KPMG Consulting: Still Betting on E-Biz

The economic gloom is not deterring this consulting firm.

Not even an 800-pound gorilla like KPMG Consulting Inc. can escape the current slide in the e-services consulting sector. As the first of the Big Five consultancies to go public, KPMG is not having an easy time. Shares of its stock, which debuted on Feb. 8 at more than $2 above the $18 offering price, have since retreated to just more than half the $24.25 high reached that day.

Making a Big Bet "Macroeconomic issues are having a severe impact on IT spending," says Merrill Lynch analyst Stephen McClellan, who lowered his long-term rating on KPMG to accumulate less than two weeks after he initiated coverage with a long-term buy.

Clearly, KPMG Consulting is vulnerable in the current market because it has bet its future on the growth in e-services. In fiscal Q2 ended Dec. 31, more than 50 percent of KPMGs gross revenue of $703 million was derived from e-business services, the highest percentage among its large consulting peers, according to Goldman Sachs.

Net income, meanwhile, fell $53.4 million on a pro forma basis in its fiscal Q2, due to a write-off of the companys 49 percent investment in Qwest Cyber Solutions, which it redeemed. Without the write-off, net income was $20.9 million.

Field Advantage Having gone public, however, gives KMPG some leverage. Before its IPO, the company could not work with partners like EDS and Siebel, because they were audited by KPMGs former parent company, KPMG LLP. But now it can, which gives it a competitive advantage over consulting firms that havent separated from their auditor parents.

"We have an advantage other [Big Five] consulting companies dont, and we will exploit it to the hilt," says Dan Johnson, executive VP for public services at KMPG Consulting.

Unlike newer consulting firms, KPMG has a proven track record: Its annual revenue exceeds $2 billion, it has 9,100 consultants, and it holds 2,500 clients. Among its joint marketing agreements with 45 software and hardware firms are strong alliances with Cisco Systems, Oracle and Qwest Communications.

Public Display KPMG Consulting derived its revenue from six vertical markets. When business in one sector falters, another potentially can pick up the slack. That occurred in fiscal Q2 when revenue in both the communications/content and consumer/industrial segments slid more than 25 percent, while revenue rose 41 percent in public services and 56 percent in financial services.

KPMG Consultings public services practice—encompassing federal, state and local governments, as well as universities—generates more revenue than its other verticals. The public services sector is more stable than the commercial sector and is somewhat insulated from economic volatility, notes Johnson.

For example, the company is involved in projects with the Bureau of Veterans Affairs and the Commonwealth of Pennsylvania. Those and other projects include alliances with Computer Sciences, IBM, Oracle, SAP and Siebel.

Proceeds from the companys $2.33 billion IPO were used to repurchase preferred stock from Cisco, leaving Cisco with a 9.9 percent ownership, and to repay debt owed to KPMG LLP, which no longer has any interest in the company. Only $28 million was left to provide working capital.

Managing directors of KPMG Consulting currently own 7 percent of the company. Perhaps that ownership interest will help it trim its 25 percent turnover rate as of December. But it may be too early to tell; its only spring.

Spot Check

KPMG Consulting has the makings of a winner—$2 billion-plus in annual revenues, 2,500-plus clients, 9,100-member professional staff, principal offices in 17 countries, 45 strategic partners—but its success requires a turnaround in IT services, which in turn, depends on an economic rebound.