March 2000

Cap Gem­Cisco Deal Impacts Ernst & Young and KPMG

Hi-Tech Companies' Interest in CPA Firm Consulting Practices Grows

By Danielle D'Angelo

The March 8 announcement of a joint venture between Cap Gemini SA and Cisco Systems Inc. comes at the heels of Ernst & Young's plans to sell its consulting division to Cap Gemini and KPMG Consulting's agreement to give Cisco a minority equity stake.

The Cap Gemini­Cisco deal is not even the latest hi-tech joint venture with a Big Five unit. On March 13, Andersen Consulting, which continues to argue in court to disassociate from its sister firm, Arthur Andersen LLP--in 1989, the first Big Five firm to create a separate consulting division--announced a $1 billion joint venture with Microsoft. Andersen Worldwide expects a final decision on the breakup of its two divisions in late March.

In the thick of tax season, consulting spin-offs and restructurings have many professionals studying their firms' own deals as much as their clients' returns. PricewaterhouseCoopers LLP recently said it will split its practice into two or more units. The trend goes beyond the Big Five firms with Grant Thornton LLP's plan to spin off its e-business practice in the spring. And more firms are in talks or looking at ways to restructure.

In the background, the Securities and Exchange Commission continues to question the impact that CPA firms' consulting services have on the attest function. The new deals likely will receive great SEC scrutiny.

"Like all businesses, the practices of the biggest accounting firms have undergone enormous changes," SEC Chair Arthur Levitt said at a speech before the New York Economic Club in October. "In 1981, management consulting services for traditional audit firms represented approximately fifteen percent of their total revenue. Today, its share stands at forty percent. Meanwhile, revenues from auditing services have dropped to approximately a third of total revenues. I can't help but wonder what impact this changing business mix has had on a culture that has prided itself on objectivity. Can the audit engagement partner truly be perceived as discharging his public duties while trying to sell his audit clients legal advice or consulting services?"

The Ernst & Young deal, announced February 29, is still subject to regulatory approval and final partner and shareholder votes by both entities. Cap Gemini, a Paris-based technology consulting company, will acquire the CPA firm's consulting practice in a stock and cash transaction worth $11.1 billion. Cap Gemini will issue 43.5 million shares--more than a third of its assets--and pay Ernst & Young $340 million. The firm's approximately 1,000 consulting partners will receive one-third of the stock issued and will become Cap Gemini employees. About 4,000 accounting and auditing and tax partners, who will remain at Ernst & Young, will receive another third of the shares, which they must sell within five years. The remaining third will go to Ernst & Young's pension plan as well as cover various administrative and transaction costs for the deal.

KPMG announced the incorporation of its consulting arm on January 31. The firm will own 80.1 percent of the new company, KPMG Consulting, and San Jose­based Cisco Systems, the global leader in data networking equipment, will own 19.9 percent. In August, Cisco agreed to invest $1 billion in KPMG and as part of the deal, the firm will add 4,000 Internet consulting professionals to support Cisco's services. The new consulting entity can take equity as compensation for services whereas KPMG cannot.

In the newly formed company between Cap Gemini and Cisco, Cap Gemini will hold a 95.1 percent stake and Cisco will own 4.9 percent. Cisco will invest $835 million: $671 million in Cap Gemini and $164 million in the new company, which reflects a 20 percent discount for Cisco's minority shareholder position. Upon completion of the deal, Cisco will receive 2.6 million shares of Cap Gemini. Dow Jones reported on March 7 that Cap Gemini and Cisco originally planned the only European joint venture but that Cap Gemini broadened the deal once it agreed to acquire Ernst & Young's consulting division.

E-businesses Want Equity Investment

With many Internet businesses wanting equity-based fee arrangements, the Big Five and other CPA firms are exploring how to invest in the businesses without violating SEC and ethics regulations. Grant Thornton said that the need for more capital is a major factor in the firm's planned spinoff of its e-business group as a separate business owned by the partnership. The firm also said that it would possibly examine the sale of the practice, an IPO, or a capital investment from another entity in the future.

Deloitte Consulting, a division of Deloitte Touche Tohmatsu that is majority-owned by audit and tax partners and has not reported any restructuring, announced on February 25 that it planned to increase the investments in its $500 million venture capital fund to provide equity to Internet startups. On February 17, PricewaterhouseCoopers announced plans to separate its accounting and auditing, business advisory, and tax practices from its management consulting division, which will allow the latter to enter into equity-based fee arrangements. Both units of Andersen Worldwide also have recently established Internet venture capital funds.

The PricewaterhouseCoopers restructuring will create at least two separate entities, but the firm reported it likely will split the consulting practice into more than one business around such specialties as management consulting, business process outsourcing, human resources, and financial advisory services. The accounting and audit, business advisory, and tax unit will retain the PricewaterhouseCoopers name. The move comes after the release of an SEC report stating that a majority of the firm's professionals violated independence regulations. See http://www.nysscpa.org for more details. *