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CGI GROUP INC.

PFSI007

Robert W. White prepared this case solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other identifying information to protect confidentiality.

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Copyright © 2006.

Version: 2007-07-09

CGI Group Inc.’s (CGI) chief executive officer, Serge Godin, cited the company’s 1998 decision to merge with BCE Inc.’s (BCE) subsidiary, Bell Sygma, as the moment it became what he called a “credible player in the large outsourcing market.” In December 2005 BCE was CGI’s single largest customer and shareholder with 128 million shares or 30% of the company’s issued and outstanding common shares. Combined revenues attributable to contracts from the BCE family of companies decreased from 14.3% of CGI’s 2005 total revenue, compared with 16.4% in 2004 and 19.3% in 2003. CGI’s top five clients represented 26.5% of total revenues in 2005, compared with 31.5% in 2004 and 35.1% in 2003 (see Exhibit 1 for summary financial statements). CGI provided end-to-end IT and business process services to clients worldwide from offices in Canada, the United States, Europe, and Asia Pacific as well from centers of excellence in the United States, Europe, India and Canada.

On February 1, 2005, CGI announced that the Board of Directors had authorized the purchase of up to 10% of the public float of the Company’s Class A subordinate shares during the next year through a Normal Course Issuer Bid (see Exhibit 2 for a description of issuer bids). The Company received approval from the Toronto Stock Exchange for its intentions to make an issuer bid. The issuer bid enabled CGI to purchase on the open market, through the facilities of the Toronto Stock Exchange, up to 27,834,417 Class A subordinate shares for cancellation. The total Class A subordinate shares repurchased during fiscal 2005

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was 14,896,200, at an average price plus commission of $7.82, for an aggregate consideration of $116.4 million.

On December 16, 2005 CGI Group Inc. (CGI) announced a 100 million share buyback and cancellation of 78% of the 30% BCE stake in CGI for C$859.2 million – to be financed through cash and credit facilities. This transaction will reduce the total number of CGI shares outstanding to an estimated 330.6 million after the repurchase of 100 million shares (also including some other shares repurchased under the company’s normal course issuer bid). Executive management’s ownership of 38.8 million Class B (unlisted class of shares) and 1 million Class A (listed on the Toronto Stock Exchange and the New York Stock Exchange) shares will represent 10.5% of the company’s equity and 53.4% of the vote (up from approximately 8% and 46%, respectively). The shares outstanding are always reduced by the number of shares repurchased because a firm cannot own itself. In this case, they were to be cancelled.

The sale marked BCE’s (Canada’s largest telecommunications company) latest move to shed non-core assets as the company, parent of Bell Canada, focused on its core telecommunications operations. The company said that it planed to sell the rest of its CGI shares 120 days after the CGI deal closed, which was expected to occur on January 12, 2006. Assuming 100 million shares are repurchased, BCE’s remaining 28.3 million stub would represent one sixth of the annual share turnover or 10 weeks of average trading volume. BCE said it and CGI “agreed that their ongoing relationship could be secured through commercial relationships.” BCE said that CGI would remain the preferred IT-services supplier until June 2016 to the Bell family of companies and CGI’s agreement to outsource its Canadian communications network management requirements to BCE will similarly be extended.

An issuer making a substantial issuer bid for voting or equity securities through the facilities of the Toronto Stock Exchange (Exchange) shall file a notice with the Exchange in accordance with Rule 6-203. In addition, unless a waiver is obtained from the Director or the Commission, a valuation of the target company must be prepared in accordance with s. 182 of the Regulation under the Securities Act. The purpose of the evaluation of CGI is to determine if the proposed acquisition price of $8.60 (volume weighted average of CGI’s trading price over the prior 20 days) for the BCE block is fair considering the fundamental value of the company. In December 2005 CGI shares had been trading below their two year high of $9.29 (February 3, 2004), in line with its 50 day moving average of $8.51, but well above its 200 day moving average of $7.83 (see Exhibits 3 and 4 for stock price performance) Driven by its strong financial performance, but mainly due to an aggressive buyback program, CGI’s shares have been trading in the $8.50 range

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and have outperformed the S&P/TSX IT sub index 1 which has been under pressure. CGI’s stock has performed at the top of its peer group over the past 24 months with a return of 12.5 % (as of December 13, 2005). What is the potential impact of the buy back on CGI’s growth potential? What are the approaches and operational issues in deriving a fair value? Is the issuer bid price fair? What are the implications of the source of funds for the repurchase? What was CGI’s December 2006 target price?

CGI GROUP INC.

Founded in 1976, CGI had grown through acquisitions and organic growth to become, in December 2005, the 8 th largest independent IT services company in the world (by line of business – IT Services and Business Process Services accounted for 88% and 12% of CGI’s 2005 sales, respectively). In 1986 CGI entered the U.S., the biggest IT services market in the world, and made its first major acquisition there in 1999, when it bought Deloitte and Touche’s IT business, DRT Systems International. Since 1986, CGI had acquired more than 20 companies.

On January 30, 2004, CGI announced that it had completed a US$192 million private debt placement financing with U.S. institutional investors. The private placement was comprised of three tranches of guaranteed senior unsecured notes, with a weighted average maturity of 6.4 years and a weighted average fixed coupon of 4.97%. The proceeds were used to reimburse the drawn-down portion of the Company’s existing credit facilities, as well as for general corporate purposes. The Company had a five-year unsecured committed revolving term credit facility (expiring in December 2009) for an amount of $800,000,000 to cover operating activity needs, working capital purposes and the financing of acquisitions and outsourcing contracts. In addition to this revolving credit facility, the Company had available demand lines of credit of $27,000,000 and £2,000,000. The credit facilities included covenants which required the Company to maintain certain financial ratios. As of September 30, 2005, these ratios were met and an amount of $786.7 million was available under this agreement. CGI’s financial strategy was to use cash to make acquisitions and to keep its leverage under 20% of its overall capitalization. Godin estimated that the current cost of borrowing under the facilities would be “5% - 5% plus”.

Despite reporting 2005 fiscal year net earnings of $216.5 million, up 18.5% compared with fiscal 2004, several analysts were wondering why CGI was not hell-bent on acquiring more rivals to insulate itself from its larger competitors. International Business machines (IBM) and Electronic Data Systems Corp. (EDS) each had $10 billion in revenue in 2005, three times as much as CGI. The implication in the financial analysts’ remarks was that unless it bulks up, CGI

1 CGI represents 4.72% of the S&P IT sub index. Other members of the index are Aasra Tech, ATI, Celestica, Cognos, Emergis, Geac, Hummingbird, MDA ltd, Nortel, Onex, Open Text and RIM.

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wouldn’t be mentioned in the same breath as outsourcing firms with more of a global scale.

CGI generally worked on three to four merger and acquisition opportunities at any one time and had about ten others it was considering from a distance. It also returned to old acquisition ideas after it had abandoned them For example, the company had discussed a potential transaction with AMS for six years before a deal was finally stuck. The merged AMS and CGI operations, increased the number of CGI professionals to 25,000 and doubled its footprint in the U.S. and Europe.

The problem was not so much what CGI was doing but what its peers in the market were doing. IBM, for example, was accused of continuing to develop technology products only so that it could feed its Global Services business. That may have been true, but in many cases they were really great, innovative products that give Big Blue the expertise that attracted customers to its consultants for advice.

While some clients might see IBM as too big and too broad, other IT firms in the market were diversifying to meet niche requirements. That’s part of the reason why A.T. Kearny decided to buy out EDS’s stake and spin off as a standalone entity. EDS had the advantage, however, of maintaining a close, potentially symbiotic relationship with A.T. Kearny that might make it appear to have more resources than CGI. Compared to these two, CGI could seem a little too broad but not really that big.

On the other hand, CGI had not demonstrated a lot of innovation around business process outsourcing, whereas specialty shops like ADP were introducing services – such as an electronic way to manage record of employment requests. Prudence had been Godin’s watchword, and he had 30 years of success to back him up. With fewer players left, it may be time for CGI to take a few calculated risks that would set it apart from other me-too outsourcing juggernauts.

CGI’s 2006-2008 business plan reaffirms its successful four pillar growth strategy, with CGI a consolidator in its industry through a balance of organic and external growth (see Table 1 for internal versus external growth of CGI’s revenue). While CGI already had critical mass in its main areas of operation, it’s strategy was to continue to increase its presence through acquisitions in selected metro markets where it sees the greatest potential to drive organic growth.

On October 4 th , 2005, CGI-AMS Inc., the wholly-owned U.S. operating subsidiary of CGI Group Inc., began exclusively negotiating with The Commonwealth of Virginia to be its private sector partner for a sweeping initiative to transform the state’s business and information technology program. RBC Capital Markets speculated that the contract could be worth C$1B - $2B to CGI over 10 years. The

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initial value for the seven-year contract for CGI-AMS was expected to be up to US$300 million with two optional three-year renewal periods. RBC Capital Markets was expecting details of the final negotiations to emerge in calendar Q1/06 or earlier. While this development was positive, pending additional information on the contract terms it did not change RBC Capital Market’s current thesis, given the contract represents 2% - 5% of CGI’s expected consensus F06 revenues. It was also possible the contracts’ EBIT margins may be below CGI’s current 9% - 10% margins, given CGI-AMS considered winning the bid as critical to its U.S. strategy, and the contract appeared to require the winning bidder to make significant upfront hiring and ongoing funding commitments. At current valuation (March 2006) of $100-$200M/year and EBIT margins of 6% - 7%, this may represent $0.01 - $0.02 per year impact on EPS or at a P/E of 15, $0.15 - $0.30/share upside to valuation.

Citigroup’s assessment is that CGI’s P/E should be at the low end for the range for the industry. “We (Citigroup) feel that this is appropriate given that the organic growth rate has not recovered and that the outlook for growth in the overall outsourcing industry is not impressive.” 2

Table 1

CGI GROUP INC. COMPARISON OF OPERATING RESULTS FOR FISCAL YEARS 2005, 2004 AND 2003REVENUE (in C$000s except percentages)

Years ended September 30

2005

2004

2003

Revenue

3,685986

3,150,070

2,589,905

Internal Growth (1)

2.2%

2.5%

3.8%

External Growth (2)

18.3%

21.3%

24.3%

Growth prior to foreign currency impact

20.5%

23.8%

24.3%

Foreign currency impact

(3.5%)

(2.2%)

(0.9%)

Growth over previous year

17.0%

21.6%

23.4%

Notes:

1. Internal growth relates to the growth of CGI revenue from existing contracts as well as new contracts for systems integration and consulting and outsourcing services. It is calculated as total revenue less the revenue run-rate from acquired companies as at the transaction date, and adjusted for the impact from the fluctuations of foreign currencies against the Canadian dollar.

2. External growth relates to the growth of our revenue from acquisitions.

2 Citigroup Global Markets, Small/Mid-Cap Research, CGI Group Inc. December 21, 2005.

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INDUSTRY OUTLOOK

Most of the recent studies and surveys conducted by research firms show that a larger proportion of corporations than ever before will increase their information technology spending over the coming quarters, a trend which is good news for systems integration and consulting practices. In addition, the outsourcing outlook for both IT and business services remained strong.

Demand for systems integration and consulting services (SI&C) in North America was expected to grow by approximately 4% to 5% annually, according to industry analysts. Demand growth for IT and business process services outsourcing was projected to be stronger.

In a study commissioned by CGI, market research firm IDC found that IT spending not yet outsourced by organizations amounts to US$60 billion a year in Canada, US$682 billion a year in U.S. and US$476 billion a year in Western Europe. Regarding business process services, IDC found that the annual spending not yet outsourced amounts to US$80 billion a year in Canada, US$1.5 trillion in the U.S. and US$480 billion in Western Europe. This was one estimate of the market potential, a portion of which would be outsourced over the coming years.

VALUATION OF CGI GROUP INC.

In general, the object of the valuation exercise is to determine the fair value of an

item that is not traded, i.e. if it were sold, what would be its fair price? The current price of an item is the capitalized value of the stream of benefits that are expected

to accrue from ownership. Conceptually this involves projecting out the expected

net benefits for the life of the item and then discounting back for time and risk to arrive at a figure of merit or price. These prices are what are observed as the

outcome of auction processes on stock exchanges and in bids for securities/companies. These prices reflect available information and change with the receipt of new information. The commonly used approaches to arrive at a value are comparables, discounted cash flow (DCF) and “street” consensus.

Comparables Approaches

A reasonable starting point is to use inputs that are determined in a competitive

market, i.e., are known and not hypothetical or theoretical. The most recent traded

price of a security is a “factual” number. Investors committed funds in the

transaction. In order to arrive at comparable numbers it is necessary to standardize

or normalize the market prices. One method is to use observable values, such as

numbers from audited financial statements. This leads to a dominate valuation approach that is based on trading multiples of comparables. In the comparable companies or comparable transaction approach, key relationships are calculated for

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a group of similar companies involved in the deal. This approach is widely used, especially by investment banks and legal cases. In the U.S., for example, the valuations included in a prospectus, cannot contain forecasts (estimates). In Canada it is permitted to use forecasts but with restrictions such as being audited; approximately 95% of Canadian prospectuses do not contain forecasts. The underlying premise is that investors will pay what they perceive it to be worth given current market conditions. It is a commonsense approach that says that similar securities should sell for similar prices. This straight forward approach appeals to businesspersons, to their financial advisors and the judges in courts of law called upon to give decisions on the relative values of companies in litigations.

A comparables table contains several valuation metrics and characteristics of companies/securities that are similar. To test for comparability an analyst examines the values of the prime variables that explain the structure of the valuation metric:

growth potential, business risk, financial risk, and margins. One way to control business risk is to select securities for companies in the same line of business. A practical approach is to select companies with the same Standard Industry Classification (SIC) codes or the revised version called North American Standard Information (NAICS) codes 3 . Many firms have been assigned multiple industry codes. The classification codes for individual companies are included in most corporate financial information data bases such as Standard & Poor’s COMPUSTAT, Corporate Retriever – Micromedia ProQuest and Center for Research in Security Prices (CRSP). Corporate financial data can differ across firms due to differences in accounting procedures. In the process of creating commercial databases the data is standardized, thus reducing the impact of these differences.

Analysts’ forecasts of sales, earnings, growth rates, etc. are routinely gathered, processed (consensus estimates) and published in commercial data bases by such firms as Thomson First Call and IBES. In sum, the starting point of the valuation is the market value of a security divided by or normalized by variables such as revenue, earnings, cash flow or book value. The comparables table, created by Progressive Financial Group Inc. (PFG), is presented in Exhibit 5 (see Exhibit 6 for precedent transactions). The specific comparables selected are, in part, a function of the analyst. RBC Capital Markets selected six companies: Accenture, BearingPoint, Computer Sciences, Electronic Data Systems, Perot Systems and Sapient 4 ; and National Bank Financial selected: Accenture, Affiliated Computer Services, Computer Sciences Corp., Keane, Perot Systems and Ciber 5 . Another

3 Canadian source of industry classification codes:

http://www.statcan.ca/english/concepts/industry.htm. U.S. source of industry classification codes:

U.S. Census Bureau, http://www.census.gov/epcd/www/naicstab.htm.

4 Mike Abramsky, Ranjit Narayanan, and Paul Treiber, RBC Capital Markets, CGI Group Inc., Research Comment, December 19, 2005.

5 Richard Tse and Dean McPherson, National Bank Financial, The NBF Daily Bulletin, IT Consulting & Services, December 18, 2005.

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complication is that fiscal year-ends differ across firms (although they tend to be the same for firms in a given industry). In this case CGI’s year-end is in September, whereas the year-end of most of the comparables is December. The data in Exhibit 5 column labels “CY” are for calendar years.

Enterprise Value (EV) is the market value of the company’s earning assets and is equal to the market value of long-term liabilities. From the following equation one can see there are two distinct ways to arrive at EV or what is often the object of the analysis, the Market Capitalization of Common Equity (S):

Enterprise Value = Market Capitalization of Common Equity + Long-term Debt – (Cash + Cash Equivalents) + Minority Interest + Capital Leases + Preferred Stock

Assume that the companies listed in Exhibit 5 satisfy most of the compatibility requirements. The next step is to calculate the ratios of market value to selected operating metrics, for example: revenues, earnings, cash flows and book value. EV or S is derived by applying the multiplier to the absolute data for the company. This is a method of predicting what a company’s publicly traded price is likely to be.

Which comparable company to use? If there is no or little variation in the ratios, then an argument can be made to use the average of ratios. The taking of averages tends to reduce the impact of measurement errors. If they are greatly different, which implies that the dispersion around the average is substantial, the average (a measure of central tendency) is not meaningful. In other words there are significant differences in the operating characteristics of the firms, for example, growth potential, margins, and financial leverage. In this case it is important to select the comparables that exhibit the operating characteristics which are most descriptive of the target company. In either case the comparable ratio is then adjusted to reflect any differences in operating characteristics, for example, if the target company has higher margins then the comparable ratio will adjusted upward. The magnitude of the adjustment is generally based on experience.

EV can be valued directly by using metrics based on total earnings power, for example: revenue, earnings before interest and taxes (EBIT) or operating cash flows (EBITDA). The alternative is to derive the market value of each component on the right hand side of the equation. The sum of these components is EV. “Net Debt” is generally defined in the industry as Long-term Debt less (Cash plus Cash Equivalents). Similarly, S can either be calculated directly using earnings available to common equity, cash flows available to common equity (generally defined to be net income less dividends plus depreciation and amortization) or book value. Which valuation metric to use, for example, EV/EBIT or P/E, is driven by data availability, stability of margins, differences in capital structure and also by convention. Trust units, financial institutions, regulated utilities are examples of industries where the convention is to value equity directly. If the

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capital structure of the comparable differs significantly from the comparable and/or is changing, then instead of valuing equity directly value EV and back out the value of equity. Industries/companies with high non-cash expenses are typically valued using cash flow metrics. The more unstable the margins the higher up the income statement you go, i.e. from EV/EBIT to EV/EBITDA to EV/SALES. This results in reduced precision because cost structures are not being directly accounted for.

Discounted Cash Flow Approach for Enterprise Value

Another dominate valuation technique is called the Discounted Cash Flow (DCF) model in which expected free cash flows are discounted back using a weighted average after-tax cost of capital (k). A critical issue in the application of the theory is the ability to obtain “quality” inputs; which in turn generate specification issues. Unlike the comparables approach in which growth, margins and risk were implied by the magnitude of the multiplier, the DCF approach attempts to explicitly quantify them. In the “generic 2-stage” DFC model, enterprise value is calculated by discounting the free cash flows over the period characterized by “unstable” change and adding a terminal value at the end the period that capitalizes the future growth of the free cash flows (once stable) using, for example, an exit multiple or infinite growth model. Free cash flows are defined to be:

FCF t = EBIT t Less Tax Exposure t (EBIT t * Tax Rate) Plus Depreciation and Amortization t (Non-Cash Expenses) Less Increases in Operating Working Capital t Less Capital Expenditures t

Where:

Operating Working Capital t = Cash Transaction Balances t + AR t + Inventory t + Other Operating Current Assets t – AP t - Taxes Payable t - Other Operating Current Liabilities t

The infinite growth model for estimating the company’s terminal value (TV) at the end of period T is:

TV T = FCF T * (1 + g) /(k –g)

Where: g = perpetual growth rate of free cash flows once stability is achieved, and k = after-tax weighted average cost of capital.

The exit model for estimating the company’s terminal value (TV) implicitly assumes that the firm will be sold at the end of period T. Thus, TV is arrived at by using an EV/EBITDA or EV/EBIT trading multiplier, namely:

TV T = (EV/EBITDA) T * EBITDA T+1

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EV = Present Value =

T

FCF t / (1+k) t + TV T / (1+k) T

t = 1

This generic DCF model critically assumes that the business risk and debt capacity (target capital structure) of the company are constant across time.

PFG’s DCF analysis of CGI takes into account the following assumptions:

1. No significant acquisition in forecast period.

2. The Company will incur a large contract acquisition costs in 2006.

3. The Company will cancel its Normal Course Issuer Bid (NCIB) program.

They forecast CGI’s 2006 revenues of $4,160 million or an increase of 12.85% over fiscal 2005 revenues. They estimated that the growth rate in revenues would decline to 10% by 2010 (see Exhibit 7 for summary DCF analysis). CIBC World Markets assumed “revenue growth rate of 5% throughout the forecast period through F2011” 6 for CGI.

PFG assumed a terminal perpetual growth of 3.5% (sensitivity range of 3.0% to 4.5%) and an EBITDA exit multiple of 5.5 (sensitivity range of 4.0 and 6.5). CIBC World Markets assumed an exit EBITDA multiple of 5. 7 Citigroup assumed

a terminal perpetual growth rate of 1% to 1.5%. 8 RBC Capital Markets assumed a terminal perpetual growth rate of 4.5%. 9

In arriving at a cost of capital PFG used “an average 5-year adjusted beta” of 1.07 (see Table 2 for betas of comparables), a 6% market risk premium and a risk free rate equal to the 10-year Government of Canada rate of 4.12%; a weighted average cost of capital (WACC) of 10.05%. CIBC World Markets used “a discount rate of 8% equal to our cost of equity assumption.” 10 Citigroup’s estimates for computing

a cost of capital were: Risk free rate of 4.21%; Market Risk Premium of 3.8%;

Beta of 1.26; A FY06-end net debt position of approximately C$1.27/share; and a WACC of 7.59%. 11 RBC Capital Markets assumed a WACC of 9.5% and FY06- end cash of $0.62/share. 12

Betas are commercially available from a wide variety of sources such as Bloomberg and the Toronto Stock Exchange (TSX). The five-year beta based on a

6 CIBC World Markets, CGI Group Inc. Equity Research, December 16, 2005.

7 CIBC World Markets, CGI Group Inc. Equity Research, December 16, 2005.

8 Citigroup Global Markets, Small/Mid-Cap Research, CGI Group Inc. December 21, 2005.

9 Mike Abramsky, Ranjit Narayanan, and Paul Treiber, RBC Capital Markets, CGI Group Inc., Research Comment, December 19, 2005.

10 CIBC World Markets, CGI Group Inc. Equity Research, December 16, 2005.

11 Citigroup Global Markets, Small/Mid-Cap Research, CGI Group Inc. December 21, 2005.

12 Mike Abramsky, Ranjit Narayanan, and Paul Treiber, RBC Capital Markets, CGI Group Inc., Research Comment, December 19, 2005.

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regression of monthly data against the S&P/TSE Total Return Index for the period ending November 2005 reported on the TSX CD-ROM products, 2006 edition was

1.391. The corresponding Market Risk Premiums based on data from January

1950 through November 2005 are reported in Table 3.

Table 2

COMPARABLE COMPANY BETAS

Company

Symbol

Market Cap

Beta

     

2-year

5-year

Accenture ltd.

ACN U.S.

US$22,515

0.90

1.14

Electronic Data Systems Corp.

EDS U.S.

US$12,512

1.24

1.22

Computer Sciences Corp.

CSC U.S.

US$10,429

1.23

1.18

Affiliated Computer Services

ACS U.S.

US$7,115

1.09

0.86

Unisys Corp.

UIS U.S.

US$1,860

1.34

1.24

BearingPoint

BE U.S.

US$1,444

1.51

1.66

Perot Systems

PER U.S.

US$1,582

1.21

1.01

Maximus

MMS U.S.

US$836

1.10

0.88

Keane

KEA U.S.

US$638

1.22

1.32

Ciber

CBR U.S.

US$383

1.38

1.28

Average

   

1.22

1.18

CGI Group

GIB.SV.A CA

C$3,622

0.74

1.06

Source: Progressive Financial Group Inc.

Table 3

FINANCIAL MARKET DATA BASED ON MONTHLY DATA January 1950 through November 2005

 

Geometric Mean

Arithmetic mean

S&P/TSX Total Return Index

10.666%

11.905%

Short-term Interest Rate (30 day)

5.855%

5.924%

Medium-Term Interest Rate (7 1/2 Ye

6.939%

7.229%

Long-term Interest Rate (17 Years)

7.109%

7.570%

Source: TSX CD-ROM Products, 2006 edition.

Both PFG and Citigroup implicitly assumed that the Capital Asset Pricing (CAPM) was the appropriate model in computing the cost of equity. Although the

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CAPM is probably the best operational model available there are competing theoretical models and the CAPM has significant short-comings. 13

Street Consensus

Analysts’ Research Reports typically contain forecasts of revenues, earnings per share and P/E for two years into the future (see Exhibit 8). They also indicate a target price usually for 12 months hence which, depending on the analyst is based on average of prices generated by valuation techniques used (RBC CM and Citigroup weighted P/E and DCF prices; CIBC WM only reported using DCF and National Bank only used P/E). PFG believed that analysts would begin valuing CGI based on September 2006’s EPS consensus low of $0.53 and high of $0.66 (see Exhibit 9) which would increase the value of CGI’s share at least $1.00 in the coming quarters of 2006. By applying the current forward multiple of 17x to an estimated 2006 EPS range of between $0.53 to $0.66, they evaluated CGI share at between $9.01 and $11.22.

Net Asset Value

The 30% of CGI held (as of December 2, 2005) by BCE would appear on BCE’s balance sheet as a minority investment. As a conglomerate the valuation of BCE would be done using a sum-of-the-parts approach, i.e. valuing each subsidiary/investment as a stand alone pure play and aggregating as an estimate of enterprise value. BCE’s net asset value (NAV) or common equity value is arrived at by subtracting net debt from the enterprise value.

The summary of RBC CM’s NAV analysis of BCE is presented in Exhibit 10. With respect to the value of CGI the research analyst concluded: “Valuation in Line With Expectations. Total proceeds from the sale will amount to roughly $1.1 billion ($1.18/BCE share) – consistent with our forward carrying value of $1.15 billion (or ($1.25/BCE share).” 14

The NAV (see Exhibit 10) of BCE Inc., as of Dec. 2, 2005, was derived using the following metrics:

Bell Canada Wireline Assets @ 4.50x 2006/7E EBITDA. Wireless @ 8.0x 2006/7E EBITDA. ExpressVu @ 15.0x 2006/7E EBITDA. Globemedia @ recent transaction value. Telesat @ 10.0x 2006/7E EBITDA. Other Assets at Market (less a holding company discount of 15% on non-Bell Canada assets).

13 See, for example, Mark Grinblatt and Sheridan Titman, Financial Markets and Corporate Strategy,McGraw-Hill, 2nd edition, 2002, Chapters 5 and 6.

14 RBC CM Research Report on BCE, Dec.19, 2005.

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QUESTIONS:

1. What is a likely explanation as to why CGI only repurchased 100 million of BCE’s holding?

2. What the implications of the repurchase for the operating strategy of CGI?

3. Is the repurchase announcement likely to change the fair value of CGI? What is your prediction as to the market’s response in terms of a share price for CGI and BCE?

4. The case asserts that the drivers of trading multiples are: growth potential, business risk and margins. Is this correct?

5. The analyst inputs to their DCF analysis differ significantly, yet they arrive at approximately the answer? Why that price? Is there an explanation?

6. What is net asset value? Pure play? Conglomerate discount?

7. Is the issuer bid price fair?

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Exhibit 1

CGI GROUP INC. SUMMARY FINANCIAL STATEMENTS

Fiscal Year Ending

9/30/2005

9/30/2004

9/30/2003

9/30/2002

9/30/2001

9/30/2000

9/30/1999

9/30/1998

Cash, Deposits & Short Term Invest.

240,459

200,623

83,509

104,221

46,008

49,341

42,229

121,418

Accounts Receivable

487,731

545,056

301,430

229,583

223,158

202,108

204,405

178,991

Miscellaneous Receivables

   

138,105

71,686

62,998

16,830

3,987

5,575

Work in Progress

214,470

222,278

122,737

98,904

84,838

56,799

79,899

12,209

Taxes Recoverable

22,118

80,814

35,767

12,567

18,977

9,785

   

Prepaid Expenses

74,531

94,617

78,183

53,115

48,931

19,442

13,631

10,716

Other Current Assets

   

41,014

         

Total Current Assets

1,040,309

1,143,388

800,745

570,076

484,910

354,305

344,151

328,909

Property

 

4,377

25,694

4,102

4,191

     

Plant

     

24,724

23,397

     

Equipment

116,388

147,121

158,043

161,011

142,687

97,146

61,757

58,668

Leasehold Improvements

228,646

106,052

82,077

45,766

30,572

25,887

17,914

9,247

Accumulated Depreciation

 

-114,789

-120,873

-132,064

-101,952

-79,649

-28,347

-20,548

Miscellaneous Fixed Assets

580,642

     

24,496

15,516

11,770

6,864

Total Long Term Investments

         

1,261

683

621

Deferred Tax Assets

46,601

102,720

22,764

28,661

29,002

24,470

 

12,391

Goodwill

1,773,370

1,827,604

1,385,518

1,133,852

1,118,963

395,903

358,787

288,065

Intangibles

 

278,240

256,320

206,493

272,403

40,411

 

1,874

Miscellaneous Assets

200,703

821,743

526,395

264,349

 

53,305

99,774

58,839

Total Assets

3,986,659

4,316,456

3,136,683

2,306,970

2,028,669

928,555

866,489

744,930

Page 15

*

Exhibit 1 (Continued)

CGI GROUP INC. SUMMARY FINANCIAL STATEMENTS

Liabilities

(Dollar values in thousands)

 

Fiscal Year Ending

9/30/2005

9/30/2004

9/30/2003

9/30/2002

9/30/2001

9/30/2000

9/30/1999

9/30/1998

Accounts Payable & Accruals

378,692

433,415

289,556

171,352

295,092

142,754

204,397

213,912

Accruals

107,014

118,541

110,398

93,806

       

Taxes Payable

79,119

99,972

66,168

37,507

21,013

7,963

15,708

34,167

Current Portion of Long Term Debt

13,653

14,529

20,555

4,172

7,528

5,770

5,139

5,561

Other Current Liabilities

129,196

123,213

86,616

61,027

50,652

33,194

21,351

11,313

Total Current Liabilities

707,672

789,670

573,293

367,864

374,285

189,681

246,595

264,953

Long-Term Debt - Net

234,042

475,291

247,431

4,328

32,752

37,644

54,625

5,730

Deferred Tax Liabilities

348,793

287,433

140,571

93,696

43,705

23,929

2,214

 

Deferred Revenues

     

61,467

74,813

     

Other Non-Current Liabilities

201,462

301,393

195,178

         

Total Liabilities

1,491,969

1,853,787

1,156,473

527,355

525,555

251,254

303,434

270,683

Minority Interst (liability)

               

Other Liabilities

-231,128

             

Page 16

*

Exhibit 1(Continued)

CGI GROUP INC. SUMMARY FINANCIAL STATEMENTS

Equity

(Dollar values in thousands)

 

Fiscal Year Ending

9/30/2005

9/30/2004

9/30/2003

9/30/2002

9/30/2001

9/30/2000

9/30/1999

9/30/1998

Investment & Foreign Exch. Reserves

 

-158,659

-89,502

34,266

23,761

2,127

   

Common Stock

1,762,973

1,820,230

1,480,631

1,332,621

1,198,096

491,807

423,764

418,772

Miscellaneous Capital Stock

     

31,132

       

Contributed Surplus

67,578

6,693

5,870

3,652

211

211

211

211

Retained Earnings/Deficit

895,267

769,421

555,310

377,944

245,945

183,156

139,080

55,264

Other Shareholders' Equity

 

24,984

27,901

 

35,101

     

Total Shareholders' Equity

2,494,690

2,462,669

1,980,210

1,779,615

1,503,114

677,301

563,055

474,247

Revenue

(Dollar values in thousands)

 

Fiscal Year Ending

9/30/2005

9/30/2004

9/30/2003

9/30/2002

9/30/2001

9/30/2000

9/30/1999

9/30/1998

Sales/Revenue

3,685,986

3,243,612

2,684,816

2,169,613

1,560,391

1,423,080

1,409,458

740,963

Total Operating Expenses

3,161,679

2,743,750

2,266,547

1,860,463

1,341,045

1,254,861

1,195,181

639,596

Interest Income

 

8,728

3,094

2,833

2,664

3,624

5,310

1,987

Depreciation & Amortization

166,469

164,451

121,133

77,005

94,582

67,531

64,875

38,711

Interest Expense

24,014

20,675

12,578

2,411

4,206

3,768

1,509

923

Net Income before Tax

333,824

323,464

287,652

232,567

162,082

123,463

169,787

63,720

Net Income after Tax

219,698

210,322

174,383

135,799

89,917

73,478

99,844

34,531

Net Income

216,488

219,600

177,366

135,799

62,789

55,666

83,816

34,828

Weighted-average number of Class A subordinate and Class B shares

439,349,210

419,510,503

395,191,927

377,349,472

299,500,350

270,442,354

267,969,082

117,307,162

Source: Company Financial Reports for 2005 and micromedia.ca for 1998 through 2004.

 

Page 17

*

Exhibit 2

ISSUER BIDS THROUGH THE FACILITIES OF THE TORONTO STOCK EXCHANGE

“issuer bid” means an offer to acquire listed securities made by or on behalf of a listed company for securities issued by that company. 15

“normal course issuer bid” (NCIB)

means an issuer bid where the purchases (other than purchases by way of a substantial issuer bid):

a) do not, when aggregated with the total of all other purchases in the preceding 30 days, whether through the facilities of a stock exchange or otherwise, aggregate more than 2% of the securities of that class outstanding on the date of acceptance of the notice of the normal course issuer by the Exchange; and

b) over the a 12-month period, commencing on the date specified in the notice of the normal course issuer bid, do not exceed the greater of

a. 10% of the public float, or

b. 5% of such class of securities issued and outstanding, excluding any held by or on behalf of the issuer on the date of acceptance of the notice of normal course issuer bid by the Exchange, whether such purchases are made through the facilities of a stock exchange or otherwise.

“substantial issuer bid” (SIB) means an issuer bid, other that a normal course issuer bid, made through the facilities of the Exchange.

15 Appendix F, Take-over bids and issuer bids through the facilities of the Toronto Stock Exchange, Sec. 6-101 ¶1450-102, TSX Company Manual.

Page 18

*

Exhibit 3

CGI GROUP INC. 1 STOCK PERFORMANCE VERSUS INDEX 2

CGI S&P/TSXInfo tech Index 10.00 400 9.50 350 9.00 8.50 300 8.00 250 7.50 7.00
CGI
S&P/TSXInfo tech Index
10.00
400
9.50
350
9.00
8.50
300
8.00
250
7.50
7.00
200
6.50
6.00
150
Jan-04
Apr-04
Jul-04
Nov-04
Feb-05
May-05
Aug-05
Dec-05
Prix (C$)
4 2 0 Volume (m)
4
2
0
Volume (m)

Notes:

1. At end point CGI is top line S&P/TSX Infotech Index bottom line.

2. CGI represents 4.72% of the S&P IT sub index. Other members of the index are Aasra Tech, ATI, Celestica, Cognos, Emergis, Geac, Hummingbird, MDA ltd, Nortel, Onex, Open Text & RIM.

3. Volume on the NYSE for CGI was left out considering it only amounts to 6.79% of the volume of CGI’ s shares.

Page 19

*

Exhibit 4

CGI GROUP INC. STOCK PERFORMANCE VERSUS COMPARABLES BY TICKER SYMBOLS LISTED ON U.S. STOCK EXCHNAGES 1

140 120 100 80 60 40 20 Nov-03 Feb-04 May-04 Aug-04 Nov-04 Feb-05 May-05 Aug-05
140
120
100
80
60
40
20
Nov-03
Feb-04
May-04
Aug-04
Nov-04
Feb-05
May-05
Aug-05
Nov-05
ACN USEquity
EDSUSEquity
ACSUSEquity
UISUSEquity
BE USEquity
MMSUSEquity
KEA USEquity
GIB/SV/A

Note:

1. At end point of graph, CGI (ticker GIB.A) is the top line – second is ACS, third is MMS, fourth is EDS, fifth is EDS, fifth is ACN, sixth is BE, seventh is KEA and eighth is UIS (by ticker symbols on US stock exchanges).

Page 20

*

Exhibit 5

COMPARABLES TABLE

(Millions of $, except per share data)

Price

Market

EV

Price/Earnings

EV/EBITDA

EV/EBIT

EV/Sales

Price/CFS

Price/BV

CAGR (Revenue)

 

13-Dec-05

Cap.

 

LTM

CY1

CY2

LTM

CY1

CY2

LTM

LTM

LTM

LTM

L5Y

05-'06

American Comparables (US$)

Accenture Ltd.

$28.36

$24,113

$22,222

19.1

19.1

18.1

9.6

9.4

6.6

11.0

1.3

17.4

14.2

12.5%

3.1%

Electronic Data Systems Corp.

$23.47

$12,355

$13,133

31.2

NMF

23.8

5.6

6.5

5.0

17.6

0.6

6.2

1.7

1.6%

0.6%

Computer Sciences Corp. (1)

$49.11

$9,234

$9,613

16.1

 

15.7 13.9

4.6

4.8

4.4

10.1

0.6

5.5

1.4

9.1%

6.4%

Affiliated Computer Services

$55.16

$7,094

$7,824

17.0

 

16.8 15.0

8.7

8.3

7.5

12.0

1.7

10.6

2.4

17.7%

16.3%

Unisys Corp.

$7.59

$2,092

$2,743

NEG

NEG

NMF

12.6

9.3

6.4

NEG

0.5

NEG

NEG

-4.7%

1.3%

BearingPoint

$6.13

$1,510

$1,757

NMF

NMF

21.5

9.6

NMF

7.2

16.4

0.5

13.2

1.3

11.7%

2.9%

Perot Systems

$14.07

$1,671

$1,517

15.3

16.3

14.6

6.8

6.9

6.2

9.2

0.8

13.9

1.8

10.2%

10.3%

Maximus

$36.30

$805

$672

21.1

19.8

17.9

8.8

9.3

8.2

10.5

1.2

16.1

2.2

10.7%

8.1%

Keane

$10.44

$627

$631

20.4

18.3

16.3

8.1

8.9

7.3

12.8

0.7

11.9

1.4

1.3%

7.5%

Ciber

$6.81

$428

$615

14.7

15.5

13.1

11.8

9.0

8.0

12.2

0.8

16.3

1.1

-0.2%

2.7%

Average

     

19.4

17.4

17.1

8.6

8.1

6.7

12.4

0.9

12.4

3.0

7.0%

5.9%

Average (Exclude high/low)

     

18.2

17.2

16.8

8.6

8.3

6.8

12.1

0.8

12.6

1.7

7.1%

5.3%

European Comparables (2)

Cap Gemini

€ 34.81

€ 4,629

€ 4,135

NEG

NMF

22.1

8.2

9.6

8.1

NMF

0.6

14.3

1.6

-0.4%

3.7%

Atos Origin

€ 57.25

€ 3,853

€ 4,563

14.7

15.4

13.5

8.5

8.5

7.6

11.3

0.8

9.8

2.2

20.8%

4.6%

Indra

€ 16.57

€ 2,549

€ 2,512

22.7

23.8

21.1

15.1

15.9

14.2

17.2

2.1

19.4

10.1

12.1%

10.7%

Tietoenator Oyj

€ 29.38

€ 2,369

€ 2,592

22.2

19.6

16.6

11.8

10.9

9.6

16.4

1.6

14.1

4.3

8.3%

8.5%

Logica CMG

£166.00

£1,271

£1,470

32.3

19.4

16.2

13.0

9.7

6.7

17.2

0.9

19.4

3.3

-1.2%

23.3%

Average

     

23.0

19.5

17.9

11.3

10.9

9.2

15.5

1.2

15.4

4.3

7.9%

10.2%

Total Average

     

20.6

18.1

17.4

9.5

9.1

7.5

13.4

1.0

13.4

3.5

7.3%

7.3%

Average (Exclude high/low)

     

20.0

17.8

17.2

9.5

8.9

7.3

13.4

0.9

13.6

2.8

7.2%

6.6%

CGI Group Inc. (C$) (4)

$8.65

$3,687

$3,696

17.9

17.1

14.6

6.9

6.7

6.0

11.0

1.0

10.3

1.5

21.0%

6.0%

(1) Proforma Dynacorp Divestiture.

                             

(2) Valuation multiples exclude extraordinary items as well as goodwill amortization for European companies.

                 

(3) LTM: Last Twelve Months; CY1: Calendar Year Forecasts One Year Hence; CY2: Calendar Year Forecasts Two Years Hence; CFS: EBITDA less interest, taxes CAPEX and dividends on a fully diluted basis; L5Y:Last 5 years.

(4) CGI reported its year ending September 2005 in early November while most of its comps have a December year-end thus CGI's FY1 is more similar to FY2 for the comps.

 

Source: Progressive Financial Group Inc. - The analysis is based on data from external sources.

       

Page 21

*

Exhibit 6

U.S. AND CANADIAN TARGET ISSUER BID PRECEDENT TRANSACTIONS

Company

Targeted

Announc.

Bid

Pre-announc.

Premium

20-Day

Premium

# Shares

Shares

Per cent

 

Shareholder

Date

Price

Share Price

 

Average

 

in TIB

O/S

of Shares

           

Share Price

 

(millions)

(millions)

O/S

Methanex Corp.

Nova Chemicals C

21-May-03

$13.30

$13.81

-3.70%

$13.82

-3.70%

9.0

126.5

7.10%

Mediagrif

                   

Interactive

Technologies Inc.

Consumer Electron

9-Aug-02

$3.15

$4.10

-23.20%

$3.66

-14.00%

5.1

23.1

22.10%

 

Saskatchewan

                 

Premium Brands

Wheat Pool

16-May-01

$13.69

$15.85

-13.60%

$15.89

-13.90%

2.2

7.8

27.80%

Canadian

                   

Occidental

Occidental

Petroleum Ltd.

Petroleum Corp.

1-Mar-00

$29.61

$26.90

10.10%

$28.27

4.70%

20.0

138.3

14.50%

BioChem

Glaxo Welcome

11-Jun-99

$20.00

$19.38

3.20%

$19.33

3.50%

8.0

109.0

7.30%

Camdev Corp.

Citibank Canada

31-Mar-97

$5.40

$6.20

-12.90%

$6.24

-13.40%

8.0

24.3

33.00%

Average

       

-6.70%

 

-6.10%

   

18.60%

Average (Excl. High and Low)

     

-6.70%

 

-6.90%

   

18.30%

Source: Progressive Financial Group Inc.

Page 22

*

Exhibit 7

CGI GROUP INC. DCF ANALYSIS SUMMARY PROJECTED FREE CASH FLOWS

C$ Thousands.

 

Year Ending September

 

Cash Flow

 

2005A

2006

2007

2008

2009

2010

Terminal

Revenues

$3,685,986

$4,159,635

$4,637,993

$5,106,431

$5,617,074

$6,178,781

$6,481,541

Percentage Change

 

12.85%

11.50%

10.10%

10.00%

10.00%

4.90%

EBITDA Margin

14.2%

15.2%

15.4%

15.6%

15.6%

15.6%

15.7%

EBITDA

$524,307

$632,265

$714,251

$796,603

$876,263

$963,890

$1,017,602

Depreciation and Amortization

$166,469

$213,046

$218,083

$262,525

$277,213

$302,734

$322,631

EBIT

$357,838

$419,219

$496,168

$534,078

$599,050

$661,155

$694,971

Taxes

$114,126

$149,242

$172,170

$193,870

$217,455

$239,999

$252,275

Expenditures

             

Working Capital

 

$2,296

-$70,192

-$30,997

-$26,546

-$28,237

-$17,868

CAPEX

 

-$296,960

-$163,503

-$227,858

-$253,454

-$278,799

-$292,594

Free Cash Flows

 

$183,767

$448,770

$405,872

$431,900

$473,328

$490,601

Terminal Perpetual Growth

 

3.50%

         

WACC

 

10.50%

         

Terminal EBITDA Multiplier

 

5.5

         

Time Exponent

 

1

2

3

4

5

 

PV

 

$166,305

$367,535

$300,817

$289,691

$287,310

 

PV Terminal Value - Infinite Growth Model

           

$4,248,088

PV Terminal Value - EBITDA Multiplier Model

         

$3,217,946

   

Infinite Growth

Exit

       

EV - Terminal Infinite Growth Model

 

$5,659,746

         

EV - Terminal EBITDA Multiplier Model

   

$4,629,603

       

Net Debt

 

$7,000

$7,000

       

Equity Value

 

$5,652,746

$4,622,603

       

Shares O/S

 

430,600

430,600

       

Price

 

$13.13

$10.74

       

Major Assumptions

             

Effective Tax Rate

34.2%

35.6%

34.7%

36.3%

36.3%

36.3%

36.3%

CAPEX as % of Depreciation

117.9%

108.3%

58.0%

74.1%

90.5%

90.5%

90.5%

Source: Progressive Financial Group Inc.

Page 23

*

Exhibit 8

CGI GOUP INC. SELECTED FINANCIAL DATA POST ANNOUNCEMENT OF SPECIAL ISSUE BID

Research Report

Revenue (Millions)

EPS

P/E

Price

 

2006E

2007E

2006E

2007E

2006E

2007E

Target

CIBC World Markets

$3,870

$4,064

$0.64

$0.71

13.60

12.20

$10.00

Citigroup

$3,818

 

$0.58

$0.66

14.40

12.60

$9.25

National Bank Financial

$3,740

$3,895

$0.63

$0.70

13.90

12.50

$10.00

RBC Capital Markets

$3,485

$4,012

$0.63

$0.72

13.90

12.20

$9.50

Exhibit 9

CGI GROUP INC. STREET CONSENSUS SUMMARY OF ANALYST ESTIMATES

12-Month Price Target (average)

$9.50

 

Estimated EPS

2006

2007

Average

0.57

0.64

High

0.66

0.8

Low

0.53

0.57

Number of Estimates

15

12

Source: Progressive Financial Group Inc.

Page 24

*

Exhibit 10

BCE INC. NET ASSET VALUE (NAV) As of December 2, 2005

 

2006/07E Estimates

 

$MM

$/Share

Bell Mobility

$11,315

$12.21

Bell ExpressVu

$3,763

$4.06

Bell Canada (Wireline)

$19,885

$21.45

Bell Canada Gross Value

$34,963

$37.72

less: Bell Canada Net Debt

($9,627)

($10.39)

Bell Canada Net Asset Value

$25,336

$27.33

Aliant (53.2%)

$2,446

$2.64

Bell Canada Holdings Net Asset Value

$27,782

$29.97

Bell Globemedia

$2,000

$2.16

CGI

$1,155

$1.25

Telesat & Other

$2,524

$2.72

BCE Gross Net Asset Value

$33,460

$36.10

Less: BCE Inc. Net Debt

($1,941)

($2.09)

Less: BCE Inc. Preferreds

($1,670)

($1.80)

Net Asset Value (pre-holdco discount)

$29,849

$34.20

Less: Holding Company Discount

($1,155)

($1.25)

Net Asset Value

$28,694

$30.95

Source: RBC CM Research Report on BCE, Dec.19, 2005.