As its shares slide, the software group is struggling to hold on to
its NHS contract. How did it all go wrong?
By Danny Fortson
Published: 09 July 2006
It is unlikely that Gavin James will be settling down on his sofa to
watch Italy take on France in the World Cup Final today. ISoft, the
beleaguered software group of which he is finance director, is one of
the main players on the massive NHS patient-record computerisation
project. The group had also been due to report its annual results on
Tuesday.
Investors desperate for some good news will have to wait a bit longer
than that, though, after iSoft's announcement on Friday that it would
postpone its results while it tried to hammer out agreements with
business partners and creditors.
Mr James is said to have been locked in "frantic negotiations" since
last month. That was when iSoft announced its third profit warning in
six months and unveiled a new approach to revenue recognition that
wiped out nearly all of its historical profits and left it in breach
of loan agreements. The turmoil has already claimed the scalp of Tim
Whiston, formerly chief executive. Since January, iSoft, which is
listed in the FTSE 250, has lost 84 per cent of its market value and
revealed plans to sack 15 per cent of its workers. It is looking
increasingly possible that it will be booted off the NHS project,
which is its single biggest source of revenue.
The Manchester-based company had been trying to thrash out some kind
of accord with its banks by Tuesday to at least stop the bleeding.
Its inability to do so sent its shares to new lows on Friday, and its
options look to be diminishing.
"The best-case scenario would be a renegotiation of [the bank]
covenants on significantly more onerous terms than what they are
today," says an analyst speaking on condition of anonymity. "The
worst case would be for a new share issue at a deep discount or a
debt-for-equity swap."
Speculation that Accenture, the lead contractor on the NHS Connecting
for Health initiative, is looking to replace iSoft, possibly with
American rivals Epic or Cerner, has added to the perception that the
company is sliding into a hole from which it will be unable to
escape.
"The question for the company is whether it can remain solvent or
not," says another analyst. "The banks, rather than the shareholders,
could end up owning this business."
It is thought that the banks have balked at renegotiating their loans
without first knowing the fate of iSoft's contracts with Accenture
and its other partner on the NHS project, the US technology firm CSC.
At its height, iSoft - which grew meteorically from humble beginnings
in the 1990s - had a valuation of more than £1bn and won repeated
awards, including the Business of the Year for North-west England
just last year. So how did it get into its current dire situation?
Winning a £300m subcontract on the £6.2bn NHS contract in 2004 was a
major achievement for iSoft, a signal of its arrival in the big
league. The reality has proved anything but. The project has been
plagued by cost overruns and delays, which cut deeply into iSoft's
revenues. A report by the National Audit Office last month said the
patient- record system would come online two years late and cost
£12.4bn - twice the original estimate. The Government underestimated
the disruption that installing a new computer system would cause, and
the sprawling set-up of contractors and subcontractors has proved
cumbersome.
Accenture has lost £260m on the project, and has placed the blame at
the door of iSoft. Bill Green, Accenture's chief executive, said last
month that the company had alternatives lined up to replace iSoft if
necessary. For its part, iSoft says it has had every indication that
Accenture is committed to working "hand in hand".
However, market observers say the partnership has frayed, and
Friday's announcement did nothing to dispel the concern.
"Accenture is very upset," says one source close to the company.
"People lost their jobs for this and they blame iSoft."
CSC has remained quiet about its intentions. Rumours that BT or a
buyout firm could swoop in and buy iSoft were dismissed by a
spokesman.
As the troubles afflicting the NHS project have deepened, profit
warnings have thrown the spotlight on to iSoft's aggressive
accounting practices. As it turns out, its amazing growth, from sales
of just £6m in 1998 to a reported £262m last year, was far less
dramatic than it seemed.
ISoft provides supply-chain software packages that allow the free
flow of information from patients to doctors to hospitals and
healthcare organisations. Such contracts are usually spread out over
several years, and include the provision of updated software packages
and services over the life of the deal. The most common agreement has
a five-year term.
Some companies pay a lump sum upfront, others dole out money
piecemeal over the life of the agreement. Under Mr Whiston and former
chairman Patrick Cryne, part owner of Barnsley Football Cclub, iSoft
often booked the full value of contracts and services as revenue
upfront, regardless of how customers paid. This meant that in many
cases it booked as current revenue money it would not see for several
years.
On 8 June, iSoft unveiled its new accounting policy, which eliminated
£165m in profits over the previous three years. Six days later Mr
Whiston resigned. (Mr Cryne left the company in 2005, after having
cashed in on more than £40m in stock. Given recent revelations,
sources say Mr Cryne's timely exit has rankled with investors.)
The group's chairman, John Weston, the former head of BAE Systems, is
leading the search for a new chief executive. Mr James, meanwhile -
who joined a year ago - is trying to keep Lloyds TSB, Barclays, HSBC
and Royal Bank of Scotland, which together are owed £144m, at bay.
After the accounting rejig, according to one analyst, iSoft is
"significantly in breach of the bank covenants". Under the
agreements, the company's debt should be no more than three times
Ebitda (earnings before costs), he says. Currently, he adds, its debt
stands at six times that.
The company has tried to downplay its predicament. It claims that it
has positive net cash of £16m, and it is hoped the uncertainty will
be cleared up when the revised earnings are eventually revealed.
However, no date has been given for publishing the postponed results.
The question is whether iSoft can do enough, or say enough, to halt
its tumble. At the moment, it is caught in a vicious circle: because
it sells long-term contracts, few would-be clients will be prepared
to sign up with iSoft if there is any doubt over the company's
future. Governments, at the top of its client list, are anything but
risk takers.
"Given all the unknown liabilities surrounding this business, it
makes you question the willingness of a purchaser to sign up with
iSoft," says an analyst. "People certainly aren't queuing up."
ISoft said last month that it would look to sell non-core assets,
largely consisting of properties, though analysts believe it could
also put some of its foreign operations on the auction block. That
would be a painful reversal of strategy for a group that has long
talked ambitiously of international expansion.
The relationship with UK hospitals is one bright spot, at least, as a
number already have iSoft systems installed. And even if its banks
are at the end of their tether, they are unlikely to want to own such
a struggling company.
Franklin Templeton, a US investor with vehicles for investing in
distressed situations, has been steadfastly buying iSoft shares
throughout their slide. It is now the group's single largest
shareholder, with a stake of more than 12 per cent.
"They are obviously thinking something different than everyone else,"
says the second analyst quoted above. "The model is to buy into a
business that is almost bust and then make back 10 times your money."
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