Tietoevry’s Dilemma: Cutting Costs or Cutting Dividends?

Leading Nordic IT Services Provider

Tietoevry is the largest IT services provider in its core Nordic market, with approximately 23,400 skilled professionals in its workforce. The company caters to a diverse clientele that encompasses nearly 800 enterprises and public sector institutions, offering IT infrastructure solutions, proprietary software, and consulting services.

The strategic merger of Tieto and EVRY in late 2019 gave Tietoevry its dominant position in the region, particularly in Norway, Sweden, and Finland, where it holds the number one position. The merger equipped the consolidated entity with an enhanced capacity to navigate the evolving demands for data-centric IT services while mitigating the impact of competitive pricing dynamics within the traditional IT infrastructure sector.

Investment Rationale

• Tietoevry has not been impervious to the careful purchasing decision trend in the context of discretionary IT expenditures, digital transformation initiatives, and customized software development. However, the company exhibits traits of sticky revenue and relatively steadfast resilience, which we think are most attributed to its involvement in proprietary software ventures and long-term strategic IT outsourcing framework agreements.

• Tietoevry announced the termination of the spin-off and IPO process concerning its Banking segment in Q1, citing unfavourable equity market conditions as its core reason. We were unsure about the reason, since the market was strong, so was its banking segment, delivering over 20% operating margin in Q1. But in any case, the decision was to remain committed to enhancing the performance of the Banking segment as an integral component of Tietoevry’s ongoing operations.

Flat Segment Performance and cost reduction

Tietoevry’s organic growth experienced a decline of 1%, as a consequence of the challenges faced by the Create and Tech Services segments. Despite these conditions, the software business, including Care, Industry, and Banking, managed to maintain a modest growth trajectory. The company’s proactive cost initiatives had defended and improved its profit level, with margins demonstrating resilience in the face of market adversities.

The adjusted operating margin has shown a notable improvement, reaching 13.5%. Nonetheless, this enhancement was mostly cost-cutting driven. Specifically, Tietoevry Create reported a margin of 12.1%, while Tech Services and Care contributed 10.5% and 31.6% respectively. Moving forward, the company remains committed to optimizing its cost structure and has initiated further measures, which include a strategic reduction in workforce within Tech Services (up to 110 positions) and a potential restructuring within Create that may affect approximately 400 employees.

Awaiting macro recovery

Tietoevry’s historical organic growth trajectory has traditionally exhibited a strong correlation with the development of GDP, thanks to its long-term contracts. However, it is important to note that the company’s growth tends to lag behind GDP by approximately two quarters. The stock performance was somewhat of a disappointment for the last two years. To stop declining motion and rebound, it is essential to see forward earnings trending upwards. Although the resurgence in performance is contingent upon a recovery within the broader macroeconomic landscape, especially for Tietoevry’s cyclical IT consulting segments, like Create.

Tech Services divestment process moving ahead

The strategic evaluation of Tech Services was initially scheduled to conclude by the end of Q2 2024, yet this timeline has been extended due to an insufficient number of interested buyers. As per the company’s statement, the process is moving ahead, and Tietoevry is currently engaged in exclusive discussions with a non-industrial party. This suggests that Tietoevry may be in a vital stage of exiting. Nevertheless, we deduce that a transaction with a non-industrial buyer would likely result in a moderate valuation, considering the absence of synergies. A value of approximately EUR 420 million to Tech Services is forecasted, based on a 5.0x 2025E EV/adjusted EBITA multiple.

While the progress in the divestment process is somewhat encouraging, given the pressing need to reduce the leverage ratio below 2x, combined with the weak performance of this segment, suggesting a relatively low eventual valuation. The historical trend reveals that Tech Services has experienced an average organic revenue decline of -4% over the preceding six quarters. Furthermore, the segment faces inherent challenges, necessitating substantial maintenance capital expenditures and recurring restructuring costs, which constituted 50% of total restructuring expenses in 2022 and 2023.

We think a successful divestment of Tech Services would significantly enhance the group’s financial health, potentially increasing organic growth by approximately 3 percentage points and bolstering free cash flow.

The continuation of strategic reviews could also pave the way for the listing of the Banking segment and the potential sale of Transform and Connect again. Although no such news or confirmation from the company. This strategic realignment would enable the company to concentrate its resources on the most promising sectors of its operations, namely software and digital engineering, thereby fostering further growth and success.

Notable Risks

• We maintain a conservative stance on the timeline and valuation within the Technology Services segment, considering its historical performance has been subpar and the unfortunate occurrence of a ransomware incident in January 2024. In our assessment, a failure to divest Tech Services would see continued higher levels of leverage than desired.

• Tietoevry continues to grapple with the challenges posed by the shrinking traditional IT infrastructure market, having exhibited underwhelming performance relative to its industry peers for some years. This situation can be reflected in both sluggish organic growth and profitability metrics.

• It is anticipated that margins will be further squeezed due to substantial salary inflation across the sector. Specifically, Tietoevry is projecting an average salary increase of 4.5% for the year 2024.

• The inherent internal complexity of the company’s operations may serve to limit the management’s ability to effectively navigate and allocate resources, thereby complicating the strategic repositioning necessary for a successful transition from traditional IT infrastructure to digital IT solutions.