* Resume on Services: We favor value & turnarounds as crosswinds develop
* Resume on Consulting & Outsourcing with Neutral coverage view
We see industry changes ahead, driven by a shift to cloud computing, increased outsourcing in Europe, and potential changes to US immigration policy. In the context of these crosswinds, we favor attractively-valued names with company-specific turnaround or margin expansion stories – and resume on Consulting & Outsourcing with a Neutral coverage view.
* Our stance on the key themes shaping the sector
1. Cloud computing represents a headwind for vendors most exposed to traditional systems integration and maintenance. We have developed a model to help quantify the potential negative impact to IT services vendors as clients migrate to new cloud-based application solutions. Although we see some positive offsets to spending on new technology areas like social,
mobility, and analytics, we remain guarded on vendors with high exposure to traditional client-server system integration and maintenance.
2. Continental Europe is in the early stages of a greater outsourcing trend. We believe continental Europe (particularly German-speaking countries) is in the early stages of a secular trend toward increased outsourcing driven by cost avoidance, which we see as independent of a macroeconomic recovery. We favor names with higher exposure to Europe (such as CGI).
3. Immigration reform on hold for now, but impacts likely to vary widely. The prospects for immigration reform appear temporarily on hold, but if enacted we think potential requirements on local hires at US client locations could have a negative impact for vendors like Cognizant, with potentially neutral-to-positive impacts for Accenture, CSC, and CGI.
4.BPO companies: Is 2014 a year of inflection, or a new normal? We highlight that the majority of BPO companies under coverage are currently experiencing headwinds due to client transitions or other competitive dynamics. We examine whether these situations are temporary, or are in fact likely to become the new normal for the industry.
* Top stock ideas: Buy CSC, GIB, WSTC; Sell FIS and G
We recommend CSC and CGI as they have company-specific turnaround or margin expansion stories, and we think the stocks can re-rate higher as they unfold; CSC is our most out-of-consensus idea. We also favor West Corp. as we find its IP/Platform based approach to be differentiated in BPO and the stock’s valuation is compelling. We also assume coverage of Sabre from Heather Bellini with no change to rating, price target, or estimates.