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Analysis of Computer Science Corp. Third Quarter FY04 Business Results

Good Quarter Gets Boos

Strong New Contract Sales, Weak U.S. Commercial Revenues

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PHOENIX, February 13 – Computer Science Corp.’s (CSC) executives should empathize with Rodney Dangerfield.  Wall Street showed no respect for CSC following the release of its third quarter of fiscal year 2004 results (Feb 11).  CSC shares dropped by more than 8% on Thursday and Friday despite a good quarterly report.  Adding insult to injury, the humiliation happened the day the Dow and most of CSC competitors’ shares thrived (see the above chart).

The reason?  Who knows...  CSC’s latest earnings basically met analyst expectations, while the revenues surged by 30%, boosted by last year’s DynCorp acquisition and by foreign currency translations. 

The best news, however, was the new contract sales.  They more than tripled in the latest quarter, from $1.8 billion a year ago, to $6.0 billion.  That’s a new all-time record for a single quarter.  Even better, about 80% of it came from commercial customers, the business that CSC has had trouble closing last year.  And the new sales in Europe, where CSC had trouble competing last year, were particularly strong.  They accounted for 55% of the third quarter total.  

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For the first nine months of the FY04, new contract sales were up 254% (from $3.9 billion to $13.8 billion).  Naturally, this bodes well for CSC’s future revenue growth.

“The record third quarter and nine months announced award totals have enhanced visibility for future revenues,” the CSC CEO, Van Honeycutt, also noted in a more obscure way.

For the full fiscal year 2004, we expect about $16 billion of new business, more than double the FY03 total ($7.7B). 

Slowing Commercial Revenues

If there was a fly in CSC’s third quarter ointment, it was the U.S. commercial revenues.  While the U.S. government business has been booming (up 30% in the quarter), the U.S. commercial revenues were down 5%.  As a result, CSC’s global commercial revenues also declined 1% in constant currency (they were up 8% as reported).

For the full fiscal year, we expect the U.S. commercial revenues to decline for the second year in a row, dragging down the global commercial accounts performance, too.  But as the new record contract sales start to kick in, we expect CSC’s commercial revenues to start growing again, with or without the help of the weak U.S. dollar.

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So as we noted a year ago (see “Back to the Future,” Feb 2003), after growing its commercial business in the 1990s, CSC is now rapidly returning to its roots – serving the federal government, especially the wartime needs of the Pentagon.

As a result, CSC’s commercial revenue share has dropped from 75% to 58% in the post-9/11 period, while the government’s portion surged from 25% to 42%. 

No. 10 “Death Merchant”

In short, CSC has done a complete turn-about-face since 9/11. The company is now the 10th-largest Pentagon supplier, a big jump from the No. 21 position before the DynCorp acquisition.

Besides CSC (#10), EDS (#27), Dell (#35) and IBM (#50) are among the Top 50 U.S. “death merchants,” based on the Pentagon spending report for 2003 (see the Pentagon Top 50 table)

Just in case you may be wondering if the 213% increase in CSC’s revenues from the Pentagon tops the top 50 list, it doesn’t.  That dubious honor goes to vice president Dick Cheney’s former company – Halliburton.  Despite the controversy over its over-charging the Pentagon for some of its oil deliveries in Iraq, this company recorded a whopping 711% jump in 2003 revenues. 

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Isn’t war great, especially if one has friends in high places? (also see “War Is Great!  Long Live NATO!”, Mar 1999).  Nor are the U.S. industrial giants the only companies benefiting from it.

Would it surprise you to learn, for example, that Humana (#11), Health Net (#14) and Cardinal Health (#33) –health care providers - are also on the Top 50 list?  Or Booze Allen (#23), a consulting firm, and Massachusetts Institute of Technology (#48)? 

Even foreign-based companies, such as British Aerospace (#13), or the Dutch NVK (#43), or the Government of Canada (#47), are also benefiting from Washington’s warmongering.

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Altogether, we figure that 9/11 may be worth about $1.4 trillion in additional military spending over the next 10 years to various U.S. and multinational “death merchants.”  Which makes the global wartime economy the fastest growing “new” market.

So who needs the Cold War and the Soviets when fighting bin Laden and Al Qaeda can be so much more profitable?

The “Not-So-Free” Cash Flow

Meanwhile, back to CSC’s latest quarter, free cash flow, or lack thereof, is a legitimate reason for Wall Street’s worrying about the financial performance.  During the first nine months of the current fiscal year, the free cash flow was a negative $173 million, more than double the corresponding amount a year ago ($85 million).  As a result, CSC’s cash on hand dropped by over 50%, from $300 million as of March 28, 2003, to $148 million as of Jan 2, 2004.

At the same time, the company’s accounts receivables have jumped by $300 million - from $3.3 billion to $3.6 billion.  Other current assets increased from $468 million to $608 million during the same period.

Summary and Outlook

On balance, there seem to be at least as many reasons to cheer the latest CSC report card, as there are to pan them.  Surging sales are bound to translate into growing revenues and profits in the future.  Yet Wall Street has chosen to ignore the good and boo the bad.

Text Box: Some Market Stats    EDS      IBM    Accenture     CSC
Market Cap:	$9.98B	$171.54B	$22.06B	$8.04B
Trailing P/E (ttm):	N/A(Loss)	22.98	21.10	16.05
Current Price:	20.77	99.71	23.46	42.91
PEG Ratio (5 yr fcst):	3.41	2.02	1.36	1.23
Price/Sales (ttm):	0.46	1.92	1.59	0.58
Price/Book (mrq):	1.74	6.09	20.82	1.61
Source: Annex Research

As a result, CSC’s devalued stock price, even if it is still within 10% of its 52-week high, appears a relative bargain compared to its major rivals (see the above table). 

That’s especially evident in terms of the Price/Earnings Growth (PEG) ratio, a forward-looking statistics measuring a stock’s valuation against its projected growth rate (calculated as a P/E Ratio divided by the 5-year expected growth rate).

The PEG Ratio makes the CSC stock look like the best bargain, followed by Accenture, IBM and EDS, in that order.  So anyone still booing CSC may be missing a good play in a global wartime economy.

Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2004: "Good Quarter Gets Boos" (Feb 2004); "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); "Cronyism Is Alive and Well at EDS" (Jan 2004);  "Five Most and Least Likely Forecasts for 2004" (Jan 2004)

2003 CSC:  "Less Than Meets the Eye" (May 16), "Back to the Future" (Feb 5)

2002 CSC:  Analysis of CSC FY02 results (May 17, 2002), "A Disastrous Quarter!" (Apr 17, 2002), “Tough Times, Soft Deals,” (Apr 25, 2002)

A selection from prior years: Analysis of CSC calendar 2000 results (Mar 26, 2000), CSC's FY2000 Business Results (May 10, 2000), Business Is Humming Nicely (Nov 3, 2000),  CSC 3Q2K, CIO Survey (Feb. 29, 2000), CSC: A Mouse That Roars? (Nov 1998)

Or just click on and use "financial engineering" or similar  keywords.

Volume XX, Annex Bulletin 2004-05
February 13, 2004

Bob Djurdjevic, Editor
(c) Copyright 2004 by Annex Research, Inc. All rights reserved.
e-mail: annex@djurdjevic.com

P.O. Box 97100, Phoenix, Arizona 85060-7100
TEL/FAX: (602) 824-8111

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