have their sights on the ICT managed services market.

Existing and prospective NMS/Capita customers will get the assurance of a big financially stable supplier, which in the slow, margin-constrained world of UK IT managed services is something many risk-aware mid-sized organizations and enterprises are looking for. However, although IT is just one service line in Capita’s extensive services portfolio, customers will be looking for the same levels of attention they enjoyed with NMS. As a result, Capita must prove that IT managed services are more than just the underpinnings of its BPO services and a sideline to its main business.

APPENDIX

Author

Ian Brown, Senior Analyst, IT Services

ian.brown@ovum.com

Disclaimer

All Rights Reserved.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of the publisher, Ovum (an Informa business).

The facts of this report are believed to be correct at the time of publication but cannot be guaranteed. Please note that the findings, conclusions, and recommendations that Ovum delivers will be based on information gathered in good faith from both primary and secondary sources, whose accuracy we are not always in a position to guarantee. As such Ovum can accept no liability whatever for actions taken based on any information that may subsequently prove to be incorrect.