WESTERN AUSTRALIA, Feb. 4 - Two of Ross Perot's brainchildren - Electronic Data Systems' (EDS) and the newly public issue of Perot Systems (PS) - were the only two major technology companies to see their stocks rise in anticipation of EDS' fourth quarter financial release after the markets closed on Thursday (Feb. 4). EDS was up 3/8 to $52, while PS increased 4 3/16 to $66 1/16, more than a four-fold jump in the first two days of trading.

EDS' loss of market share was also evident in its fourth quarter new contract sales. They were "only" $2.5 billion, less than half that which the company reported in the fourth quarter a year ago ($5.8 billion). And during the same three months, IBM closed $9 billion of new deals, outselling EDS by almost a four-fold margin. For the full year, IBM outsold EDS by almost a three-fold margin ($33 billion vs. $11.8 billion).

Clearly, the recent turmoil at the top of the house (Les Alberthal's and Gary Fernandes' retirements) has negatively affected EDS' new business sales performance. It's all reminiscent of the first half of 1996, when the company's sales suffered while the top management took its eye off the ball, focusing on its divorce from General Motors (GM), rather than on generating new business (see Annex Bulletins 96-FB7, 4/22/96 and 96-FB10, 7/16/96).

Unlike in 1996, however, when the stockmarket failed to take notice of such EDS problems for almost six months (see Annex Bulletin 96-51, 10/23/96), it is doubtful that Wall Street will be as forgiving when the market opens tomorrow (Feb. 5). Especially considering that EDS' new chairman and CEO, Dick Brown, predicted during the post-release teleconference with analysts that the $4.2 billion revenue which the company derived from GM last year, is likely to drop by 7%-10% in 1999. The GM revenues declined by 3% in 1998, after rising a meager 1% in 1997, the first full year of an independent EDS.

Despite such a GM shortfall, Brown also said that he expected double-digit revenue growth in 1999. Which means that the company's commercial side of the business, the so-called "base" revenue which accounted for three-quarters of the total, will have to rise by at least 17%. In 1998, the "base" revenue was up by about that much (16.5%), so the challenge isn't all that great.

But EDS will have to grow by a lot more than that in 1999 if it is to make up the ground it had lost to the rivals in 1998. The big win of a $1 billion, seven-year the state of Connecticut "megadeal" over its top competitors (IBM, CSC), which EDS locked up in the waning days of December, will give the company a good push in that direction. Especially as the company was also named as a finalist in two other "megadeals."

As for EDS' bottom line, its net income for the full year, including all the adjustments, was $743 million, up slightly (2%) over 1997. But adjusted for a lower 1998 tax rate (34.4% vs. 36%), EDS' net was actually down 1%.

During the analyst conference, Brown refused to forecast the EDS future earnings, showing that he is quickly learning from his predecessors mistakes.

EDS' gross profit also rose about 2% in 1998, but its gross margin dropped 1.5 points to 17.3%, roughly the level it was at in 1996, the year which included a half-a-billion-dollar charge related to its GM divorce. Since the peak in 1993 (24.9%), EDS has now lost 7.6 gross margins points.

EDS' operating profit was down 12% to $1.1 billion, for a 6.3% operating margin, down from 8% in 1997.

First of all, the equity, the bottom line from the shareholders' standpoint, was up 11% in 1998 to $5.9 billion. Second, long-term debt was down by 34% to $1.2 billion. Third, thanks to the positive cashflow generated by operations, and the fact that EDS' management didn't squander its earnings on stock buybacks as IBM's did, EDS' cash was up by 28% to $1.3 billion.

When EDS won the Xerox $3.2 billion megadeal in 1994, Xerox CEO, Rick Thoman, a close friend and confidant of IBM chairman Lou Gerstner, was then an IBM executive. Naturally, back then we had no idea that one day, EDS and Xerox would lock horns in a court battle. After all, it's not every day that you see a major company sue one of its biggest customers in a "megadeal" dispute. The last time EDS was forced to do it was in 1992, when it sued the state of Florida. That dispute was eventually settled in 1995 through arbitration. Citing confidentiality clauses in its Xerox agreement, EDS said that it couldn't comment on the latest lawsuit.

But even without the benefit of today's hindsight, we warned in 1994 that the Xerox deal could be a Pyrrhic victory for EDS. It may temporarily boost the company's revenue and new contract sales, but it may also hurt its long-term margins. For, the hotly contested "megadeals" are often like the game of chicken: The last bidder to say "no" gets stuck with the deal. Here's an excerpt from the Annex Bulletin 94-46 (10/19/94):

"In each case, EDS 'won' over IBM and other competitors. The third quarter (of 1994) was the first period in which the benefits from these two "megadeals" were supposed to figure materially. They did. The net effect was that EDS' gross profit margins dropped from 25% to 23%. The operating margins declined from 14% to 12%.

Compared to the rest of the I.T. industry, such bottom-line results are, of course, terrific. As is EDS' net margin of 8.3%. But in each case, the latest results are lower than those previously reported. For the thrifty, margin-conscious EDS shareholders, if not for its growth-crazed management, they ought to sound a few alarm bells. And prompt questions such as - 'is EDS' buying the business'?"

For prior to winning the Xerox deal in March 1994, EDS was on an 11-deal losing streak against IBM in North America. As an IBM executive put it back then, "it was just a matter of time and place before EDS went deep' (i.e., 'bought the business,' see Annex Bulletin 94-14, 4/01/94).

"Nobody actually asked EDS' chief financial officer, Jody Grant, that question during this morning's teleconference with (mostly) Wall Street analysts. But he tried to ward it off, anyway. 'We've been reasonably dominant in our ability to win against IBM,' he opined.

Sure… (EDS) may check with the mainframe PCM executives. They also thought (for a while) that they could 'buy the business.' Until they almost got bought out themselves (in Hitachi's case - almost literally; in Amdahl's - nearly - yet, still counting...)."

Speaking of buyouts, as predicted last fall, this week Hitachi bought out EDS' 16% share of Hitachi Data Systems (HDS) reportedly for just under $50 million, ending a 10-year partnership. The price implies that, HDS, the $2 billion-dollar Hitachi subsidiary, is worth only about $300 million, less than it was ten years ago, when Hitachi and EDS bought the $850 million NAS from National Semiconductor.

Nor is its parent (Hitachi) in much better shape. Here's an excerpt from the Annex Bulletin 98-38 (10/30/98) followed by the latest news: