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IT SERVICES

A Spate of Class Action Shareholder Lawsuits Hits EDS

Wall Street’s Legal Vultures

EDS Current Woes Resemble IBM's 10 Years Ago

TUCSON, Sep. 27 - Every time the stock price of a major publicly traded company drops precipitously, it is a safe bet that Wall Street’s legal vultures will descend upon the vulnerable prey.  IBM experienced that almost 10 years ago.  EDS is feeling it now.

In the last three business days alone, a spate of new class action shareholder lawsuits has been filed against the Plano, Texas, IT services company and its top officers (see Appendix A).  The legal actions followed a two steep tumbles in the value of the EDS stock - the first on Sep 19 from $36 to $17, the second on Sep 24, from $17 to just above $10. 

Most lawsuits allege various improprieties in handling public disclosures by the company and its top officers.  Here’s an excerpt from just one example:

Electronic Data Systems Corp. and certain of its officers and directors with issuing false and misleading statements concerning its business and financial condition. Specifically, the complaint alleges that defendants made misstatements of material facts and omitted to state material facts in their public statements and elsewhere, including failing to disclose that EDS's backbone revenue from its Information Solutions IT outsourcing business is highly susceptible to interruption due to terms in EDS's service contracts that enable EDS customers to unilaterally suspend discretionary spending on IT outsourcing, affirmatively misrepresenting the predictability of EDS's future cash flows by touting the anticipated revenue that EDS would supposedly receive from its IT outsourcing service contracts with customers without disclosing that payments under such contracts were not guaranteed, and failing to disclose that EDS faced significant potential threats to its liquidity if its share price fell because of put-option and other obligations that ultimately obligated EDS to in effect buy back a total of 5.44 million shares of EDS stock at fixed prices averaging over $60.00 per share. 

(see Shareholder Class Action Against Electronic Data Systems Corp. by the Law Firm of Schiffrin & Barroway, LLP)

Take a look especially at the red highlighted quotes from the above paragraph.  Can you think of any other IT services company, starting with IBM, that would not be “guilty” of the same “infractions?”  We can’t.

What the Wall Street legal vultures seem to be saying is that, if an IT services company’s customers run into trouble and have to breach or renegotiate their contracts (e.g., the airlines, WorldCom, etc.) - the current trend that IBM executives called “rescoping” when they disclosed in April and July their similar woes (see “Ban IBM Hoarse Whisperers” - July 17, 2002), then that’s the IT services provider’s fault.

Using the same twisted legal logic of victimizing the victim, we should be punishing the rape victim for not having screamed louder, not the assailant who caused her the pain and suffering.

Aside from ludicrousness of such legal arguments, what is it that makes EDS, and not IBM, for example, and attractive target for the Wall Street vultures?  After all, IBM was the first to disclose that “rescoping” was going on in its business.  And that seems to be objectionable and illegal, according to these legal buzzards. 

The answer is simple.  The IBM stock did not drop to less than a third of its market capitalization in less than a week, wiping out over $12 billion in shareholders’ paper value (about $30 billion since EDS’s 12-month high, reached in late November 2001). 

But when the IBM stock experienced a same precipitous drop about 10 years ago, the Big Blue also became a target of Wall Street’s legal vultures (see the chart).

This write recalls being called by some of these buzzards to help them with expert witness testimony against IBM, a company of whose management Annex Research was critical at the time (see the contemporaneous Annex Bulletins from the 1990-1992 period).  We refused.  There is no money in the world that can compensate for honor, integrity and truth.  Ten years later, top executives of Enron, WorldCom, Tyco, etc. are also discovering that.

By the time the EDS saga plays itself out, this company may be remembered as the first of many to tell the truth publicly about its business.  Which is why it took the brunt of the blame game.

This is not to say that the blame is not deserved.  It was and it is.  Any time a company does such a turn-about-face from bullish to bearish in the space of only a few weeks, it deserves to be chastised - for lack of prescience, if nothing else.

But if a lack of prescience is a crime, then most of the Fortune 500 CEOs should be in jail right now, led by Sir Lou, the blind-for-seeing former IBM CEO and a failed “visionary.”  He drove the company into a brick wall, jumping off the wagon just before it hit and cashing in on stock options. 

Guess that’s also prescience of sorts.  But it is the kind for which the CEOs of Enron, WorldCom etc. are being rightfully prosecuted.

Class action lawsuits against EDS by the Wall Street vultures?  Oh, please… don’t they have anything better to do?  Such as go after a corporate carcass, rather than against a vibrant company.

A Great “Dick Brown Show”

How do we know EDS is still a vibrant company?  Well, in part because of what happened this week at the EDS Senior Leaders meeting in Plano (Thursday and Friday). 

Dick Brown, the EDS CEO, reportedly spoke for almost four hours.  He took full responsibility for what had happened, and answered every question posed to him by the other top EDS executives.  And he did a lot of listening, too.

“It was an outstanding performance,” one participant said of the boss’s show afterward.  “Dick really bared his soul more than at any other time in the past.”

But now comes the hard part.  Convincing the rest of the world that EDS is still a vibrant company with lots of upside potential.  And rebuilding the broken trust - perhaps the greatest challenge so far in Dick Brown’s illustrious career (also see Appendix B).

Upbeat Note from HP Services

Meanwhile, a senior Hewlett-Packard executive also sounded an upbeat note during her visit to London on Monday (Sep. 30). 

“We haven't seen demand change much over the last six to nine months,” Ann Livermore, HP's executive vice president and the head of HP Services, told Reuters in London. “We haven't seen it get worse.”

It is in this area of outsourcing that EDS reported a lack of new deals. EDS's profit warning dragged down shares in computer services firms.  But Livermore said the financial services sector was the hottest growing segment at the moment with more financial companies choosing to outsource.

“We still believe there is very strong demand for managed services business, which is the fastest growing segment in the industry,” she said. “We are working on a number of large deals that are in our funnel right now.”

Earlier this month, HP signed its largest services deal ever, a $1.3 billion contract to manage technology for Canadian Imperial Bank of Commerce (see “HP Breaks into IT Services Major League”)

Happy bargain hunting!

  Thursday September 26, 2002

• Milberg Weiss Announces Class Action Lawsuit Against Electronic Data Systems Corporation
  6:33 pm - Business Wire

• Law Office Of Mark McNair Announces Class Action Lawsuit Against Electronic Data Systems Corp -- EDS
  6:31 pm - PrimeZone Media Network

• Shareholder Lawsuit Filed Versus EDS
  2:39 pm - Dow Jones Business News

• Lovell Stewart Halebian LLP Announces Class Action Lawsuit Against Electronic Data Systems Corp., Officers
  2:23 pm - Business Wire

The last few weeks have been a difficult time for our company. EDS has been buffeted by outside market forces and by the consequences of our own decisions. In this crucial time, it is important you hear directly from me.

We re deeply disappointed our lowered guidance for third-quarter earnings precipitated such a dramatic drop in EDS ’stock price. While the market has spoken, you should know we believe it to be a substantial overreaction. Though many of our previous investors may have left us for the moment, our clients and our colleagues have not.

EDS remains a solid enterprise, with a strong business plan, excellent people and great clients. Your company is financially stable, with the resources to fund ongoing business and take on new clients.

Our talented people, our technical capabilities and our global network remain second to none. The quality of our work remains unaffected. Operational and service excellence for clients remains our prime focus.

Together, your management team and I accept full responsibility for our performance this quarter. Last Friday, at a meeting of EDS ’senior leadership team, broadcast to EDS locations worldwide, we began our return. We candidly appraised our situation, took action to address the most immediate issues and laid plans to address business fundamentals.

• We are reducing EDS ’expense base while better aligning earnings and cash flow to reflect the realities of market in which growth has substantially slowed –and may remain soft well into next year. Specific actions include a company-wide reduction in overhead costs, reprioritization of sales expenditures and initiatives to address under-performing assets.

• We are refocusing our new business efforts to emphasize the growth opportunities in our existing client base and the cross-selling of services within our portfolio. Selected large-scale contracts will remain an important part of our strategic mix. In pursuing all new business, we will continue to take into account increased industry sector risks while optimizing earnings and cash flow.

• I have commissioned a special team to review EDS ’revenue forecasting processes and systems. While they served us well in the past, our systems did not meet our needs this quarter. I will ask the team to report its findings to our board of directors.

• We will continue to review our portfolio of services to ensure it provides maximum financial value. For example, our decision to sell our subscription fulfillment business will simplify our business model.

• In Europe, management teams are already working with a small number of under-performing accounts to ensure we provide the service clients need while meeting our budget requirements. Where necessary, we have made management changes.

EDS’ business model is sound. We operate it with integrity. We do not ignore our failings – we learn from them. The core values of EDS remain as the foundation of all we do.

The 140,000 strong EDS global team knows we have to rebuild your trust through our performance, one proof-point at a time. We have fully committed ourselves to this task.

For additional Annex Research reports on EDS, check out... 

EDS Issues Earnings Warning (Sep 18)

Analysis of EDS 4Q01 Results (Feb 8, 2002)
... At IBM, most charts point south. At EDS, most point north. ... For, at EDS, growing in
low double digits is considered not good enough by its ambitious management. ...

Annex Research Analysis of EDS 4Q00 Results (Feb 7, 2001)
... 7 - Back in April 1999, Electronic Data Systems (EDS) uncharacteristically invited
analysts and investors to a face-to-face tête-à-tête in the plush New ...

EDS Takes Over US Navy (Oct. 10, 2000)
... EDS’ Navy Blue (Logo) Blends Well with US Navy Blues. PHOENIX, Oct. 10 – Electronic
Data Systems (EDS) has just taken over the US Navy and the Marines. ...

Analysis of EDS 2Q Business Results (July 26, 2001)
... Quarter of Record New Contract Sales. PARIS, July 26 - “Once again, we delivered
on our commitments to you,” a confident Electronic Data Systems (EDS) CEO and ...

Analysis of EDS 3Q01 Results (Oct 25, 2001)
... EDS on a Roll…. What Terrorism? ... Electronic Data Systems (EDS) is on a roll,
leaving in the dust any and all challengers - from high up, or low down. ...

EDS Second Quarter Results (July 28, 2000)
... "Pruning" of Unprofitable Contracts; Stock Buybacks, Leave Some Scars. PHOENIX,
July 28 – Electronic Data Systems (EDS) second quarter revenues were flat, in ...

Annex Bulletin - 98-28 ("EDS 2Q98")
... SERVICES. Analysis of EDS' Second Quarter Results. EDS Sets New Records.
Despite GM Woes, EDS Sets Revenue, New Sales High Water Marks. ...

Annex Bulletin - 99-04 (EDS 4Q98)
... 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 ...

Annex Bulletin - 98-38 (EDS 3Q98)
... EDS Business Segments. Meanwhile, back to EDS' third quarter business, the Asia/Pacific
region, meaning the "P"-part of it, meaning the Australian part of the "P ...

Annex Bulletin - 2000-02 (EDS' e-Price Clubs)
... EDS Forsakes Stock Buybacks after Spending $1.8B in 1999 on Them. PHOENIX, Feb. ... Well,
let us present to you a real fourth quarter slam-dunk contest winner: EDS. ...

Volume XVIII, No. 2002-19
September 27, 2002

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

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