VCI Valassis Communications, Inc.

To Begin With

In today’s world, companies strive to remain focused on functions and activities that are close to their core competence and provide competitive advantages. But the complex marketplaces in which companies perform demand a host of other functions as well. This need opens the door of opportunities for providers of business services.

Business services can be defined as ancillary services provided by companies to other players in the market. It can also be called a tertiary sector. Hence, the main business of one company can be a business service for another. But given its unique nature, Zacks has classified the group as one of 16 sectors (the S&P has only 10 sectors and business services is part of its ‘Industrials’).

The business service sector is highly fragmented, with no single service provider showing market dominance. As per business reports, the top 50 companies of the sector contribute less than 25% of overall revenue of this sector.

This industry covers an array of services that include marketing, consulting, staffing, security, telecommunications, Internet services, logistics and waste handling. In its expanded sense, the US business services sector generates consolidated yearly revenue of about $620 billion, though many companies mentioned below do not strictly fall within the generally accepted definition of the industry.

Industries in the Business Service Sector

Advertising & Market Services and Direct Marketing plays a vital role in informing consumers about new products, eventually helping the producers to better penetrate the markets. The Interpublic Group of Companies, Inc. (IPG), Omnicom Group Inc. (OMC), Valassis Communications Inc. (VCI), Harte-Hanks Inc. (HHS) and Vertis are important players in this sector.

Consulting Service providers offer expert advice in a given field for smoother functioning of the companies. Major companies in this arena include Accenture plc (ACN), Bain, Booz Allen, Deloitte Consulting (an affiliate of Deloitte Touche Tohmatsu) and IBM Global Services (IBM).

The Staffing business helps companies identify and recruit the right person for the right job. This sector is dominated by Insperity Inc. (NSP), Kelly Services Inc. (KELYB), ManpowerGroup (MAN), ADP TotalSource and the U.S. operations of Adecco.

Internet Service Providers and Telecommunication Services act as a bridge to connect knowledge, information and personnel across the globe. This sector is ruled by AOL Inc. (AOL), AT&T Inc. (T), Verizon Communications Inc. (VZ) and Comcast Corporation (CMCSA).

Surveillance, Investigation & Security Consulting Services providers offer specialized security services. This sector is dominated by FTI Consulting (FCN) and Kroll.

Waste Management service providers offer services such as collection, transport, processing, recycling, disposing and monitoring of waste. Waste Management Inc. (wM), Republic Services Inc. (RSG) and Waste Connections Inc. (WCN) are the major players in this arena.

The U.S. and Europe are the largest markets for the business service sector. Some of the dominant players beyond the U.S. boundary include waste and remediation services provider Veolia Environnement (VE) (France), facilities support services provider Serco Group (UK), staffing services provider Adecco (Switzerland), travel agency service provider TUI Travel (UK), and security services provider G4S (UK). Other big names in the field are Rentokil Initial (UK) and ISS (Denmark).

The emerging economies such as India and China are also becoming important destinations for the business service sectors.

Earnings Review

Out of the 31 companies under the Zacks coverage universe of the Business Service industry, only 42% could beat earnings estimates in the last reported quarter. The average surprise was 37.7%. While the highest surprise came from SPS Commerce, Inc. (SPSC) (800%) the lowest was from Rentrak Corporation (RENT) (-150%).

The average earnings surprise from Advertising & Market Services and Consulting Service, the two major components of Business Service sector, failed to impress.

Of the 18 companies under our Consulting Industry coverage, Information Services Group, Inc. (III) delivered the highest surprise of 300%, with the lowest of -100% coming from Hill International, Inc. (HIL). However, most of the companies delivered a positive surprise in the last concluded quarter.

The average surprise from the Advertising & Market Services Industry (14 companies under our coverage) was a negative 24.6%, with less than 50% of the company delivering a positive earnings surprise.

The divergence further establishes the fragmented nature of the sector.

OPPORTUNITIES

Labor Intensive: Given the nature of intangible products offered by the service sector, it is labor intensive. Labor, both skilled and unskilled, is essential for the smooth functioning of this sector. Being a labor-intensive sector, it offers immense employment opportunities.

Global Reach: Companies can reach its consumers or prospective buyers across the globe when Advertising & Market Services and Direct Marketers act on behalf of them in informing consumers about new products or added features of existing products. Thus, these service providers help in widening a company’s customer base and/or maintaining a better retention ratio.

Cost Effective: All business operators prefer to minimize costs of operation and maximize margins. This sector offers cost effectiveness to the companies that opt for their services. Companies will have to incur higher costs if a company employs the services by themselves and does not take the help of the service providers.

Service providers specialize in particular services and reduce the operational cost of a company, eventually helping companies to limit overall costs. Notably, an increased number of companies opting for such specialized services would increase volumes for the service providers. As a result, they can offer services at a lower cost, which in turn further lower costs for companies.

Specialized Service: The industry offers specialized services based on the latest technologies. This is evident for the security and consulting services. To safeguard data, companies are compelled to engage security service providers, who need to have the latest and most efficient technologies in place to persuade their clients and win business contracts.

Also, with the increased number of mergers and acquisitions across the globe, the prospects for legal service providers look good. Consulting service is another wing of this industry that is gaining traction these days.

With business complexities on the rise, companies are opting for expert advice before entering into any new venture rather than risking losses due to trial and error. Hence, this service sector also looks promising as it is indispensable for companies that are fighting to survive in a competitive market.

CHALLENGES

Growth Tied to Health of Economy: One of the major factors that could impact the growth of the service sector is the overall health of the economy. The companies in the business service sector derive revenue by providing essential services to other companies. Spending by companies to avail services might reduce drastically if the pace of economic growth is slower than the expected level. This would naturally reduce the business of the service providers and affect their fundamentals.

Requires Continuous Spending for Research and Development: Importantly, consulting service providers need to remain abreast of the latest technologies through continuous spending on research and development. The performance of these providers can be hampered if they do not acclimatize and/or widen its services with ongoing developments.

Training, Maintaining Skilled Workforce: Since skilled workers are always in high demand, there remains a possibility of high turnover rate within the sector. The training of unskilled workers or taking in new skilled workers increases operational costs, thereby affecting margins. This sector needs to have a more skilled workforce to take advantage of the technology that develops at a relatively rapid pace.

Competition: Maintaining or increasing market share remains a challenge for business service providers. As discussed earlier, the main business of one company can be a business service for another company; hence target customers for both may be the same at times. Therefore, a business service provider is always required to be adequately equipped to win over customer demand. While larger providers bank on the broader variety of their service offerings and can effectively take up difficult ventures, the relatively smaller players compete in the industry backed by their specialized services.

The Zacks Consensus Estimate for the Business Service industry for 2013 lies between -$1.75 and $2.42 per share.

Zacks Industry Rank

The Zacks Industry Rank, which derives its predictive power from the time-tested Zacks Rank, helps us identify the industries that are expected to outperform others. The top 1/3rd of the Zacks Industry Rank qualifies as industries with ‘Good’ prospects, the bottom 1/3rd as those with ‘Bad’ prospects, and the middle 1/3rd as those that are ‘Neutral.’ Most of the constituent ‘industries’ in the business services sector fall in the top 1/3rd of the list.

Business Service, at Zacks Rank #45, is placed in the top 20% of the industries or in the top 1/3 of the total Zacks industry rank list. Most of these companies carry a Zacks Rank #3 (Hold).

The Consulting industry is currently at #26, which puts it in the top 10% of the industries. Of the 18 companies in the Consulting industry, 8 have Zacks Rank #1 (Strong Buy) or Zacks Rank #2 (Buy), while only 3 have Zacks Rank #4 (Sell) or Zacks Rank #5 (Strong Sell). Companies like Towers Watson & Co. (TW) and CRA International Inc (CRAI) are Zacks Rank #1s while CoreLogic Inc (CLGX) has Zacks Rank #2.

Internet commerce, currently positioned as #60, has companies that mostly carry Zacks Rank #3. The industry has made its place within the top 25%.

Almost 80% of the companies, under the #95 ranked Advertising & Market Services Industry, including players like Interpublic Group, Omnicom and Harte-Hanks, carry a Zacks Rank #3.

The Financial Transaction Services industry, with players like Visa and Mastercard, is currently at #108, or in the middle 1/3 block.

To Conclude

A dearth of skilled labor in the business services sector can have an impact on future growth possibilities. Non-availability of quality workforce at a reasonable rate might increase overall operational costs.

However, due to the highly fragmented nature of the industry, it is difficult to set a distinct trend or predict a concrete future for the industry. The expected annual compounded growth rate for this sector is 4% from 2010 to 2015.

With population growing at an accelerated pace and economic turmoil being a constant drag, generating employment is a burning issue. This sector, being labor intensive, involves lower capital investments and confidently addresses this problem. Thus, we can safely say that despite all the hurdles, this industry is essential to business operations going forward.
 
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