BERNSTEIN RESEARCH

IT Services: Yes, the

Consulting Market
Can Improve!

Rod Bourgeois
+1 (212) 756-4593
bourgeoisrm@bernstein.com

Allen Shim
+1 (212) 407-5921
shima@bernstein.com

JANUARY 2005 SEE THE LAST TWO PAGES OF THIS REPORT

FOR ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES
 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 1

Consulting Market
Drivers Show Promise
Overview Our work does not support widespread views that there are no compelling
spending themes in place to drive IT consulting spending. While we do not
see a single spending driver, such as a new killer application, we do see
multiple spending themes that we believe will support an improving con-
sulting market. Thus, we believe incremental valuation upside is achievable
in 2005. We emphasize that prior consulting demand cycles were driven by
killer applications, whereas we think the current consulting rebound will be
driven by quite a different set of factors.
On the demand side, we see drivers in place for a consulting market re-
bound to progress over at least the next couple of quarters: First, an IT mess
was created during the bubble, due to the heavy software deployment ac-
tivity, and now all these applications must be connected. Second, our chan-
nel checks tell us ERP-related work, particularly SAP, is “hot,” which
should drive considerable consulting activity. Third, ongoing needs to
achieve Sarbanes-Oxley compliance should drive IT consulting and systems
integration activity.
Looking at supply-related factors, aggregate consulting headcount growth
is positive, and we see a decidedly encouraging sign at Accenture — the com-
pany is paying referral bonuses to employees who help to source new hires.
This is a tangible sign that overcapacity issues, at least in North America, have
subsided. While the positive consulting indicators outweigh the negatives, we
have witnessed a minor recent slowdown in high-end consulting headcount
growth, which merits close monitoring as a critical indicator.
We favor BearingPoint and Sapient, the smaller consulting stocks, as
these names have the most leverage to the consulting rebound and the most
upside to our target valuations (of $11.00 and $10.00 per share, respectively).
We also consider Accenture ($28.50) a reasonable investment in 2005, as we
see $0.03-$0.05 of upside to calendar 2005 EPS estimates, based largely on the
consulting rebound and share buybacks. We remain cautious on EDS (mar-
ket-perform, $23.50) and CSC (underperform, $44.00), as we see company-
specific and meaningful secular challenges for the large IT outsourcers.

Improving Market, Somewhat Over the past year, our generally positive outlook for IT services stocks (de-
Heightened Valuations spite our substantial secular concerns related to overcapacity and the shift
toward offshore) has been primarily based on our view that the consulting
market would modestly rebound. In light of some evidence of an improved
consulting market and the heightened valuations in the industry, we are
providing an updated consulting market outlook. This outlook is based on
our tracking of quantitative demand and supply metrics, channel checks,
CIO/CFO survey results, and qualitative logic concerning relevant spend-
ing themes. Note that our current consulting market forecast methodology
has largely been in place since 2003; in our July 2003 black book, we fore-
casted that the IT consulting market would show a modest rebound in 2004
— a forecast that we have since periodically updated and reiterated based
on our systematic methodology.

BERNSTEIN RESEARCH
2 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

To tangibly track the consulting market cycle, we have compiled the

growth rates of the consulting business segments across the major IT ser-
vices firms, adjusted for currency effects, and calculated the aggregate con-
sulting business growth for these firms (see Exhibit 1). This analysis shows
aggregate consulting growth (adjusted for currency) has improved consid-
erably in the past year; year-over-year growth has risen from (10.1)% in the
third quarter of 2003 to 3.6% in the third quarter of 2004. As this market
progress has generally buoyed IT services company fundamentals, sector
valuations have generally risen (see Exhibit 2).

Exhibit 1 Consulting-Related Revenue Growth Across

Major Services Companies (Calendar Quarters)
3Q:01 4Q:01 1Q:02 2Q:02 3Q:02 4Q:02 1Q:03 2Q:03 3Q:03 4Q:03 1Q:04 2Q:04 3Q:04
Accenture1 7.4% 0.9% (3.3)% (6.7)% (12.9)% (12.9)% (14.7)% (10.0)% (1.8)% (1.4)% 3.8% 13.5% 11.5%
IBM 1.0 (12.6) (13.3) (11.0) (8.9) 10.7 5.2 6.1 (5.3) (1.1) 4.2 3.4 6.6
BearingPoint2 469.9 389.7 331.4 324.0 (0.3) 0.0 6.0 0.7 (11.0) 0.5 5.2 12.5 18.2
EDS 12.7 10.7 3.1 7.9 8.3 (1.1) (10.1) (19.1) (8.0) (13.0) (6.0) (6.0) (4.0)
CSC (0.7) (10.5) (23.0) (18.4) (19.5) (20.1) (4.0) 5.8 0.0 1.1 (3.6) (4.7) 1.3
Sapient (49.3) (54.5) (54.2) (53.6) (37.7) (33.8) (12.4) 9.8 2.4 23.7 34.3 45.1 43.7
Total 10.9% 0.9% (3.5)% (2.2)% (9.6)% (3.5)% (5.7)% (3.2)% (4.4)% (1.7)% 2.8% 5.8% 7.7%
Currency Effect 2.1 1.6 3.1 7.6 10.2 5.7 8.0 8.2 6.0 4.1
Total (in Constant Currency) (4.4)% (11.1)% (6.6)% (13.3)% (13.4)% (10.1)% (9.7)% (5.4)% (0.2)% 3.6%

1 Fiscal year ends in August; revenue is on a net basis, excluding reimbursable expenses.
2 Formerly KPMG Consulting; data based on North America figures only.

Source: Corporate reports and Bernstein analysis.

Exhibit 2 IT Services: Stock Performance Since Start of

Second-Quarter Earnings Season (07/28/04-01/12/05)
100%
90%
80%
SAPE, 69%
70%
60%
50%
40%
30% EDS, 27%
20% PER, 19%
CSC, 16%
10%
ACN, 9%
0%
BE, (6)%
(10)%
(20)%
7/28/04 8/13/04 8/31/04 9/17/04 10/05/04 10/21/04 11/08/04 11/24/04 12/13/04 12/30/04
Note: The S&P 500 Index has increased 8% since 07/28/04.

Source: FactSet.

Macro Factors Suggest
Some Pent-Up Demand Exists
When we look at the consulting market at a macro level, we see a conflu-
ence of underlying factors that support our view that pent-up demand ex-
ists for “clean-up” and infrastructure-related IT work, which in turn sup-
ports an improving demand backdrop for the IT consulting market. These
factors include: (1) respectable corporate profit growth, improved corporate
cash flows, and record-high corporate cash balances; (2) a relative absence
of “discretionary” IT spending in the post-tech-bubble years, causing some
desired IT initiatives to go unaddressed; (3) an IT “mess” (e.g., ERP does
not connect to CRM does not connect to SCM) that still needs to be cleaned

BERNSTEIN RESEARCH

No New Killer App, But
Spending Themes Are Plentiful
Corporate America Has
the Capacity to Spend
IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 3
up after the aggressive IT buildout that occurred in the bubble; and (4)
movements toward service-oriented architectures, which require invest-
ments in software platforms/infrastructure.
When we look at the consulting market at a more micro level, we see a
number of specific spending themes that we think will drive a healthier
consulting market over at least the next couple of quarters:
• The need for systems integration initiatives to fix pervasive soft-
ware-application disconnects (e.g., ERP does not connect to CRM
does not connect to SCM);
• ERP-related consulting and systems integration work. Our chan-
nel checks tell us that ERP-related work is “hot” (while CRM and
supply chain work is lackluster by comparison). In this context,
we see Accenture’s partnership with SAP as a meaningful positive
for both companies;
• Prospects for a comeback in custom software development (see our
prior research for details);
• Business process transformation initiatives;
• Demand to deploy shelfware (software that has been bought but
not yet implemented);
• Greater RFID adoption (RFID-related investments should continue
to ramp up, stimulating systems integration and business process
consulting activity — see our prior research for details);
• A healthy level of merger-and-acquisition activity, which tends to
drive urgent IT planning and systems integration needs; and
• Ongoing needs to achieve Sarbanes-Oxley compliance, which we be-
lieve will drive IT consulting and systems integration activity (our
primary research makes it clear that some IT initiatives were put off
in 2004 due to the need to focus on Sarbanes-Oxley; this situation
should have created some pent-up demand to benefit 2005).
Because the IT consulting market relies heavily on IT capital budgets, con-
sulting tends to move along with overall IT spending. Exhibit 3 shows that
corporate profit growth has historically driven IT spending activity, with a
one- to two-quarter lag providing the best correlation. This exhibit also
conveys the healthy level of corporate profit growth achieved in recent his-
tory; S&P 500 EPS growth was 15.0% in the third quarter of last year (along
with IT spending growth of 14.3%, helped by currency).
BERNSTEIN RESEARCH
4 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

Exhibit 3 YoY Growth in S&P 500 EPS and Technology Spending

40%

30%

20%

10%

0%

(10)% 2
R:
(20)% One-Quarter Lag = 0.58
Two-Quarter Lag = 0.52
(30)%

Dec-04E
Jun-96

Jun-97

Jun-98

Jun-99

Jun-00

Jun-01

Jun-02

Jun-03

Jun-04
Dec-95

Dec-96

Dec-97

Dec-98

Dec-99

Dec-00

Dec-01

Dec-02

Dec-03
S&P 500 EPS Technology Spending

Source: First Call and Bernstein Strategy Group.

While corporate earnings growth appears prone to decelerate in up-

coming quarters due in large measure to tougher comparisons, historical
patterns suggest the current level of profit growth is sufficient to drive a
healthy level of IT spending over the next couple of quarters. Bernstein ex-
pects IT spending growth of 6-9% in 2005.
In addition, companies have historically tended to spend their cash on
IT when they have had it (see Exhibit 4), and corporate cash flows have
clearly improved (see Exhibit 5), with corporate cash balances now at re-
cord levels.

Exhibit 4 Non-Financial Corporations: YoY Growth1 in Real

Information Technology Spending and Gross Cash Flow (1953 - 3Q:01)
35%
30%
25%
20%
15%
10%
5%
0%
(5)%
(10)%
(15)%
(20)%
1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

Gross Cash Flow Information Technology Equipment and Software Capital Spending
1 Smoothed on a trailing-four-quarter basis.

Source: FactSet and Bernstein analysis.

BERNSTEIN RESEARCH
 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 5

Exhibit 5 Large-Cap Universe (Excl. Financials): Free Cash Flow (Percentage of Sales)

9%
8% 7.5%

7%
6%
5% 15-Year Average = 4.4%
4%

3%
2%
1%
0%
1Q:01 2Q:01 3Q:01 4Q:01 1Q:02 2Q:02 3Q:02 4Q:02 1Q:03 2Q:03 3Q:03 4Q:03 1Q:04 2Q:04

Source: FactSet and Bernstein analysis.

Software Spending Patterns
Convey a Cycle Different
from the Past
IT consulting and systems integration demand is partly driven by software
sales activity, as companies tend to hire consultants to assist with software
deployment and related IT work. Exhibit 6 shows that software revenue
growth and consulting revenue growth were tightly linked historically.
Therefore, we track new software license sales each quarter in order to get a
read on the need for deployment-related consulting work.

Exhibit 6 IT Consulting and Systems Integrators vs. Enterprise

Software Leaders: Revenue Growth Over Last 12 Months
120%

Systems Integrators
100%

80%

60%

40%
Enterprise Software Leaders
20%

0%
Jun-92 Mar-93 Dec-93 Sep-94 Jun-95 Mar-96 Dec-96 Sep-97 Jun-98 Mar-99 Dec-99 Sep-00

IT Consulting and Systems Integrators Enterprise Software Leaders

Source: FactSet and Bernstein analysis.

Software license sales growth, in aggregate, has been respectable in re-

cent quarters. Partly benefiting from somewhat easy comparisons, year-over-
year software license sales growth has been around 11% over the past couple
of quarters, after the software rebound that began late in 2003 (see Exhibit 7).
When dissecting software growth by subsegment, it is important to recognize
that the strength in overall software spending has been in the “infrastruc-
ture” areas (e.g., systems management, data management, technical applica-

BERNSTEIN RESEARCH
6 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

tions), while the absence of a new killer application has allowed the enter-
prise applications segment to remain relatively weak (see Exhibit 8).

Exhibit 7 YoY Growth in Software License Revenue

30%

20%

10%

0%

(10)%

(20)%

(30)%
1Q:00

2Q:00

3Q:00

4Q:00

1Q:01

2Q:01

3Q:01

4Q:01

1Q:02

2Q:02

3Q:02

4Q:02

1Q:03

2Q:03

3Q:03

4Q:03

1Q:04

2Q:04

3Q:04
Growth Excluding Consumer Growth Excluding Consumer and MSFT

Source: Corporate reports and Bernstein analysis.

Exhibit 8 YoY Growth in Software Licensing by Subsector

YoY Growth
Subsector 2Q:04 3Q:04 Sample Companies
Microsoft – Client and Server Tools 14% 12% MSFT
System and Network Management 22 23 CA, BMC
Apps Design and Development (2) 10 CPWR, WIND
Data Management and Analysis 9 7 ORCL, VRTS
Enterprise Apps (12) (8) SBL, PSFT
Technical Apps 18 20 SNPS, CDN
Consumer Apps 26 47 ERTS, INTU
Middleware 0 6 BEAS, TIBX

Source: Corporate reports and Bernstein analysis.

This infrastructure-oriented spending pattern supports our view that the

current demand cycle is different from the past. While consulting demand
cycles in the 1990s were mainly driven by killer applications (e.g., ERP in the
mid-1990s and ERP, CRM and SCM in the late 1990s) and the related demand
for software deployments, we see demand in the current cycle as generally
driven by different forces. We think demand is being driven by “clean-up”
activities and software platform/infrastructure-related spending — the IT
function generally needs to be cleaned up, after the extended period of
spending weakness that followed the bursting of the tech bubble. In effect,
we think pent-up demand is helping today’s consulting market.
Moreover, we maintain that consulting demand is now less reliant on
software sales. Indeed, we see meaningful consulting activities that should
occur even without new software license sales. For example, consulting
businesses should benefit from a comeback in customer software develop-
ment, a rebound in higher-end consulting (M&A, re-engineering, enterprise
architecture planning), software-deployment work on existing software li-
censes (shelfware), systems integration consulting needed to fix pervasive
disconnects across existing software applications, and “transformational”
deals and other initiatives involving substantial business process re-
engineering work. This list conveys multiple examples of consulting activi-
ties that are largely not reliant on new software licenses, which underscores

BERNSTEIN RESEARCH
 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 7

why we can maintain a favorable outlook for consulting despite our general
skepticism about enterprise application spending.

Supply Indicators Because we believe “planning and scoping” work tends to proceed “im-
Positive Overall, But plementation and integration” work (see Exhibit 9), we forecasted (in mid-
With Potential Issue 2003) that a high-end consulting market rebound would proceed a low-end
consulting rebound. Our latest cut at consulting headcount data suggests
this pattern is occurring (see Exhibit 10).

Exhibit 9 Spending Mix Across Typical Phases of an IT Project

Timing Spending Mix
Market Project Phase Project Steps (No. of Months) Services Software Hardware
Consulting Prioritization, Business Study/Analysis/Scoping Three 15% 0% 0%
Feasibility Study Software and Hardware Evaluation

Integration Design and Initial Hardware and Software Purchases One 5% 60% 15%
Development Design, Architecture Two 10 10 5
Development Eight 40 0 0

Implementation Unit Test Two 0% 0%

and Integration Parallel Test Two 30% 20 75
Migration/Rollout One 0 0
Troubleshooting and Tuning 0 Two 10 5
100% 100% 100%
Note: While recognizing it is difficult to typify IT projects, an attempt has been made here to characterize a common pattern.

Source: Bernstein analysis.

Exhibit 10 YoY Growth in Monthly U.S. Consulting Employment

25%
20%
15%
10%
5%
0%
(0)%
(5)%
(10)%
(15)%
Jan-91
Jul-91
Jan-92
Jul-92
Jan-93
Jul-93
Jan-94
Jul-94
Jan-95
Jul-95
Jan-96
Jul-96
Jan-97
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05

Mgmt and Tech. Consulting Services Computer Systems Design and Services

Source: BLS and Bernstein analysis.

A rebound in low-end consulting is very important, as all IT services

firms have material exposure to the segment (see Exhibit 11) — for instance,
consulting accounts for about 60% of Accenture’s revenue, with this
amount evenly split between the high and low ends.

BERNSTEIN RESEARCH
8 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

Exhibit 11 Quantification of Cyclical Revenue and Margin Leverage, by Services Company

Percentage Discretionary Revenue Revenue Operating Margin Upside Potential Margin
Overall Commercial Leverage Rating Current Normalized Upside Leverage Rating
Sapient 83.5% 64.7% High 11.7% 15.0% 3.3% High
BearingPoint 92.3 60.0 High 4.3 9.0 4.7 High
Accenture 70.5 62.0 High 12.9 14.0 1.1 Low
EDS 27.3 24.6 Material 3.1 7.5 4.4 Medium to High
Perot Systems 28.4 25.6 Material 7.9 10.0 2.1 Medium
CSC 33.5 23.5 Material 6.3 7.5 1.2 Low
Note: CSC and Accenture “current” operating margins based on fiscal 2004 data. “Normalized” refers to the margin levels (excluding one-time items)
we see as achievable in a healthier demand environment. Most of EDS’ margin improvement potential stems from fixing problem contracts.
Source: Corporate reports and Bernstein estimates and analysis.

Exhibit 10 shows that employment growth in high-end consulting

(management and tech consulting) rebounded in mid-2003/early 2004 and,
then, consistent with our forecast, employment growth in low-end consult-
ing (computer systems design and services) turned positive in June 2004
and has continued progressing in recent months. Moreover, this rise in low-
end consulting headcount growth is being achieved despite an aggressive
shift to offshore IT labor. The rebound in U.S. consulting headcount
growth, despite the offshore migration of consulting/IT jobs, is compelling
evidence that consulting activity has risen.
As another encouraging supply-related data point, we have learned
that Accenture is providing referral bonuses to employees who help the
company locate new hires. This incentive program geared to stimulate hir-
ing activity represents an inflection point, in our view — an indication that
overcapacity issues (at least in the United States) have subsided and the
consulting market is improving.
While overall consulting headcount growth is positive, one potential is-
sue merits close monitoring. We have recently witnessed some slowing in
high-end consulting headcount growth (see Exhibit 10 again). As high-end
consulting activity can serve as a leading indicator, if a high-end headcount
slowdown becomes more than just a one- or two-month pattern, it could sig-
nal an impending pullback in low-end IT consulting activity. Stated another
way, while we do not anticipate this will occur, if we see a clearer pattern that
the high end is pulling back, it could serve as a leading indicator of a general
tapering off of IT consulting demand over the next few quarters.

Lackluster Bookings Can consulting rebound despite lackluster bookings? Yes, and weak
vs. Market Rebound? consulting bookings have been reported by both Accenture and IBM in
recent history, so we have indications that aggregate consulting bookings
are flattish. However, we see this as largely due to a decline in average pro-
ject length.
For a given level of bookings (i.e., in a flattish bookings scenario), a de-
cline in average project length implies a higher revenue run rate (e.g.,
smaller projects ramp more quickly and should drive follow-on deals, as-
suming the environment remains healthy), meaning a modest rebound can
occur despite lackluster total bookings. For this reason (coupled with our
positive outlook for consulting demand), lackluster consulting bookings do
not sway our consulting market thesis, as long as we get continued confir-
mation that average project length is down and as long as our broad set of
indicators are sending positive signals.
Recall that IBM and Accenture both have reported flattish consulting
bookings and have cited a decline in average project size, which is consis-

BERNSTEIN RESEARCH
 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 9

tent with our ongoing view that customers are tending to break projects
into smaller chunks. We view this approach as a way for clients to better
“stage” their investments in order to limit risk and improve ROI.

Sector Summary: Cycle Should In sum, we reiterate our view that — despite softness in software applica-
Help Near-Term, Though tion sales — consulting businesses should benefit in the next couple of
Longer-Term Problems Exist quarters from cyclical factors and some pent-up demand for systems inte-
gration and “clean-up”-related IT work. At the same time, we worry that if
longer-term enterprise-application-software spending does not improve,
consulting market improvements will run out of steam. In other words, if
software-license sales do not improve, the consulting demand cycle will
ultimately slow. And, in absence of an improving cycle, longer-term in-
vestment prospects within the IT services industry will be much more lim-
ited, as we continue to see substantial secular challenges (e.g., overcapacity,
shift toward offshore labor).
Finally, to place our consulting market views in the context of the
broader IT services industry, we summarize our views across the other ma-
jor segments of the industry (see Exhibit 12), including IT outsourcing, BPO
and payroll processing.

Exhibit 12 IT Services: Summary of Positive and Negative Trends by Market Segment

Representative
Market Segment Companies Positives Negatives
IT Consulting/ • Accenture • Cyclical rebound is brewing • Secular challenges from overcapacity and
Systems Integration • BearingPoint • IT consulting/systems integration should benefit offshoring trend
• Sapient from upcoming IT/corporate spending themes • Absence of new killer application to drive demand
(e.g., application connectivity, business • Business model transitions create risk
process transformation) • Performance-based contracting adds to risk profile
• Investor expectations are lower today, as challenging
secular trends are more recognized
IT Outsourcing • EDS • Likely to benefit from increased add-on work as • Maturation will limit future signings
(ITO) • CSC consulting market rebounds • Contract restructurings will be major obstacles
• Perot • European region is bright spot in • Business model has considerable shortcomings
Systems outsourcing demand • Offshore shift brings headwinds for
• Government demand trend should remain robust traditional players
Business Process • ACS • Represents the key growth and diversification • Considerable market ramp-up constraints exist
Outsourcing (BPO) • Accenture opportunity in the service industry…penetration rates • Contract execution and performance risks
(emerging are low are substantial
BPO player) • Economics are not as challenged as in IT outsourcing • Competition is increasing
(less mature, broader sources of value creation, • We are skeptical on scalability (margin expansion
lower capital intensity) prospects) of the BPO business model
Payroll Processing • ADP • Provides late-cyclical characteristics (with favorable • Some signs of market maturation
• Paychex exposure to rising interest rates and U.S. • Long-term earnings growth is lower versus history
• Ceridian payroll growth)
• Defensive stock attributes
• “Healthy” underlying economics relative to other IT
service businesses (i.e., strong returns, healthy
balance sheets)

Source: Bernstein analysis.

The IT outsourcing market is mature and quite competitive, and we

see substantial shortcomings in the IT outsourcing business model (e.g., weak
cash generation, reliance on megadeals that can be risky, ongoing pricing
pressures and contract restructurings). Our November 19 downgrades of
EDS and CSC anticipated new secular challenges for the large IT outsourcing
vendors. Based on our contract signings data and recent CIO interviews, we
see a shift occurring away from megadeals and toward multi-vendor out-
sourcing arrangements, which we think will present increasing challenges for
the Big Three outsourcers (EDS, CSC and IBM GS), which have vast installed

BERNSTEIN RESEARCH
10 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

bases of large contracts. These concerns are somewhat offset by our view that
add-on work is improving (note that add-on work in the outsourcing busi-
ness tends to flow with the consulting market).
The BPO (business process outsourcing) market represents an impor-
tant source of growth and diversification for services vendors, though we
see considerable market ramp-up constraints. And, importantly, the ulti-
mate “scalability” of the BPO business is yet to be proven. Contrary to
common assumptions, we are skeptical that margins in the BPO business
will expand as existing deals mature and scale is added.
The key drivers of the payroll processing market (e.g., employment
growth) appear prone to move slowly, but this market still offers logical at-
tributes as a late-cycle investment. That is, we still view ADP as a low-risk,
reasonable-reward investment with favorable exposure to rising rates, and
we think further upside to earnings expectations is achievable.

BERNSTEIN RESEARCH

Overview
Stock Evaluation and Scoring
IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 11
What Stocks Look Best in 2005?
The stocks we favored over the past year have generally experienced up-
ward moves, so valuations are meaningfully less compelling today. How-
ever, we believe investors should remain exposed to the sector, particularly
consulting-oriented stocks, for three primary reasons: we see the consulting
market as rebounding, as discussed in the previous chapter; defensive tech
stock exposure may be logical, given the general run-up of tech sector
valuations since August; and we believe IT services earnings estimates for
2005 are generally realistic to modestly conservative.
The IT services stocks we cover fall into three broad categories: consult-
ing names with attractive cyclical exposure, solid long-term businesses, and
large IT outsourcers facing difficult core-market dynamics.
The first category includes Accenture, BearingPoint and Sapient. Our
sector thesis today favors the smaller consulting names BearingPoint and
Sapient, with these stocks having the most leverage to a consulting rebound
and the most upside to what we view as fair value. We see under-
appreciated turnaround leverage at BearingPoint, plus considerable take-
over prospects. And we like Sapient’s short- and long-term prospects due
to its differentiated business model, with leverage to the offshore trend at a
cheaper valuation than the major Indian stocks. Accenture is a low-
risk/modest-reward investment, with upside to fiscal 2005 estimates along
with solid growth, cash flows and ROIC.
The second category includes ADP and Perot Systems. These stocks’
heightened valuations will likely limit their upside, but we still see cause
for certain investors to remain exposed to these names. ADP is currently
our best large-cap idea, as we see recent tailwinds (i.e., rising rates and im-
proved retail brokerage volumes) and, more generally, the stock offers a
sound bet for investors desiring favorable exposure to rising interest rates
and a defensive profile. Perot, with a well-positioned business mix (i.e., 45%
healthcare, 15% government, 9% offshore), is arguably a solid stock to buy
on a pullback.
The third category includes EDS and CSC, the large IT outsourcers.
EDS is trading essentially in line with our view of fair value and faces sig-
nificant secular challenges as well as company-specific risks. We worry that
CSC’s stock may face material downside, as its free-cash-flow generation is
insufficient, in our view, to support the stock’s current price.
We have outperform ratings on ADP (with a share-price target of
$47.00), Accenture ($28.50), BearingPoint ($11.00) and Sapient ($10.00);
market-perform ratings on EDS ($23.50) and Perot ($16.00); and an under-
perform rating on CSC ($44.00).
We have evaluated and scored each of the IT services stocks we cover
against four sets of attributes: long-term prospects (including business-model
attractiveness and favorability of exposure to secular and cyclical trends);
short-term prospects (including the achievability of upcoming estimates and
the favorability of other potential catalysts); risks (including market and
company-specific risks); and valuation (including free-cash-flow yield and
relative price-to-forward earnings). Subattributes — such as business-
BERNSTEIN RESEARCH
12 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

model attractiveness under “long-term prospects” — were also evaluated

and scored.
Our analysis, captured in Exhibits 13 and 14, suggests that our IT ser-
vices stocks fall into three general categories: consulting names with favorable
cyclical exposure (Accenture, BearingPoint and Sapient), solid long-term busi-
nesses (ADP and Perot Systems), and large IT outsourcers facing challenging
core-market trends (EDS and CSC). The sections that follow discuss the logic
applied in scoring our stocks across key attributes, with detail on our out-
perform-rated names — Accenture, BearingPoint, Sapient and ADP.

Exhibit 13 Stock-Scoring Against Comprehensive Set of Attributes

Stock Category
Consulting Firms Outsourcers Processors
Accenture BearingPoint Sapient EDS CSC Perot Systems ADP
Long-Term Prospects M/H M H L L/M M/H M/H
Business Model M/H L/M H L L/M M/H H
Secular Trends M L/M H L L/M M/H M
Cyclical Trends M/H M/H H M M M/H M/H
Long-Term Score 3.5 2.7 4.5 1.5 2.0 4.0 3.7

Short-Term Prospects M/H M M/H M L/M M M/H

Achievability of Upcoming Estimates M/H M M/H L/M M/H M/H M/H
Other Near-Term Catalysts M M M M L/M M M/H
Short-Term Score 3.7 3.0 3.7 2.7 2.5 3.2 4.0

Risk Profile M/H M M L L M M/H

Market Risks M/H M M L/M L/M M M/H
Company-Specific Risks M/H L/M M L L L/M M/H
Risk Score 3.5 3.0 3.0 1.5 1.0 2.5 4.0

Valuation Attractiveness M/H M/H M/H M L/M M M

Free-Cash-Flow Yield H M na H L L/M M/H
Relative Price-to-Forward Earnings M/H M/H M/H L/M M M M
Valuation Score 3.5 4.0 3.5 3.0 1.5 3.0 3.3

Note: L = low, M = medium, H = high. “Low” suggests a poor score and “high” suggests a strong score. “Valuation attractiveness” accounts for the
price of each stock relative to its underlying growth and return prospects. Long term = six to 24 months, short term = six months. 1 = low, 2 =
low/medium, 3 = medium, 4 = medium/high, 5 = high.

Source: Bernstein analysis.

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 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 13

Exhibit 14 Summary of Stock-Attribute Scores

Good Businesses — Compelling

Consulting Names With to Buy on a Pullback
Attractive Cyclical Exposure
Short-Term (Six- Month) Prospects
5

ADP – 3.3
4 SAPE – 3.5

BE – 4.0 ACN – 3.5

3
EDS – 3.0 PER – 3.0

CSC – 1.5
2

IT Outsourcing Names
1
Facing Challenging
Market Dynamics

0 1 2 3 4 5
0
Long-Term (Six-to-24-Month) Prospects
Note: Scoring: 1 = low, 2 = low/medium, 3 = medium, 4 = medium/high, 5 = high. Numbers next to ticker symbols represent valuation attractiveness scores.
“Low” suggests a poor score and “high” suggests a strong score.

Source: Bernstein analysis.

While 2005 expectations for the tech sector are fairly high (see Exhibit
15), we see those for IT services stocks as generally realistic (see Exhibit 16).

Exhibit 15 Technology Sector: Net Margin and YoY Sales Growth

11% 20%

10% 16%

YoY Sales Growth

Net Margin

9% 12%

8% 8%

7% 4%

6% 0%
3Q:04E

4Q:04E

1Q:05E

2Q:05E

3Q:05E

4Q:05E
1Q:04

2Q:04

Net Margin YoY Sales Growth

Source: FactSet, First Call and Bernstein analysis.

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14 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

Exhibit 16 Revenue and EPS Estimates (CY:05E)

Revenue ($ million) EPS
Company SCB Consensus SCB Consensus
ACN $15,436 $15,426 $1.46 $1.41
ADP 8,578 8,585 1.83 1.84
BE 3,663 3,645 0.55 0.49
CSC 17,282 16,979 3.34 3.42
EDS 19,187 20,280 0.80 0.74
PER 2,062 1,968 0.88 0.86
SAPE 324 327 0.31 0.29

Note: BE estimates exclude charges and dilution from convertible debt.

Source: First Call and Bernstein estimates.

Accenture: Works in 2005 Long-term prospects. Accenture’s business model is sound, due largely to
as Core Business Rebounds the company’s entrenched relationships with leading clients. The strength
of Accenture’s model is evidenced by its strong cash flows and ROIC. Also,
the company is positioned to be a leader in the BPO market. These positive
attributes are somewhat offset by secular challenges related to overcapacity,
the offshore-labor shift, and our skepticism about the margin-expansion
prospects of Accenture’s BPO business.
Short-term prospects. Accenture should benefit in upcoming quarters
from the modest rebound we believe is occurring in the company’s core
consulting business (60% of revenues), with modest upside to consensus
earnings estimates (stemming not only from the consulting rebound but
also from share buybacks). Because we see investor skepticism resulting
partly from Accenture’s lackluster bookings, we think further evidence of a
consulting rebound can help the stock, even though it is trading near the
upper end of its range.
Risks. As long as we see prospects for at least a modest consulting-
market rebound, Accenture’s risk should be limited. We believe that Accen-
ture’s turnover (currently at 20%) and talent loss — key problems over the
past couple of quarters — should be monitored. We also believe the off-
shoring trend is bringing economic headwinds — a clear deflationary pres-
sure and potential operating-margin impairment.
Valuation. The limitation on Accenture’s stock is valuation, particularly
following the recent post-earnings-release rally. The stock is now trading at
a relative price-to-forward earnings multiple of 1.07x — modestly above the
stock’s historical average multiple of 1.05x. Given the cyclical tailwind be-
ing experienced, and Accenture’s solid cash flow and competitive position,
we believe a relative price-to-forward earnings multiple of around 1.15x-
1.20x is achievable. Our conservative target share price of $28.50 for the
stock is based on a price-to-forward earnings multiple of 19.5x (and of 1.15x
on a relative basis) applied to our calendar 2005 EPS estimate.

BearingPoint: Value Way Some patience may be required near-term, but BearingPoint’s valuation is
to Play Consulting Rebound attractive in light of its “fixable” sources of earnings improvement as well
as takeover targets.
Long-term prospects. BearingPoint faces some challenging market and
company-specific obstacles. The IT consulting and systems integration
market has overcapacity and is shifting toward offshore-labor use. Because
the company is relatively lacking in offshore capacity, it faces risks of share
loss and offshore-driven deflation.

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 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 15

While some observers argue that BearingPoint should make major in-
vestments to build presence in the BPO market, we believe that Bearing-
Point should stay focused on improving the earnings performance of its
core systems integration business. Moreover, we question the underlying
margin-expansion prospects expected by many BPO prognosticators.
Short-term prospects. BearingPoint is in a turnaround position. We
see a legitimate concern that a near-term setback could occur as the new
management transitions into position and begins improvement initiatives.
However, we think near-term bumps are priced in, and we think man-
agement should be able to articulate a path toward fixing the underlying
drags on the company’s earnings — a relative lack of low-cost labor in
offshore locations, poor utilization in Europe, redundant SG&A costs, and
a high tax rate.
Risks. Much of BearingPoint’s current risk stems from its recent man-
agement transition. While we see attractive attributes in new CEO Rod
McGeary, we see a number of issues that must be quickly addressed by
new management (currently lacking a CFO). We see a significant challenge
in meeting Sarbanes-Oxley requirements, and last quarter’s abrupt earnings
dropoff in the company’s Asia/Pacific business must be rectified.
Valuation. Because we believe that Bearing-Point has four major “fix-
able” sources of earnings improvement (a lower tax rate, increasing utiliza-
tion, reducing subcontractors, and reaping SG&A savings), we see Bearing-
Point’s “normalized” earnings level as substantially higher than the cur-
rent run rate, and the stock’s current valuation is attractive when account-
ing for normalized-earnings prospects. On the basis of our normalized EPS
estimate of $0.68, BearingPoint is trading at a relative price-to-earnings
multiple of only 0.74x. Our $11 target share price is based on 16 times our
normalized EPS estimate as well as our sum-of-the-parts valuation analysis.

Sapient: Offering Rebound We view Sapient as a sound way to gain exposure to both a consulting
Plus Offshore Exposure market rebound and the offshoring trend.
Long-term prospects. We favor Sapient’s long-term positioning for sev-
eral reasons. First, with over half of its billable staff in India and a proven
global delivery model, the company will benefit disproportionately from
the offshore-labor trend. Second, Sapient’s business model is quite distinc-
tive. The company’s core business is higher-end (often custom) systems
integration work, which is now being completed with a heavy offshore
component — a quite unique focus compared to IT services peers. Also,
most of Sapient’s business is based on fixed-time, fixed-price contracts,
which limit risk for customers — a compelling proposition for customers
trying to get comfortable with offshoring.
Short-term prospects. Delays on a couple of government projects
caused Sapient to post revenue at the low end of expectations in the third
quarter. This raised concerns and effectively served to lower expectations
that had risen dramatically over the past year. The combination of these
somewhat lower expectations and our view that fourth-quarter revenue
will more than recover from the third-quarter setback means we favor Sapi-
ent’s near-term prospects. In addition, we believe that the company is on a
trajectory to achieve a 15% operating margin in 2005 (following operating
margins of 1.7%, 8.2% and 11.7% over the past three quarters and an ex-
pected 13.4% operating margin in the fourth quarter). The ability to expand
margins is a noteworthy attribute in light of worries that other Indian play-
ers face margin contraction.

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16 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

Risks. In some respects, the main risk to our positive view on Sapient
is investor sentiment about the technology sector, given the volatile na-
ture of Sapient’s trading pattern. Other risks include multiple compres-
sion among Indian stocks, pricing pressures due to challenging secular
trends (overcapacity, offshoring), delays in cyclical IT rebound/economic
activity, and turnover.
Indeed, execution on successful hiring and retention (minimizing turn-
over) are critical for Sapient, especially given our view that supply is the
company’s primary growth constraint. Turnover rose from 19% in the first
quarter to 21% in the second quarter of this year (summer months can be
tough on turnover), but we see prospects for turnover to subside in upcom-
ing periods.
Finally, uncertainty about Sapient’s “steady-state” tax rate is an under-
lying risk to our earnings estimates. We think Sapient’s CFO has an oppor-
tunity to lower the uncertainty surrounding this factor.
Valuation. Sapient’s valuation looks attractive versus other offshore
companies. Sapient is trading at a 27x price-to-forward earnings (2005)
multiple versus the 35x average being achieved by offshore-company
leaders (Cognizant, Infosys and Wipro). Our $10 target share price on
Sapient is derived by applying a 30.6x multiple (versus an average multiple
of 35x for leading Indian firms) to our EPS estimate of $0.32 for the year
ending in March 2006 (the end of fiscal 2006 for Indian peers). Also, our
target-valuation calculation conservatively excludes Sapient’s $1.30-per-
share cash balance.
In sum, Sapient has a timely and distinctive business model, with lev-
erage to both a consulting market rebound and the offshoring trend at a
cheaper valuation than the major Indian stocks — not to mention further
room for margin expansion.

ADP: A Logical Long-term prospects. While ADP’s core payroll business is facing some
Late-Cycle Investment maturation, the company’s overall growth prospects are respectable (high-
single-digit top-line growth, plus some margin expansion), and its business
model is impressive (strong ROIC and cash flows).
Short-term prospects. Our thesis on ADP has emphasized that the
Street has been underestimating the leverage possessed by the Employer
Services business as long as payroll growth is positive (even modestly posi-
tive, as in the current situation). Part of this thesis has run its course, given
the upside reported in the September quarter. However, we still see ADP’s
profile as attractive in the current environment, due to ADP’s late-cycle at-
tributes and recent tailwinds. The stock offers a sound bet for investors
seeking favorable exposure to rising interest rates and a defensive profile.
Moreover, the recent rise in interest rates and strength witnessed in retail
brokerage volumes could provide a near-term source of fundamental
strength not assumed in consensus estimates or guidance.
Risks. We see very little earnings risk for ADP, particularly because
ADP has avoided recognizing portfolio gains in recent history (i.e., it still
can recognize some gains if it runs into a “rainy day”). The potential for a
controversial acquisition is somewhat of a risk, recognizing that ADP is
prone to pursue additional acquisitions.
Valuation. ADP’s free-cash-flow yield of 5% is respectable — essen-
tially in line with the peer group, despite having above-average growth and
returns). ADP’s relative price-to-forward earnings multiple of 1.35x — in
line with its historical average — is a limiting factor for the stock, though

BERNSTEIN RESEARCH
 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 17

we think incremental multiple expansion is feasible in the event of above-

expected interest-rate increases and/or payroll growth.

Valuation Methodology To derive our target share prices for ADP, Accenture, BearingPoint, Perot
and Sapient, we applied target relative price-to-forward earnings multi-
ples to our forward EPS estimates; to derive our target prices for EDS and
CSC, we applied target free-cash-flow yields to our normalized free-cash-
flow estimates.

Investment Conclusion Consulting stocks Accenture, BearingPoint and Sapient are the most di-
rect ways to bet on a modest consulting rebound, though it is important to
remember that outsourcing companies (EDS, CSC and Perot) will also
benefit from the add-on work likely to coincide with an improved con-
sulting market. Despite this potential consulting business improvement,
we remain cautious on the larger IT outsourcers (EDS and especially
CSC), which we downgraded in November based on a number of secular
concerns that were very much reinforced by our primary research and
signings data analysis.
At EDS, also rated market-perform, with a $23.50 share-price target, the
turnaround is progressing (slowly), but the company is fairly valued based
on our normalized-free-cash-flow estimate ($800 million) and limitations on
a realistic valuation multiple, given EDS’ weak growth prospects.
At CSC, rated underperform, with a share-price target of $44, business
and management’s approach to contract structuring are improving, but
challenging secular trends and a poor cash-flow yield suggest substantial
valuation risk.
Perot Systems, rated market-perform, with a $16 target share price, has
a robust business mix and disciplined outsourcing model, but we think
valuation limits Perot’s upside. Our concern about valuation stems from
our expectation that the completion of the UBS contact in 2007 will cost Pe-
rot about $0.25 in EPS.

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 18 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE!

SRO REQUIRED DISCLOSURES

• References to "Bernstein" relate to Sanford C. Bernstein & Co., LLC and Sanford C. Bernstein Limited, collectively.
• Bernstein analysts are compensated based on aggregate contributions to the research franchise as measured by account penetration,
productivity and proactivity of investment ideas. No analysts are compensated based on performance in, or contributions to, generating in-
vestment banking revenues.
• Bernstein rates stocks based on forecasts of relative performance for the next 6-12 months versus the S&P 500 for U.S. listed stocks and
versus the MSCI Pan Europe Index for stocks listed on the European exchanges — unless otherwise specified. We have three categories of
ratings:
Outperform: Stock will outpace the market index by more than 15 pp in the year ahead.
Market-Perform: Stock will perform in line with the market index to within +/-15 pp in the year ahead.
Underperform: Stock will trail the performance of the market index by more than 15 pp in the year ahead.
• As of 12/31/04, our ratings were distributed as follows: Outperform/Buy - 48.7%; Market-Perform/Hold - 45.7%; Underperform/Sell - 5.6%.
• Accounts over which Sanford C. Bernstein & Co., LLC, Sanford C. Bernstein Limited, and/or their affiliates exercise investment discretion own
more than 1% of the outstanding common stock of EDS / Electronic Data Systems Corp, PER / Perot Systems Corp, SAPE / Sapient Corp.
• Sanford C. Bernstein & Co., LLC currently makes a market in SAPE / Sapient Corp.
• The following companies are or during the past twelve (12) months were clients of Bernstein, which provided non-investment banking-
securities related services and received compensation for such services ADP / Automatic Data Processing.
• An affiliate of Bernstein received compensation for non-investment banking-securities related services from ADP / Automatic Data Processing,
CSC / Computer Sciences Corp.
• This research report covers 6 or more companies. Please visit www.bernsteinresearch.com for price charts.

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 IT SERVICES: YES, THE CONSULTING MARKET CAN IMPROVE! 19

CERTIFICATIONS
• I/(we), Rod Bourgeois, certify that all of the views expressed in this report accurately reflect my/(our) personal views about any and all of the
subject securities or issuers and that no part of my/(our) compensation was, is, or will be, directly or indirectly, related to the specific recom-
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Copyright 2005, Sanford C. Bernstein & Co., LLC, a subsidiary of Alliance Capital Management L.P. ~ 1345 Avenue of the Americas ~ NY, NY 10105 ~ 212/486-5800. All rights reserved.
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BERNSTEIN RESEARCH