February 29, 2000 8:55 AM PST

Ernst & Young sells consulting unit to Cap Gemini

Big Five accounting firm Ernst & Young today said it agreed to sell its consulting unit to European information technology services firm Cap Gemini for roughly $11 billion in cash and stock.

Under the agreement, Paris-based Cap Gemini will fold Ernst & Young's consulting business of about 18,000 consultants into its global computer services business, the two companies said in a statement. The firms, which have been negotiating a possible deal since last December, have said that the combination would create a management consulting firm with more than $8.5 billion in revenues.

"It's like the meeting of the minds," said Tom Rodenhauser, an industry analyst ConsultingInfo.com. "It puts Cap Gemini squarely back on the map with a U.S. presence. And, from the (Ernst & Young) standpoint, it's a pretty handsome payoff."

The deal comes at a time when a growing number of the Big Five firms--KPMG, Andersen, Deloitte & Touche, Ernst & Young and PricewaterhouseCoopers--have been devising ways to take their consulting units public or increasing efforts to distance themselves from other units, such as auditing, accounting and corporate finance.

For the most part, Rodenhauser said the sale of Ernst & Young's consulting arm to Cap Gemini "neatly closes up the conflict of interest issues that the consulting side and accounting side (of the firm) were inevitably going to face."

But analysts have said that separating such a firm's consulting side from its accounting side is a major challenge. A larger issue remains--an accounting firm cannot provide professional consulting services to clients that it audits. Breaking away completely with a Cap Gemini merger could help Ernst & Young avoid some of those conflicts of interest.

But, Rodenhauser questioned how tempting a European-based stock option package will be for luring top consulting talent.

"Cap (stock) does look pretty good, but the question is how does that translate in the U.S., which is really a primary focus of this deal," added Rodenhauser, who also said he expects some type of exodus from Ernst & Young as a result of the proposed deal. "If they're going head to head (for talent) with these (Internet consulting) firms by offering Cap stock options, would it woo or be met with ambivalence."

For months, KPMG has talked about spinning off its own consulting unit and could be the first among the Big Five to begin operating as a separate, publicly trading company. Earlier this month, KPMG incorporated its consulting unit, the first step toward a public offering. In addition, most of the traditional, more established consulting firms have suffered from a talent exodus as they continue to compete against newer Internet consulting firms that can lure talent with hefty stock option packages.

Under the terms of today's deal, Cap Gemini, which has reportedly been seeking a U.S.-based partner to increase its global presence, said it will issue a maximum of 43.5 million new shares and pay 375 million euros ($365.5 million) for Ernst & Young's consulting arm. Subject to stock market conditions, no more than 50 percent of the Cap Gemini newly issued shares will be sold by April 1, 2001, of which a minimum of 25 percent will be issued upon closing of the deal to cover certain tax, pension and other liabilities of the Ernst & Young partners. Based on Cap Gemini's closing stock price of 257 euros ($249.45) yesterday, the cash and stock deal is valued at 11.6 billion euros, or $11.2 billion.

Initially, the proposed agreement covers Ernst & Young's consulting businesses in the United States, Canada, the United Kingdom, Germany, France, Spain and Italy. Over the coming weeks, Cap Gemini said other countries are expected to join the agreement, including Sweden, Norway, Finland, Denmark, the Netherlands, Belgium, Australia and New Zealand.

The completion of the deal is now subject to the vote of Ernst & Young partners, which will take place in the next few weeks on a country-by-country basis, the two firms said. The votes should be completed by April. Cap Gemini said its shareholders will then discuss and approve the terms and conditions of the transaction at a meeting by the end of this June.

"The size of the deal is minuscule (compared to other big deal mergers), but in the consulting world, it's a pretty darn big merger," said Rodenhauser.

 

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