EUR 850.00 For Business Accounts Only

Morningstar | Atos Falls Heavily After Weaker Outlook for IDM Business; Shares Now Trade at Moderate Discount

Atos raised eyebrows during its third-quarter trading update after it cut its organic revenue growth outlook for the full year and guided to the low end of its operating margin target. In addition, Atos provided fiscal 2019 guidance that again lowered top-line growth expectations. The firm cited ongoing challenges in its infrastructure and data management business (roughly 56% of total revenue) and highlighted contract-specific and commercial execution issues. The contract-specific issues are less of a concern to us than the commercial execution issues. We are bothered by management’s comments that Atos lost deals to classic IT service competitors, and it increases our prior concerns about the firm’s long-term competitive standing in the IT services market. We foresee the IDM business as a significant hindrance to Atos’ overall growth rate.

After the quarter, we retain our narrow moat rating but lower our fair value estimate to EUR 90 per share from EUR 95 as we account for the company's weaker-than-expected growth outlook. With the IDM competitive losses noted in the quarter, we believe this is an anomaly rather than a trend. If it becomes a trend, however, we reserve judgment on whether the firm should receive a negative rather than stable moat trend rating. Still, with the shares falling precipitously after the quarter (and down roughly 43% year to date), we now view the once significantly overvalued stock as moderately undervalued.

For the quarter, revenue grew 0.1% year over year to EUR 2.88 billion at constant scope and exchange rates (up 1.5% in reported terms adjusting for IFRS 15). Organic IDM revenue declined 4.6% to EUR 1.53 billion and was by far the worst-performing division. Atos’ three other divisions posted solid organic growth, with Big Data and cybersecurity the continuing standout performer.

With the firm digesting the acquisition of Syntel and soon Six Payment Services, we expect a large reshuffling of Atos' portfolio and strategic focus in fiscal 2019. With the company announcing an analyst day in early 2019 (date still to be determined), we anticipate an important midterm outlook from management to quell our competitive discontent with the firm (management will give an outlook for fiscal 2019 to fiscal 2021).

In terms of margins, we believe the slow rate of top-line growth led to the lowering of the full-year operating margin target. Looking to fiscal 2019, we think the Syntel acquisition will be accretive to margins. As a result, we align our operating margin expectations with guidance.