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Analysis of Computer Sciences Corp.’s Fiscal Year 2002 Results

What “Contraction?”

CSC Ends Year with Strong Finish; FY02 Profit Up 48%, Revenue Up 9%

PHOENIX, May 17 - It was only appropriate that Computer Sciences Corp. (CSC) should have released its fiscal fourth quarter and full year FY02 results one day before IBM CEO’s address to Wall Street analysts.  Because they made some Sam Palmisano claims sound rather funny, if not ridiculous. 

While IBM Global Services (IGS) revenues were down 3% during the Jan-Mar quarter, CSC’s were up 5% during the same period, led by its federal government business that surged by 18%.  As you saw in “Sam is No Change Agent” (May 6), EDS’s revenue was also up 7% in the first quarter.   Accenture’s revenues were also up in its latest quarter (ended Feb. 28).

For the full fiscal year that ended Mar. 31, CSC’s revenues rose by 8%, led by an 11% increase in federal government business, and by a 15% surge in its outsourcing segment.  Net profit was up 48%.

As you saw in our “What ‘Recession’?” report (Annex Bulletin 2002-05, Feb. 8), most EDS trends for the full year were also up, most IBM’s were down.  Ditto re. Accenture (see Annex Bulletin 2002-01).

And then we heard IBM/Palmisano on May 15 claim that IBM had gained market share against the competition!? (see “No New News at IBM,” May 15).  And that the industry is supposedly contracting!?

So to repeat what we wondered in “Sam is No Change Agent” (May 6):

Wonder what industry Palmisano thinks IBM is in?  Travel? (which may be valid, given the speed with which the IBM stock has plummeted lately. J). 

Meanwhile, back to CSC, during its post-earnings release teleconference with Wall Street analysts, most CSC watchers were tripping over each other trying to congratulate CSC on excellent results.  No wonder the stock jumped 12% the following day (May 15) to $46, on the heels of a 6% jump the day before the earnings release. And it has been inching upward since (it closed at $48 today, still short of its 52-week high of $53).

By contrast, the IBM stock dropped precipitously from its Jan. 9 high of $126 to its three-year lot of $76, before bouncing up to $85, still a three-year low.

Homemade Turnaround

And what was it that CSC did that made the Wall Street analysts go “gaga” over its latest release?  Well, one thing was its top-line growth in the face of the gripes by the likes of IBM, HP and other hardware vendors.  Another was cost-cutting that uncharacteristically accompanied such growth.

CSC’s Selling, General and Administrative (SG&A) expenses were actually down 11% compared to a year ago, even though revenues increased 8%.  And news like that is music to investors’ ears. 

“We’re delighted with our performance over the last fiscal year,” gloated the company’s CFO, Leon Level.

On May 15, the IBM chief talked about similar productivity improvements that the Big Blue needs to achieve in the future.  Ironically, on May 14, CSC business results showed such productivity gains in real life.  What IBM only talked about as wishful thinking, CSC had already pulled off.

A feat like that is all the more remarkable given that a year ago, CSC’s was one of the gloomiest stories around the IT industry (see CSC Hits a Big Bump, May 2001).  The company had just reported a $37 million loss in its fourth quarter, and was laying off 1,700 people, accompanied by a $149 million charge.

Back on the Street, knives were out for CSC leaders.  Some Wall Street analysts (again uncharacteristically) expressed their doubts that the CSC management was capable of pulling off a homemade turnaround.

CSC proved them wrong.  Its FY02 results are a textbook example of a homemade turnaround.  They show that not every rebound has to be led by outside “turnaround artists.”  Provided, of course, that the insiders have the vision and the courage to act as real “change agents.”

Strong Government Sector

To be fair, CSC was also fortuitous.  As one of this country’s top defense contractors (CSC was the No. 12 on the Top 50 Pentagon suppliers list in 2000 - see “Bush League All-Stars,” Feb. 4), the company reaped the windfall benefits from the post-911 increases in U.S. military spending.

The top-secret intelligence community’s “Groundbreaker” project, for example, “was an important driver in the quarter,” admitted Van Honeycutt, the CEO, adding that the customer had asked CSC not to talk about the contract details.

CSC’s Department of Defense revenue increased by 17% in the latest quarter, and is poised for growth in the current fiscal year, too.  The company has about $26 billion of federal government contracts in the pipeline that stretches over 35 months.  CSC expects the U.S. government spending on IT to increase at about 10% per year over the next several years.

That was one BIG difference between CSC and IBM.  As we noted in our Jan. 18, piece about IBM, “Big Blue Stock to Take a Dive?” as well as in the “Sam is No Change Agent” (May 6) Annex Bulletin, IBM got out of the federal government business in 1994:

The Big Blue had the “foresight” to get out of the federal government business back in 1994 (!?), when it sold its Federal Systems Division to Loral Corp. (see Annex Bulletin 94-06, Jan. 25, 1994).  Which meant that IBM dug itself even deeper into a hole.  Of course, it thought it was cashing a post-Cold War “peace dividend.”

(Annex Bulletin 2002-02, Jan. 18, 2002)

The reason we said that CSC was “fortuitous” and had benefited from a post-911 “windfall” was that this vendor, just like IBM, tried to de-emphasize its federal government business in the post-Cold War era.  It’s just that the methods differed.  Instead of getting out of it entirely, CSC did it more prudently - by pressing hard on its commercial business accelerator pedal, while hanging tough in the government market. 

As a result, we had held up CSC as one of the IT industry’s fastest transformation stories during the 1990s (see CSC: A Mouse That Roars?, Nov. 1998).  For, CSC had the best of both worlds.  Its government business grew slowly but steadily to its present level of $3 billion per year, while its commercial sector exploded during the 1990s.

Back in 1991, for example, the federal government accounted for two-thirds of CSC business.  Six years later, the scales were totally reversed.  CSC’s commercial revenues represented three-quarters of the total, with the federal government accounting for only 25% (see the chart).

Text Box:

As a result, CSC’s revenues grew at a compound annual rate of 23% between 1992 and 2002, the fastest growth rate of any top IT services competitor, a feat that also earned the “gold” for long-term growth last year (see “IT Services Heptathlon 2001,” Annex Bulletin 2001-11, May 2001).

Now, CSC is poised to reap further benefits of hanging in there through the Clinton administration budget cuts.  And IBM is having to figure out what to do with excess capacity.  Maybe use it to gain market share in the government market in Argentina?  J

“The demand is as robust as its ever been,” the CEO Honeycutt punctuated the same point.  “But the decision cycle has been elongated.”

Nevertheless. Honeycutt said he expected CSC to grow at 6% to 8% in the current fiscal year.  He added that this is an internal growth rate, without taking into account any possible future acquisitions.

Text Box:

Some Blemishes

So if CSC is doing so well, and has been bringing home the bacon to its shareholders, more or less consistently for over 10 years now, how come its market capitalization is only $8 billion, as compared to Accenture’s $19 billion, for example? (We picked Accenture for comparison because both companies are about the same size - around $11.5 billion in revenues - and in the same line of business).

Well, the technical answer to that question is because the Accenture stock is trading at about 1.2 times revenue per share, while CSC’s at only 0.7 times.  But why such a valuation discrepancy?  The answer -  because Accenture is almost twice as profitable. 

In the first half of its FY02, which ended Feb. 28, Accenture’s profit before tax was about the same as was CSC’s for its entire FY02 ($492 million vs. $497 million).  And that’s after Accenture wrote off some $305 million as various one-time charges.

Interestingly, CSC is ahead of Accenture in terms of sales productivity (CSC ‘s revenue per capita is $187,000 vs. Accenture’s $153,000).  But Accenture’s profit margins are generally double or better than the comparable CSC ones. 

Whether or not that warrants Accenture’s  $19-to-$8 billion market cap edge - for two companies of basically the same size - is debatable.  But so is any market value on Wall Street.  The ultimate judgment is in the eyes of a beholder - the investor, in this case.

So cutting expenses won’t cut it for CSC.  It will have to find a way to cut juicier deals and raise its gross margin. 

Another good thing that CSC has going for itself vis-à-vis IBM, for example, is that it has not been trying to buy Wall Street recommendation through stock buybacks.  Let us hope that this healthy attitude continues in the future, too, and that CSC doesn’t succumb to someone’s “bright” idea of improving investor relations through share repurchases.

Given CSC’s relatively low cash on hand ($149 million vs. Accenture’s $1.1 billion), that seems unlikely.  And it would certainly be imprudent to borrow money.  But even that’s been done before...

Therefore, additional areas of improvement on which the CSC management needs to work, are:

(1) increasing profit margins;

(2) improving investor relations;

The first challenge means working on facts; the second working on perceptions.  The first is management science; the second is PR art.

Happy bargain hunting!

Bob Djurdjevic














































Volume XVIII, No. 2002-14
May 17, 2002

Editor: Bob Djurdjevic
Published by Annex Research
e-mail: annex@djurdjevic.com

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