Analysis: Deloittes in 'split' u-turn.

It was as sudden as it was inevitable. Last Wednesday Deloitte Touche Tohmatsu finally succumbed to market pressure and announced it would split from its consulting division.

The announcement effectively marked the end of the Big Five’s involvement in large, mostly IT-driven consulting projects, as clients began to refuse to buy such services from their auditors.

Deloittes’ decision was a shock as the firm had consistently and vehemently argued it would not split itself in half just to ease fears of perceived conflicts of interest.

But the fallout from the Enron disaster has changed the auditing landscape, and Deloittes was in effect painted into a corner. It was almost possible to hear the gritted teeth of Jim Copeland, global head of Deloittes, grind as he conceded defeat: ‘We came to this decision very reluctantly,’ he said.

The client service argument
Deloittes, which boasts that it always ‘puts clients first’, used the client service argument to good effect in explaining how it was forced to make such a u-turn.

‘In the current environment, we cannot expose our clients to possible criticism because of the perception problem surrounding the scope of services audit firms may provide to clients,’ Copeland said.

Rather immodestly, Copeland added: ‘We cannot put our clients in the position of having to choose between working with the best auditing professionals in the world and our world-class colleagues at Deloitte Consulting.’

If Copeland was annoyed, imagine how his opposite number in London felt.

Forced by Enron to split
Senior partner John Connolly must have been extremely agitated that, having fought off Arthur Levitt and the Securities & Exchange Commission two years ago, he was now faced with having to split his UK empire in half – and all because of the unscrupulous activities of some Texan cowboys in Houston.

Ironically, the consultants in Deloittes are said to be in the minority in that they actually get on with their colleagues in the audit side of the firm.

The same could not be said for Andersen’s ex-colleagues at Accenture, who must be eternally grateful that they had to drop the once-revered, now reviled name of Arthur Andersen.

There has always been a love-hate relationship between the two sides of the Big Five organisations – the consultants, when they were growing up, relied on the good names of the audit firms for credibility. But more recently, many felt the old audit practices were holding them back, preventing them from competing fully in what had become a highly competitive marketplace.

Partners ‘crushed’ to leave
So while the firms argued that they were responding to external pressure to hive off their consulting arms, they could also have been giving in to internal pressures. But this notion was dismissed by Connolly, who said his partners were ‘crushed’ by the news they had to go.

This was a view backed up by other consultants who have been watching the Big Five break-up with interest. ‘Deloittes seemed to be about the only ones to have got it right by living in peace and harmony with each other,’ said Rob Anderson, head of consulting at Edengene, a niche consultancy.

‘But in other firms there was a sense of fear and loathing, largely based on ignorance, between the consultants and the accountants,’ he said.

All the firms have cited regulatory pressures and ethical considerations to support the sales – except of course in the unusual circumstances surrounding the Andersen split – but there was always the suspicion that partners were cashing in as well.

Ernst & Young pulled off a coup by selling out to Cap Gemini for £7bn in 2000, and if the dotcom bubble hadn’t burst, PwC could have been £13bn better off if Hewlett Packard had not got cold feet. KPMG raised several billion dollars by floating its consultancy in the US, and no doubt PwC will be hoping to do so when it comes to market this year.

Partners have benefited
With the exception of some tax horror stories coming out of the E&Y camp, it is clear the partners’ pockets have benefited significantly.

There is also another question – will the conflict issue go away by just by selling the family silver?

Within five minutes of signing the decree absolute on its divorce, Andersen began rebuilding its consultancy practice – and all the other firms offer consultancy by any other name within their accounting practices.

Fees paid for these services will still have to be declared in the non-audit column by audit clients. And shareholders will inevitably question the level of those fees.

Figures in KPMG’s latest annual report revealed a three-way split between assurance, tax and financial advisory services.

This latter category included corporate finance and corporate recovery services, forensic work and transaction services.

Stripping out the £340m brought in by consulting services, the firm still had a fee income of more than £1bn, of which only two-fifths was traditional audit work – and even this figure included other non-audit work.

Assuming similar figures for the other members of the Big Five, and certainly the E&Y report is along the same lines, one can see there will still be plenty of opportunities to milk clients for lucrative, high value services.

The Big Five have argued they are best placed to provide these services to their clients, but others disagree.

Referring to the split between audits and other services, Edengene’s Anderson said: ‘I can’t think of any assignments where you need both skill sets.’

Not rosy for generalist advisory firm
In fact, Anderson does not see a rosy picture for the generalist advisory firm where areas of work such as post M&A integration have all but dried up.

‘In the short-term, they are all taking a kicking in the market – conditions are very adverse for the generalist consultancy,’ Anderson said. Which means Deloittes might face a problem in deciding on the form of its spin-off.

PwC took over a year to decide to follow the IPO route chosen by KPMG, which has still to sell off its European consulting practice.

The collapse of the PwC/ Hewlett Packard deal suggested there was little appetite for a trade sale, and there might be a limited demand for consulting IPOs in the current market – so which way will Deloittes jump?

As Connolly admitted, the firm has yet to decide its preferred option – though it had had plenty of time to come up with a contingency plan.

The road to seperation

1989: Andersen Consulting forms a separate partnership, beginning a decade-long divorce row with Arthur Andersen.
1997: Price Waterhouse and Coopers & Lybrand announce they are to merge, forming PricewaterhouseCoopers.
1999: Arthur Levitt, chairman of the US Securities & Exchange Commission begins his investigation into auditor independence.
Dec 1999: Ernst & Young and Cap Gemini admit they are in talks to merge E&Y’s consultancy business into the Paris-based management consultancy for #7bn.
Feb 2000: SEC begins formal hearings on auditor independence.
June 2000: Andersen Consulting formally splits from Andersen Worldwide.
Sep 2000: Big Five are out in force for SEC hearings in Washington DC and New York.
Sep 2000: PwC and Hewlett Packard announce HP will acquire PwC’s consultancy arm for £13bn.
Nov 2000: HP pulls out of PwC talks.
Dec 2000: SEC announces compromise on audit independence, which no longer requires accountancy firms to spin off consultancy arms.
Jan 2001: Accenture, the re-named Andersen Consulting, is officially launched.
Feb 2001: KPMG Consulting floats in the US, valuing the company at $2bn.
Jul 2001: Accenture floats in the US.
Dec 2001: Enron collapses.
Jan 2002: PwC announces intention to float consulting arm.
6 Feb 2002: Deloitte Touche Tohmatsu ‘reluctantly’ announces it is to split off its consultancy business.