After six months of on-and-off negotiations, Computer Sciences Corporation officially put itself on the block this week. But two buyout attempts by private equity buyers have already floundered. There’s little reason to think the third time will be the charm. What’s more likely is a big lashing of leverage – a sort of do-it-yourself buyout.
The bait for a buyer has been the group’s bloated costs and under-geared balance sheet. Cutting employees would raise CSC’s gross margins, which are among the lowest in the business. And putting a bit of leverage would cut CSC’s tax bill.
The problem for a LBO is that there isn’t much on the hook to lure private equity. CSC is already chiseling away 5,000 high wage jobs in Europe, which may save it $300m annually. This should lift the group’s margins towards those of its peers.
And while cash flow may be steady, there’s not enough of it. CSC should pull in perhaps $2.2bn in ebitda this year. Of this, it will probably spend $1.5bn in capital expenditures, software upgrades and outsourcing contracts. All of these are necessary to keep the business ticking over. This leaves free cash flow of $700m.
Now assume a private equity buyer pays a 5% premium to the group’s current market capitalisation, giving an enterprise value of $12.3bn. If one assumes 70% of this is debt at 8% interest, the result would be annual interest payments of around $690m – essentially all of the group’s cash flow.
True, once all those employees are cut another $300m may flow in. Yet this isn’t that much of a security blanket. CSC’s business may be stable for a technology services company. But it isn’t completely immune to a downturn.
So, what will it do? It could try to lure in a trade buyer, such as Hewlett Packard. More likely, however, it will imitate a competitor, Affiliated Computer Services. After private equity baulked, ACS piled on the debt itself. It borrowed 50% of its enterprise value and offered to buy back 45% of its stock. If CSC’s managers are convinced that the group’s valuation is too low, they may find this a suitable blueprint.