Financial Watch : CSG Moves into New Markets with Kenan Acquisition

For much of 2001, industry rumors persisted that Lucent Technologies would eventually sell off the Kenan billing and customer care assets it purchased in 1999. With just a few days left before the end of the year, CSG Systems announced it would purchase the Kenan division for $300 million in cash. This is a far cry from the $1.4 billion in stock that Lucent paid for Kenan three years ago, but the deal appears to make a lot of sense on all sides.

Lucent gets cash for a business unit that many industry watchers say it had not paid much attention to. CSG gets desperately needed new functionality and entry into geographic markets to stay competitive.

Desperately Seeking Diversification

When most people think of CSG, they think cable and satellite billing and not much more. CSG has been successful in the U.S. cable market, but the company needs much more not only to make it through the current economic slowdown but also to continue to prosper.

"Both Amdocs and Convergys have been actively winning new business," says Michael Turits, first vice president and senior analyst at Prudential Securities. "Amdocs has been taking more market share by winning new contracts, and the same goes for Convergys. For CSG, the growth has really come from the incremental addition of AT&T related customers into the base and not from anything else. There's a little bit from price increases, but those have tapered off. And contract renewals don't count as growth."

Lucent's billing assets, which include the Kenan Arbor/BP line of products, bring verticals such as wireline, wireless and IP billing to CSG's portfolio.

"The U.S. domestic cable market is growing at 1 percent a year, so unless CSG takes market share, there's no real organic growth driver," Turits says. "So, it was incumbent upon them to do something dramatic."

The addition of new product functionality brings CSG closer to competing with Amdocs and Convergys. Amdocs offers wireline, wireless and IP billing. And with its recent acquisition of Clarify from Nortel, it adds a stronger CRM product to its line. Convergys plays heavily in the cable space, and its acquisition of Geneva in 2001 gives it a more powerful story on the wireless and data sides as well.

"Companies have to cover wireline, wireless, IP and cable," Turits says. "Now you have CSG in each one of those. Amdocs is in each one but cable, and Convergys is in each one but wireline. So at least at first glance, CSG has a competitive edge."

In addition to broadening CSG's product offering, the Kenan assets also bring an international flavor to a company that's been rooted in the U.S. market. "The majority of Kenan's revenues come from outside the U.S.; probably 95 percent of our revenues are from within the U.S.," says Liz Bauer, senior vice president of investor relations and corporate communications at CSG. "There are some areas where they are going to be our main support structure, such as Asia-Pacific, where we don't have any operations."

Lucent's Kenan products had about 200 service provider customers scattered across 40 countries. While much of this business came from Tier 2 and Tier 3 customers, the products can also be found in use by such top-level players as AT&T Wireless, British Telecom, Cingular Wireless, France Telecom, NTT and Verizon. "They've had most of their success in Europe, Asia-Pacific and Latin America," says Peter Giglio, vice president of equity research at Gerard Klauer Mattison.

In addition to the new functionality and new markets, Kenan also brings a different way of doing business. "CSG has a service bureau orientation with a large portion of revenue from AT&T," Giglio says. "The service bureau model is not as high growth or as high risk of a model as the software model."

Turits adds that CSG has not traditionally been strong with software; rather, the company has made its name with transaction processing. "CSG does have a component of revenue that revolves around licenses, but those were mainly tied to the processing business," he says. "Very little software was sold on a standalone basis, and now they are entering an entirely new kind of business model. Can they sell on a license basis?"

CSG's Bauer acknowledges the shift will take some adjustment. "You'll see some of the opportunities that got the Kenan folks most excited is they have been purely product-centric, but there are prospects that would love to see Arbor/BP run in a service bureau operation," she says. "At the same time, we are looking at how we can make their license business a more sustainable one." Seventy percent of CSG's revenue has come from processing and 30 percent from software and services, Bauer says. "You'll see a shift in that; we're not sure how dramatic it will be yet."

Up to Snuff?

Ever since Lucent got hold of the Kenan business, there have been accusations that the network equipment company didn't really know what to do with the successful billing software firm.

In some cases, Lucent would offer the Arbor/BP billing software to its customers as a cheap or free add-on to a hardware purchase, and many in the industry said the company treated the Kenan assets as an afterthought.

Yet surprisingly, the Kenan products do seem to be relevant to today's market. "From my discussion with buyers, Kenan rarely is on the bleeding edge, but do they have strong products that will be competitive going forward? I think they do," Turits says. "Whether or not CSG can convince prospective buyers and develop the product and support is another question."

Bauer says CSG execs were pleasantly surprised when they examined the Kenan product line. "We heard the same thing about Lucent not putting in the time and effort into R&D, but once you dig underneath the covers, they've enabled their service providers to introduce over 100 services," she says. "You don't do that without investing in these technologies, whether it's SMS, online chats or IP VPNs. They have really been doing some innovative things in a company that really did not provide them with the support to do it."

The Financial Details

At first glance, the $300 million CSG is paying for Lucent's billing and customer care assets seems like a good deal. After all, it's one-fourth of what Lucent paid for the same property just three years ago. However, the deal is actually on target with other recent deals and with the Kenan business' financial outlook.

"The original purchase price was a stock transaction, so it's difficult to compare a $300 million cash purchase price with almost $1.5 billion paid in stock," Giglio says. "If you convert that to today's value, it would be less than $300 million due to Lucent's current stock price."

Giglio says he wouldn't consider the deal a steal. "It's similar in valuation to what Amdocs is paying for Clarify," he says. Amdocs is paying Nortel $200 million for the Clarify assets, or about two times forward revenues. CSG's $300 million price tag for Kenan comes out to about a 1.7 times multiple of estimated 2002 revenues of $180 million for the billing and customer care division.

Since the deal was announced, CSG has actually revised upward its outlook for revenues. Previous financial guidance for 2002 was $480 to $510 million in revenues. The revised figures for 2002 are $660 to $690 million in revenues. Previous guidance for 2003 and beyond was 15 percent to 20 percent growth for revenues and earnings. The revised numbers are 20 to 25 percent growth in revenues and 25 to 28 percent growth in earnings.

"We think it's overly ambitious," Turits says. "The implication is that the Kenan business would have to grow 30 to 40 percent by our calculations."

Turits adds that before the Lucent acquisition, Kenan did about $175 million in sales in 1998. Today, CSG is expecting $180 million in contribution as a result of the acquisition. "Between 1998 and 2002, there's been next to no growth in the revenue generating capability of this business."

CSG counters the claim by saying the Kenan business has had significant momentum. "Wall Street is scratching its head, but Kenan signed 55 contracts in the past 18 months," Bauer says. "I'm glad they think it's aggressive. I don't think Kenan got the credit they probably deserved when they were under Lucent; we'll have to come out very strong and make sure the integration goes smoothly and get some contract wins."

The deal also includes a supply agreement whereby CSG will provide Lucent with billing and customer care software. "My guess would be a significant portion of that will be to help support existing Lucent customers," Turits says. "Anyone who has bought or received software from Lucent would want some kind of assurances that they'll get support, so this way they get that support from CSG."

Going Forward

The deal is not yet a guaranteed success. "CSG has three challenges: growth, integration and competition," Turits says. "CSG has not traditionally been viewed as a strong software developer; so the question is can they take this software and integrate it with their existing cable billing platform."

CSG has been closely identified with legacy systems, but Bauer points out that the company has Unix-based products and a strong Unix products team. "They've been working closely with the Kenan organization, and since we currently run several of our products on Unix, it's not like it's foreign to us."


Note: The information in this article should not be used as the primary basis for investment decisions. The information is based on sources Billing World & OSS Today believes to be reliable. The statements expressed are not necessarily those of Billing World & OSS Today.