Computer Sciences Corporation (NYSE:CSC): CSC May Miss FY2014 Revenue Target

Computer Sciences Corporation (NYSE:CSC) may miss its fiscal 2014, and 2017 revenue goals, as the next phase of turnaround gets more difficult. The company’s margin expansion and cost takeout has tracked ahead of the plan, but the topline has fallen short of expectations.

Falls Church, Virginia-based CSC offers information technology (IT) services to clients in the global commercial and government markets. The company’s offerings include IT and business process outsourcing, and IT and professional services.

Although there is some upside remaining in margins over the next few quarters, CSC will soon need improve revenue growth to drive further upside rather than cost saves.

Deutsche Bank analyst Bryan Keane is more skeptical that CSC can accomplish a revenue turnaround near-term especially given with the recent significant amount of business model changes.

CSC targets revenue of about $16 billion in fiscal 2014 and $18 billion in fiscal 2017. The company is expected to generate sales of $13.07 billion for the year ending March 2014, which is implying a drop of 12.9 percent from last year.

CSC is still in turnaround phase, particularly in aligning sales force and skill sets to higher value-added selling and smaller deals. Over the past few quarters, CSC has won smaller deals, which are faster to ramp and generally have better margins.

Further, CSC’s pipeline in cloud, BPO and applications has grown significantly, highlighting that CSC is targeting healthy areas of the services market. The recent acquisition of ServiceMesh should help CSC in signing more cloud oriented deals.

On the flip side, CSC is not responding fast enough to the opportunities including moving to a consulting partnership model, improving cross-selling and focusing away from software licenses towards a services based BPO model.

Keane notes that it is clear that CSC would come in about $3 billion below its fiscal 2014 revenue targets of $16 billion and clearly miss its fiscal 2017 revenue goal of $18 billion.

The company plans to refresh the sales force (currently 1,200 employees) with new hires with deeper client relationships beyond the CIO. Positively, the faster than expected shift in the market dynamics and the company repositioning, CSC now expects the next-gen services to contribute to 40 percent of revenues in the future up from 20 – 25 percent.

Although some divestitures were contemplated, CSC has divested about $1.6 billion of revenues which can explain some of the shortfall. CSC realizes that its business model needs to change in order to fix top-line issues.

However, Keane noted that further cost take out becomes more challenging. CSC margins have tracked ahead of the expectations which along with lower interest expense and share buyback drove upside to EPS guidance.

In addition, CSC is re-evaluating its pricing strategy as it is losing deals because of price. It should leverage integrated global delivery model effectivelyand creating a utility based pricing model, which could improve win rates but put pressure on billings.

The company expects to expand margins beyond fiscal 2014 by operating leverage, standardization of offering, mix changes towards higher value services, offshoring, leveraging shared services, resetting the pyramid structure, as well as automation.

Keane said the slower workforce restructuring especially in Europe has pushed out the restructuring expenses but delivers greater value. In addition, the company has $2.1 billion in cash which the company could leverage for buyback to drive EPS upside.

Also, the headwinds from the one-time out of period adjustment (21 cents in the second quarter) should eventually moderate as the CSC’s internal audit completes its review. However, the recent Wells notices from the SEC may increase the cost of accounting issues.

Nevertheless, CSC would need to report some revenue growth in its commercial business to achieve tis fiscal 2014 forecasts. The IT services demand environment remains relatively healthy, but CSC has to go out and win the deals. In addition, federal government budgets still remains weak and may prove to be a headwind for CSC, which derives more than 40 percent of its annual revenue from federal contracts.

As such, it becomes more difficult to become constructive on the shares (at least in the near-term) unless the company shows positive revenue growth. CSC shares, which trade 12.3 times its forward earnings, have gained 29 percent this year.