Under new management

Covansys seeks to improve bottom line, expand business into federal market

"This is an area where we want to go aggressively," said Arvind Malhotra of the plan by Covansys' new management team to focus on growing its public-sector business this year.

A change in top management at Covansys Corp. should improve the company's ability to compete for small and medium-sized opportunities in the state and local government market, according to analysts and industry observers.

The transition brings two former top executives from IBM Corp. of Armonk, N.Y., to assume daily operations of Covansys of Farmington Hills, Mich.

Ned Lautenbach, former head of IBM Global Services Worldwide, became Covansys' chief executive officer Nov. 15, and Martin Clague, former vice president of IBM's Global Industries e-Business Solutions, became Covansys' president and chief operating officer Jan. 1.

Lautenbach is co-chairman of the board of Covansys and a partner at the New York-based investment firm Clayton, Dubilier & Rice Inc., which owns about 25 percent of the company.

Lautenbach replaces Michael Bealmer, who analysts said did not meet the expectations of either investors or Covansys' board of directors. Both have high expectations for the new management team.

Covansys "is very well-backed and very financially sound," said Bill Loomis, an analyst at Legg Mason Wood Walker Inc., Baltimore, which rates Covansys as a strong buy. The company has no debt, is cash positive and has a more than $100 million war chest, Loomis said.

Arvind Malhotra, senior vice president of Covansys' public sector, said the new management team wants to focus on growing its public-sector business between 15 percent and 20 percent in 2002. "This is an area where we want to go aggressively," he said.

The company is actively trying to improve its operating margin, said Gary Dean, an analyst with Robert W. Baird & Co. of Milwaukee. The operating margin, or operating income, is a company's earnings before interest and taxes.

Four years ago, Covansys had an operating margin of 10 percent, but it's down to zero now, Dean said. "There is a lot of room for improvement," he said.

Covansys had $404.7 million in revenue in 2001, of which about $116 million was from its state and local government business, according to company officials. Covansys has 4,400 employees.

Earnings for the fourth quarter ended Dec. 31, 2001, were $1.7 million, generating earnings per share of 5 cents. The company reported a net loss of $10.5 million for 2001, or 37 cents a share, which included $23.7 million in pre-tax charges for restructuring and other costs.

On Feb. 21, Covansys stock closed at $8.20 a share, with a 52-week high of $13.65 and a 52-week low of $6.38.

Under its new leadership, Covansys is taking steps to boost both revenue and margins, Malhotra said. The company hopes to break into the federal market this year by winning projects with civilian agencies.

The company also is looking to acquire companies that would strengthen its state and local criminal justice offering.

"We want to come out more strongly in that space," Malhotra said, referring to law enforcement and criminal justice solutions related to homeland security.

Covansys, formerly Complete Business Solutions Inc., provides software and solutions for retirement, health and human services, justice, transportation and an array of emerging markets, including Health Insurance Portability and Accountability Act compliance and unemployment insurance, Malhotra said.

The company's state and local competitors are both large and small systems integrators, including Accenture Ltd., Affiliated Computer Services Inc., American Management Systems Inc., Ciber Inc., Keane Inc., KPMG Consulting Inc., Maximus Inc. and Tier Technologies Inc., according to analysts.

Despite the company's success in the state and local market, Covansys officials recognize that state budget shortfalls and a weak national economy have reduced the demand for IT services.

"There has been some erosion [of the market], but we will make up for that with new awards," Malhotra said.

The majority of Covansys' business comes from software automation for state government retirement and from health and human services programs, Malhotra said. These contracts make up 90 percent of Covansys' public-sector business, he said.

Clarety, Covansys' public retirement fund systems framework, is deployed in six states: Indiana, Mississippi, Nebraska, Nevada, Ohio and Rhode Island.

Loomis said Covansys delivers quality software at less cost than the Big Five consulting firms. While the company can't tackle "mega projects," it can compete on an equal footing with other integrators in all states for most state and local IT projects, he said.

The number of fixed-price contracts Covansys has is growing, and this may cause problems for the company in the future, Loomis said. A number of integrators have become bogged down on fixed-price contracts, and this is something company executives should be watching closely, he said.

Malhotra said the company's business is composed of 36 percent fixed-price contracts and 64 percent time and materials contracts.

"We have a pretty decent track record [with fixed-price contracts]," he said.

Tom Davies, a senior vice president with Current Analysis Inc., Sterling, Va., believes Covansys will have trouble growing its business this year.

"The budget situation is not good news for companies like Covansys," he said.

"Covansys and companies like it will find the state and local market especially challenging for the remainder of this year."

Davies said Covansys is primarily a software and IT services company and not a major systems integrator, such as Electronic Data Systems Corp. of Plano, Texas, or a business process outsourcing company, such as ACS of Dallas.

"They do not have the same core competencies," Davies said. "It's not just an issue of the size of the project."

Dean, whose company gives Covansys a "market outperform" rating, disagreed. Covansys' government work is "a little more insular and defensive" than its commercial work, he said, and government budgets aren't likely to shrink much, even in a weak economy.

"Generally speaking, the IT services firms have reached a bottom of demand after a two- to three-year period and business should go up," Dean said. Although it's too soon to assess whether Lautenbach and Clague have improved the company's margins, Dean said "they are talking a good game."

Staff Writer William Welsh can be reached at wwelsh@postnewsweektech.com.

About the Author

William Welsh is a freelance writer covering IT and defense technology.

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