Where is T-Systems‘ next move going to?

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On Friday, August the 3rd Adel al Saleh, CEO of T-Systems and Dirk Wössner, CEO of Telekom Deutschland, announced in a video post in the company’s internal social media site that T-Systems’ telecom business (called TC) will be moved from T-Systems to Telekom Deutschland. He also made a few other interesting announcements, which will undoubtedly affect the future of German IT outsourcing company T-Systems. In this article, I discuss what to make of this move.

Let’s start by looking at the details of the announcement. Al Saleh announced four changes. They are

  1. The telecom business of T-Systems (comprising fixed and mobile) will globally move to Telekom Deutschland, which is the German branch of Deutsche Telekom AG (DTAG).
  2. The so-called classified ICT business will be moved to Telekom Deutschland as well.
  3. The Internet of Things business unit will be moved into a separate legal entity.
  4. The Security business unit will be moved into a separate legal entity as well.

Background

Before discussing the four announcements in detail, let’s be specific about the background of this move. During the last years, T-Systems was not that successful. As the unit fully consolidates into DTAG numbers were never disclosed, but rumors, as well as insiders, reported the business to be ‘problematic.’ At the 1st of January 2018, Reinhard Clemens was officially removed as T-Systems CEO and replaced by his successor Adel al Saleh. Al Saleh joined from Northgate Information Solutions (NIS) where he became CEO in 2011. His major accomplishment was to streamline NIS operation by selling off non-core parts like managed services or public sector business; in 2011 NIS had 10.000 employees, now it has less than 5.000 and is pure HR and payroll outsourcing company. What is notable is that al Saleh has no ‘large IT’ background, he did not join from a hardware vendor, a global consulting business, or a large-scale outsourcer. One can speculate if al Saleh was the first choice of DTAG or if he was the candidate who stayed until the end of the recruitment process.

Until al Saleh joined T-Systems operated in three units. In the order of relevance from a revenue point of view, they were ITO – the IT Outsourcing business, TC – the telecoms business, and Digital Division – a unit with no apparent purpose anybody did understand. What al Saleh did strategically in 2018 is to split up the company in separate silos different from these three units. Each silo received end to end (means EBIT) responsibility and was more or less entirely responsible for its fate. The logic behind was to put 11 ducklings in the pond and see which survives. Extract cash out of the healthy ducklings and invest it into the ones which show the potential to grow. This move made T-Systems look as depicted below in a slide which was taken out of a presentation publicly available on the internet.

The move was not unique as it replicates the guidance of the McKinsey playbook outlined in the book “Strategy Beyond the Hockey Stick” (No Affiliate Link).

In 2019 al Saleh made the next strategic move trying to sell the mainframe operations business out of the Managed Infrastructure Services (MIS) silo to IBM. The deal failed because of missing approval of the German antitrust agency. Effectively al Saleh was sticking to his playbook and trying to sell what he believed is a non-core business. Some might argue that this was a smart move as the mainframe business is dominated by IBM, who own licenses for the operating system zOS. Winning mainframe outsourcing deals is usually dependent on low price, and because of the license owner and the main competitor being IBM, it might be hard to win against IBM. On the other hand, of course, not all customers like to work with IBM.

The TC part of the announcement

Given that context, the announcement seems to be the next step in the playbook. Al Saleh has identified TC to be non-core to the future of T-Systems and sells it off to Telekom Deutschland. Let’s dive into that first. MIS is by far the most massive silo in T-Systems. The assumption is that this means it is the core business. They provide a full spectrum of infrastructure outsourcing services, and the TC unit can be relevant to it. Customers of MIS need international WAN links to connect to T-Systems data centers, other subsidiaries, and the internet. So theoretically, T-Systems could create competitive advantage by combining TC with MIS. If a customer buys one MIS project, he gets the TC services for less.

The keyword in that sentence is, unfortunately: theoretically. What I mean by that is that this business model is only possible in small parts of the globe. DTAG only operates in certain parts of the world and does not own backbone infrastructure or last-mile connectivity in all countries where T-Systems operates (or tries to attract customers). In the current, but also in the past business model, TC was successful if they remarketed services produced by DTAG. It was not so successful if it had to buy links from other local providers and remarket them to its customers. The reason for this was, of course, risk and margin stacking.

Al Saleh’s decision means that he does not believe to be able to leverage this potential competitive advantage in the future. The reason for that might be that either

  • DTAG will not invest in their global WAN business and instead strategically focus on markets where they own last-mile connectivity and disinvesting in others. Therefore, al Saleh might think that the TC offering might only be competitive in a few of T-Systems’ markets. If TC services cannot be marketed everywhere T-Systems operates, it will not allow for economies of scale, and in the long turn, create a silo in a silo organization. Al Saleh does not want that and therefore moves it over to Telekom Deutschland.
  • He believes that the TC market changes in a direction where he cannot compete. The TC market turns into an increasingly commoditized market with eroding margins. For example, technologies like SD-WAN might enable customers to buy cheapo internet links and run sophisticated WAN tunneling, QoS, and traffic optimization by themselves or a specialized provider.
  • Finally, he might have learned that T-Systems is not very successful at running the TC business and therefore, might decide to let that business go.

So given the above, the decision does not seem to be unreasonable. He is disinvesting in a business he cannot run very profitable.

The Classified ICT part of the announcement

Classified ICT is the part of T-Systems, which provides services to institutions with a certain degree of relevance to the German public’s safety and security. These are, for example, the German Bund or the Ministry of Defense, among others. Not much is publicly known about these projects except random pieces of information surfacing periodically in the media. One example is that T-Systems operates the TESTA NG and the TESTA D networks, which are used for data exchange in the Schengen Information System (SIS II).

However, it can be speculated that these projects are generally profitable and commercially attractive. Competition is limited as acquiring and running such a project requires an additional company or staff certification, which represents a higher entry barrier compared to mainstream customers. A higher entry barrier means less competition and means higher margin. Also, these projects generally tend to be longer than the typical 3 to 5-year outsourcing project so they can turn out to be cash cows for many years.  

This means that Classified ICT might be a rather profitable business which has some unique ties to German state or German state authorities.

So going on step further this means either

  • Al Saleh might think the business cannot be run profitably in the future for undisclosed reasons. This cannot be disputed, because neither T-Systems nor the business units inside T-Systems disclose their numbers. However, it would be unlikely that such a business cannot be run profitably. Globally defense contractors rarely go out of business. Also, this is supported by labeling the Classified ICT business as ‘growth’ in the previous picture.
  • Al Saleh needs to generate cash to invest in the growth segments. This thought very much in line with the ‘Strategy beyond the hockey stick’ playbook. If DTAG decided not to provide T-Systems more cash to drive growth and investments, cash needs to come from monetizing T-Systems existing assets. Al Saleh tried this with the selling of the mainframe business, and now he tries it with the Classified ICT business.
  • The TC business might be in bad shape and maybe generating losses at the moment. To get rid of the losses and make the move of TC to Telekom Deutschland viable, al Saleh had to include a dowry. The dowry is Classified ICT.
  • Finally, al Saleh might try to make T-Systems and easier acquisition target by removing barriers. The line of thought is that contracts with the German state or state authorities might include contractual Change of Control clauses. So in case of T-Systems changing its ownership structure, the state authorities might have been given additional legal means such as canceling contracts, receiving down payments, or even exercising veto rights.

My take on that is that the latter three points do not represent a contradiction. All points might be true, and Al Saleh might keep his options open.

The last part – Floating the ducklings

The last part of the announcement was straightforward. The security business and the IoT business will be moved to separate legal entities to allow for easier growth by enabling small scale M&A. Fair enough.

It cannot be disputed that both sectors are currently growth sectors and that potential acquisition targets exist. Furthermore, it cannot be disputed that driving an M&A transaction within DTAG is maybe not straightforward, even if the to be acquired company only employs 50 staff. If these units identify acquisition targets, it might take ages in DTAG to come up with an offer. If that makes sense from a procedural point of view, it might be a smart decision.

Summary

In the grand scheme of things, this means that Al Saleh is disinvesting in businesses, which he cannot run profitably in the future, tries to make investing in growth businesses less painful, and sets up T-Systems to be an easier acquisition target by untangling its ties with the German state. It is not like inventing the iPhone, but it is not stupid either.

One remaining question is, of course, at what cost. Does this move weaken the ability to generate new business? The answer for T-Systems MIS is that it depends on the geography of the clients it targets. Maybe losing TC is a disadvantage during the acquisition process of some new customers, most certainly, for the majority of its acquisitions, it is not. Do the other parts of the business care? If you tender an SAP S/4 transition would you care if the potential partner for that also offers MPLS links in Brazil? Not really! The Classified ICT part is not so easy to answer. Giving away this part of the company weakens the “Deutschland AG” membership of T-Systems. It makes the company smaller but does not dampen other business unit’s ability to drum up business. Also, what else should al Saleh do instead if he does not get money out of DTAG for making any moves than selling of profitable, independent business units? All in all, the benefits might outweigh the cost.

Finally, the question to ask is what this means for T-Systems in the future as a second-order consequence. Out of the 11 ducklings starting to swim in the pond, three are about to be sold, and two have moved farther away from the main group. This leaves six ducklings in the water. They are MIS, SAP, Road Charging, Dedicated SI Solutions, Digital Solutions, and Public Cloud Services. Road Charging is undoubtedly a bit alien to the group, and al Saleh might get rid of them next. The remaining five can be considered as rather uninspiring mainstream IT business.

The move will also make T-Systems smaller once more; my prediction is that the company will be below 30k staff if all the changes take effect. This sends T-Systems in the second or even third row of IT businesses. In comparison to Atos, DXC, and IBM which are all north of 100k staff T-Systems is now a local mid-market player with dominance in Germany and appropriate size in some other parts of Europe. It is being set up as an acquisition target for anyone interested in growing his business in Germany, maybe Chinese, maybe Indian.

With that, thanks for reading and happy speculating about the Magenta future.

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