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Companies: Dimension Data's strategy unraveled

By EYAL S SHEVEL

As South Africa’s flagship information technology operator, Dimension Data‘s new strategy will have a major impact on the hi-tech economy. EYAL S SHEVEL offers an investment perspective.

Dimension Data recently issued a trading update wherein it outlined its earnings forecast for the six months to 31 March 2002. In an associated presentation to analysts, the group also detailed its strategy going forward and the progress made in achieving the goals.

The biggest criticism of Didata over the past year has been the company’s reliance on reselling software. Earnings from reselling declined substantially following the IT slowdown in 2000. As such, Didata’s management have embarked on a new strategy aimed at reducing the company’s dependence on product reselling in favour of a model based on providing customers with holistic solutions.

Management stressed that the IT industry has changed dramatically over the past two years. Customers now demand IT specialists that can provide solutions that show clear and discernible benefits in terms of return on investment (ROI). Closer collaboration between customers and suppliers is crucial to the competitiveness of all the enterprises involved.

It is against this background that Didata is developing its new strategy. The group believes that it has the necessary competencies required to develop these intimate relationships. The aim is to create a company that can meet the full spectrum of client needs from designing and implementing the IT infrastructure to providing service and support on a global platform. Contracts recently signed with some of the world’s largest multinational corporations, including HSBC, Vodafone, AstraZeneca, General Motors and Exxon Mobil provide tentative support for is strategy.

To complement the focus on offering holistic solutions, Didata has initiated a number of steps to ensure that a strong working relationship exists between all the group’s operating units. A Global Strategic Development Group (GSDG) has been established to oversee this integration. Furthermore an effort is being made to reduce the number of programming codes used to improve solution integration.

Didata’s service vision is encapsulated in two major offerings: Global Services Operating Architecture (GSOA) and Customer Interactive Solutions (CIS). GSOA is an in-house developed services delivery architecture that combines the group’s existing global delivery processes with commercial and proprietary software to support and manage client infrastructure online in a proactive, real-time manner.

The implementation of this is now largely complete and all regions have been integrated. Management expects this area to show compound growth of about 30% in the next few years. CIS solutions provide companies with the ability to monitor and control all aspects of their customer/supplier relationship. Already CIS projects currently underway should generate $131m in revenue.

Focusing on current interim period earnings, all regions have been affected by the global IT slowdown although to different degrees. In North America, where the slowdown has been the most severe, revenues are expected to remain flat with lower margins resulting from increased pricing pressure. The situation in Australia largely mirrors that of the US with flat revenue and weaker margins forecast.

Conditions for Datacraft Asia have been particularly challenging as the IT slowdown coincided with the global economic slump. The December quarter was extremely difficult but the situation has improved since the new year. Recent strong demand for services should support margins in the region.

In South Africa the depreciation of the rand has impacted customers’ buying power and that will result in lower rand revenue. Dollar earnings will be further weakened by the 36% decline in the value of the rand. However the advanced stage of service offerings in South Africa will support operating margins. The UK has not been immune to the problems facing the IT sector.

The services business, however, has grown ahead of expectations as such revenue is expected to weaken while margins should show a slight improvement. Europe is the only region to have exhibited strong growth, although off a low base. Earnings growth, lead by gains in market share, is expected across the board except in Germany where it is expected to be flat.

In their trading statement Didata said that overall they expected revenue to be flat in H1. However, once the effects of currency devaluation are taken into account revenue is expected to decrease by 5%. Rough calculations thus indicate H1 revenue of approximately $1,14bn. Furthermore gross margin will be 0,5% lower than the initial indication of 22,6% at 22,1%, and gross profit should total about $252m. Overhead costs are estimated to be $230-$240 million in H1 and similar in H2.

The global IT slowdown has clearly had a significant effect on Didata’s profitability. Reduced demand and increased competition have resulted in lower revenues and thinner margins. Consequently EPS is expected to decline substantially in 2002. Furthermore the severe deterioration in demand has hampered the group’s efforts at implementing its strategy.

This, combined with the overriding negative sentiment regarding the industry, will prevent any substantial re-rating before the second half of 2002. Nevertheless, management believes that the benefits of its strategy will begin to emerge in H2 2002 at which time the group will be in a much stronger position. This should coincide with the expected upturn in the general IT environment.

On a fundamental basis the stock is thus rated as a hold until there is greater clarity regarding the success of Didata’s service offerings, and the direction of the IT industry as a whole.

Eyal S Shevel is a Financial Analyst with Sasfin Frankel Pollak Securities

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The Big Change is a business strategy blog and newsletter published by Arthur Goldstuck, managing director of World Wide Worx, a leading technology research organisation based in Johannesburg, South Africa.

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