If you're considering investing later this year in the initial public offering of
, take a minute to read at least one sentence in the firm's securities filings: "Our business involves the delivery of professional services and is highly labor-intensive."
This line really says it all. Because KPMG Consulting helps companies choose technology products and manage their businesses, it would have you believe that it's in the technology game. Really, though, it's a service outfit. And as a highly labor-intensive enterprise, it has more in common with a law firm, investment bank or even a steelmaking company (for its labor component, not its capital requirements) than it does with a high-tech concern.
And yet, KPMG Consulting, flush with an alliance with and billion-dollar investment by
, will cover itself in the technology flag when it attempts to go public in several months.
Its financial results, impressive for a consulting firm, tell a cautionary tale, however. KPMG Consulting plans to leave the fold of its Big 5 accounting-industry sibling, KPMG, by selling as much as $1 billion worth of stock. Its revenue certainly tells a growth story. Overall revenue was $570 million in the year ended June 30, 1995, and rose to $1.9 billion in fiscal 1999. Revenue for the first six months of fiscal 2000 was $1.1 billion, up 17% from the year-earlier period.
But the firm's profit margins are hardly techlike. Gross margins, which take into account salaries paid to professional consultants but not other administrative expenses, are about 20%, factoring in recent acquisitions of other consulting firms. Operating margins before doling out cash to partners (a practice that goes away when those partners become equity holders of a public company) are in the 12% to 13% range, a fraction of what true tech companies earn. Net profit for fiscal 1999 was a puny $28.3 million, or 1.4% of revenue.
Profitable, yes; run out and call your broker, no.
It's undoubtedly a good idea for KPMG Consulting to break off from its green-eyeshade-wearing kin, what with its nasty conflicts over advising the same companies the accountants are auditing. The quibble is with these companies going public. Sure,
have raised money successfully in public markets. But those smaller firms have explosive growth rates and are all about information technology. And even they eventually have trouble scaling their businesses as they get bigger.
Despite the liberal use of the word Internet throughout KPMG Consulting's May 5 filing with the
Securities and Exchange Commission
, the firm says "e-business based revenues" account for less than half of the total, or 44%. KPMG does have tech-specific clients. But according to its filings, its high-tech group accounts for 9% of revenue, and the communications and content group is another 9%. The big sectors are public services (like local governments) and financial services (like banks.)
What's more, KPMG Consulting's labor costs will be a continual wild card. Forget for a moment how this offering will enrich existing partners of both the consulting and accounting firms. A major reason to go public is to create a currency for employee retention. But the rate at which consultants are jumping ship points up the risks of doing this deal -- and the rising expense of feeding consultants.
According to the filing, the firm had a 29.5% turnover among its professional consultants for the nine months ended March 31. That's up from 22.7% for the year that ended last June. "This situation has required us to increase the compensation we pay our professionals at a rate higher than the general inflation rate, " the McLean, Va.-based firm notes. A successful IPO will help. Fully 98% of employees, "including our clerical and administrative support staff," have stock options.
The relationship with Cisco, which will end up with a stake of just under 20%, is a coup. But it also cuts off KPMG Consulting from pursuing Cisco's biggest competitors for five years. The terms of the agreement specifically hobble KPMG Consulting's dealings with
, according to the filing.
KPMG Consulting does share one characteristic with other go-go tech companies: It is taking equity investments in its clients, dubbed "alliance partners." The accountants undoubtedly would have a problem with that, though the practice has became standard for Silicon Valley law firms. That practice is a double-edged sword for a public company. It looks great when the stocks are way up but will force analysts to reconsider the firm's valuations when the stocks are down.
Three early investments KPMG Consulting mentions are
(down 76% from its high),
(down 80%) and
(down 77%). KPMG Consulting undoubtedly is way ahead on those investments. But, in exchange for negotiated rates, it likely has taken equity as well in private clients whose IPOs will never see the light of day.
Service companies never will be the next
or the next Cisco. We'll find out whether they'll be the next billion-dollar IPO in a few months.
Clearing the Air(waves)
Whew! You shareholders of
are a loud bunch. You flooded me with emails after I published a letter from art historian Sharon Dale (whose given name I initially botched), who suggested that Cisco's television branding campaign could presage a decline in earnings, just like at Knight/Trimark and Tyco.
First of all, to those who took offense at my belittling the feedback of an art history professor, you read me wrong. There was no sarcasm. I think it's great that folks from all sorts of professions want to air their views on the stock market, and don't think that humanities types can't manage money.
Now, you defenders of brokerage-services firm Knight/Trimark and conglomerate Tyco are correct: Neither firm has experienced a decline in earnings since introducing branding campaigns. I should have checked those facts first. My fault. But just because I don't think Cisco's TV commercials are a sign of weakness doesn't mean I'm pooh-poohing the idea. Being an investor is all about wondering what might go wrong, poking holes in the thesis and making sure an investment is rock-solid.
Cheerleading is fine. But the rah-rah crowd won't ever help you get out before it's too late.
A Charitable Moment
Anyone who's made any money either investing in technology or working in the technology industry should consider how to give a little back. One way is to contribute time or money to
CompuMentor. The San Francisco-based nonprofit helps other nonprofits with training, support and products so they can have up-to-snuff technology. Now CompuMentor has started a Web portal, called
TechSoup, which bills itself as an online, one-stop resource for nonprofits trying to boost their technology.
This is a group that does good and is staffed and funded by an industry that does extremely well but doesn't always remember to say thanks. It's not just a Silicon Valley organization, either. It offers its goods and services around the country. And it needs all the help it can get, especially because it competes for consultants with the very companies who help fund it.
Adam Lashinsky's column appears Tuesdays, Wednesdays and Fridays. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Lashinsky writes a column for Fortune called the Wired Investor, and is a frequent commentator on public radio's Marketplace program. He welcomes your feedback at