Tuesday, 9 September 2008

Morse still aims for 7.2% margin

Morse's "disappointing" FY08 results (for the full text of the results announcement from Morse Click here) were little surprise following recent profit warnings, and serve to highlight the tremendous challenge facing Executive Chairman, Kevin Loosemore, to restructure the business to reach its elusive 7.2% medium-term margin target (see our 8th July comment Morse restructures … for sale?). Indeed, with just a couple of months in the hot seat, Loosemore gave a very frank assessment on Morse's prospects, commenting “I don't know what we can deliver”. Nevertheless, he and newly appointed CFO, Mike Phillips (ex-Microgen) are sticking to the 7.2% margin target, though they see it more as a milestone than a destination.

Frankly, the number is now mainly symbolic as Morse is most unlikely to remain a mini-conglomerate of disconnected SITS businesses for too long. Loosemore’s job is to knock the individual businesses into shape and get the best possible price for each of them as, frankly, they're not likely to go as a “job lot”. Restructuring Morse into five divisions is probably only a first step. If the aim of the exercise is to create focused, healthy niche businesses, then the starting point for each could best be described as 'small but imperfectly formed'. For example, Business Application Services (BAS) (essentially, ex-Diagonal) is itself five different services businesses operating in multiple geographies, with seemingly little in common – and all this to generate <£50m in sales with, to all intents and purposes, zero profit. Loosemore has a steep hill to climb to bring Morse to 7.2% margins. Here's some 'back of a fag packet' estimates you can try at home. Suppose Morse was already a 7.2% margin business. On its c. £250m of revenues we'd be looking at £18m OP. Let's say Morse's revenues split roughly 50/50 between products and services (for the pedantic, actually it’s 53/47). Now, management doesn't disclose product operating margins, so what would you like to use? How about 1%? After all, Computacenter's total operating margin is around 1% and that includes services. That leaves nearly £17m of OP to be generated from Morse's services, or a 13.4% margin. This is more or less the margin for Morse's investment management consulting business alone, which by the way is only 7% of group revenues. Even if they double product margins (dream on), they'd need to generate an average 12.4% margin from the services businesses to reach the 7.2% group average. This is Capita-land margins, not reseller-land. Obviously, the “7.2% Morse” that Loosemore has in mind will have a very different structure than today!

We have respect for both Loosemore and Phillips and wait with great anticipation for the next steps.

Footnote – Back in 2004, when Mike Phillips was FD at Microgen, there was a fight to buy SAP consultancy, Diagonal. Morse ‘won’ with a £50.2m cash and shares bid. Morse’s share price then was 134p. Today Morse’s share price is 38p and the whole of Morse is ‘worth’ just £51m. Conversely, Microgen (which hasn’t managed any big acquisitions since) has seen a more modest decline in its share price from 60p in mid 2004 to 49p today. To put both those declines into context, FTSE SCS Index is 13% higher today than in mid-2004. Probably a futile game to play the “What if Microgen had won and Morse had lost…?” One suspects the acquisition would have been a poisoned chalice for both companies.

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