Financial Watch :Convergys Brings Geneva Into the Fold

Economists say we’re in a bear market. It’s been over a year since the markets reached their all-time highs, and since then many companies have declared bankruptcy, folded or experienced drastic layoffs.

The technology market as a whole is still in a slump, but you wouldn’t know it based on the almost $700 million that Cincinnati, Ohio-based Convergys will pay to acquire one of the billing industry favorites, Geneva Technology. The deal involves Convergys issuing 17.6 million shares to the shareholders of the Cambridge, U.K.-based Geneva. Based on the Convergys stock price when the announcement was made March 6, the deal is estimated to be worth $692 million.

The valuation of this deal is impressive, and many observers feel Geneva deserved it. “[Geneva] did something that couldn’t have been done in an IPO in terms of realizing their value,” says Pete Sokoloff, managing director of Peter A. Sokoloff & Co., which advises billing and OSS companies on mergers and acquisitions.

Sokoloff adds that if Convergys had tried to acquire Geneva 18 months ago, competition to purchase Geneva may have been tough. “This was a good time to do it, because the value of Convergys’ currency—in other words their stock—hasn’t gone down like almost everyone else,” Sokoloff says. “In fact, it’s remained stable and actually went up in 2000. But a year and a half ago, Convergys’ currency was too cheap. Now, they can get out and do a deal like this with a stock that’s not deflated like everyone else’s.” Sokoloff adds that the deal is not so big that it would overwhelm the company if it doesn’t work out.

In many cases of corporate acquisitions, the acquired company reaps the benefits of being brought under the auspices of a larger and presumably more established or dominant entity. With the Convergys-Geneva deal, both companies get something.

Opening Markets

Geneva opened a North American head office outside Washington, D.C., last June, hoping to break into the U.S. market. The company had signed up a couple of customers, but nothing like the cachet a Tier 1 name brings. “I think Geneva basically needed the benefit of an incumbent in North America,” says Yumi Koh, telecom software equity research analyst at Morgan Stanley Dean Witter. “The North American telecom market deregulated two years before Europe, so we’re talking about billing companies that at the minimum have a two-year lead time in terms of getting into some of the Tier 1 network operators.”

Among Convergys’ wireless clients are big names that include AT&T Wireless, Sprint PCS and Verizon Wireless. “Billing companies encounter a lot of competition when bidding for Tier 1 telecom accounts,” Koh says. “On top of that, you have a lot of the market that is still internally developed in terms of the legacy market. It’s very tough for a third-party European company to displace providers like Convergys or Amdocs in the U.S.”

Now, Geneva gets its billing and rating product in front of some of the top North American providers. “Geneva would have had a long, uphill battle; with Convergys they got a tremendous sales force and tremendous knowledge of the U.S. market,” Sokoloff says.

But that geographic advantage goes both ways. Geneva may be a new name to potential North American customers (winning only a small amount of business in the United States), but the company has built a solid reputation on the other side of the Atlantic—a feat Convergys has yet to accomplish.

“Clearly, Europe is our No. 1 growth target, and we have to be successful there,” says Randy Mysliviec, senior vice president of marketing at Convergys. “With the Geneva merger we picked up market share, mind share, as well as 50 marketing people and 100 developers.” The total Geneva workforce worldwide numbers about 450. The plan is to keep everyone on board with the combined company.

The two companies have almost no overlap in clientele, according to Mysliviec. “In my 22 years in this business, this is the only acquisition I’ve been involved with where there’s been almost no overlap,” he says.

Technology Coup

Geneva’s technology brought a lot of attention to the company, especially its service-agnostic approach to rating and billing. Geneva’s namesake product can handle wireless and wireline voice, data services over circuit-switched or IP networks, application hosting and other types of services. Its modular approach to rating and billing has also given the company a high profile in the industry. “In terms of functionality, Geneva provides a critical technical bridge for Convergys in two key areas,” Koh says. “It enhances Convergys’ IP functionality; and second, the modular architecture provides an excellent bridge for Convergys to sell additional software component to carriers.”

Koh adds that the key goal is to give Convergys an improved wireless data solution to target the U.S. market. “Geneva will transfer that knowledge base over to Convergys, and those Tier 1 customers are among the few who can afford to ramp up.”

Convergys already has GPRS capabilities with its Atlys system, but because North American carriers lag behind on wireless data, Geneva’s customer base may be more of the target for 2.5. But Convergys is also looking to Geneva as a way to watch its back, stateside. One of Convergys’ marquee wireless customers, Sprint PCS, chose competitor Amdocs for its wholesale business last September. Once a competitor gets a foot in the door, there’s no telling if the customer might move even more business its way.

Another interesting twist to the deal involves the entrance of Convergys—traditionally known for its service bureau model—into the licensing game. Geneva uses a license model for sales, but in the current slow market a one-time license charge isn’t as attractive as the service bureau, which is based on long-term recurring contracts. “So much of what Convergys did with this acquisition is contrarian,” Sokoloff says. “First, they paid a big price in a market that’s saying the companies are worth much less. Second, they bought Geneva so they could have a strong license sale capability in their holster.”

At the time of the acquisition announcement, Jim Orr, Convergys’ chairman, president, and CEO, said that in addition to offering products on a license or service bureau basis, the combined company also would offer a “build-operate-transfer” model. “They are saying they will build it and run it for you and then turn it over,” Sokoloff says. “It takes out the extreme nervousness carriers have, and they have one-stop finger-pointing if something goes wrong.”

Convergys also plans to make full use of Geneva’s modular features, in particular, offering Geneva’s standalone rating engine to its customers. “The marketplace wants modular applications,” Mysliviec says, especially the Tier 1 customers who want to get new services to market. “If a customer said they wanted a rating engine, we would normally have to sell them a whole suite,” he adds.

The two companies are integrating Geneva with Convergys’ Catalys IP billing product. They hope to have a combined product ready for market by the end of 2001. After that, according to Mysliviec, the companies will work on joint development efforts.

Crunching the Numbers

The merger with Geneva seems to make sense for Convergys from a business and technological perspective, but it may take some time for the company’s balance sheet to catch up. Convergys is expecting incremental revenues of at least $70 million, $125 million and $210 million in 2001, 2002 and 2003, respectively. But the company will also see diluted earnings per share of about $0.15 and $0.11 in 2001 and 2002, respectively, with accretion (growth) expected by 2003.

Even with the slow realization of growth from the deal, it’s hard to find anyone in the industry who feels this was a bad business decision. “The deal is expanding Convergys’ presence in two key areas—the data and IP market and the European market—which are strategic to the company’s long-term growth opportunities,” says Morgan Stanley Dean Witter’s Koh. “That’s why I think the benefits long term really outweigh the dilution we’ll see in 2001 and 2002.”

Koh adds that prior to the Geneva acquisition, she was forecasting Convergys’ billing business to grow 14 percent in 2001. With Geneva, that number goes up to 17 percent. In 2002, the numbers go from 12 percent growth without Geneva to 17 percent for the combined company.

While it may take a couple of years for Geneva to add to Convergys’ earnings, Convergys already has 80 percent to 90 percent forward revenue visibility. This means that 80 percent to 90 percent of the company’s next 12 months’ revenue is locked in and under contract.

Geneva will operate as a wholly owned subsidiary business unit. Convergys has no plan to drop the Geneva name from its product, but eventually Geneva offices may have their signs changed. “Eventually the company will be called Convergys,” Mysliviec says. “When we think we won’t lose brand equity, we’ll see the name of the company quietly slip away.”