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Analysis of Electronic Data Systems Fourth Quarter Business Results

“Hot Air Jordan” Flaunts Flop as Feat

EDS Flounders Under New Leader, Loses $1.7 Billion in 2003

PHOENIX, February 6 – When Michael Jordan was in his prime as an all-star NBA player, appreciative fans and media dubbed him “Air Jordan.”  The nickname reflected his outstanding leaping ability.  Now another Michael Jordan is emerging on the business stage who deserves a similar epithet.  Electronic Data Systems’ (EDS) CEO may end up being known as “Hot Air Jordan” - for his ability to spew out hot air over his company’s red ink.  While EDS is floundering, Jordan is flaunting the biggest flop in its corporate history as a feat.

“Our fourth quarter results, excluding NMCI[1], met expectations,” he said in a statement that accompanied the February 5 release.  “We completed our management team, and solidified our technology and marketing strategies.”

If the free flow of red ink in the quarter “met expectations,” Jordan must be setting at least one new record – for rock bottom expectations!  Consider some highlights…

·        EDS lost $354 million in the fourth quarter alone, and $1.7 billion for all of 2003. 

·        New contract sales plummeted 47% to $4.3 billion in the fourth quarter, from $8.1 billion the year before.  For the full year, they slumped from $24.4 billion to $14 billion, a 43% drop.

·        Free cash flow in the quarter dropped from $848 million in the fourth quarter 2002, to $387 million, a $461 million deficit.

·        Equity dropped 19% from a year ago.

·        We estimate that the 2003 revenue declined about 5% in constant currency (it was up 0.5% as reported).

·        The gross margin plunged to 9.2% in 2003 from 17.5% the year before – an all-time low.  Etc.

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In short, Jordan’s 2003 performance is making the former CEO Dick Brown look great by comparison.  Brown was fired after delivering a $1.1 billion net profit in 2002, its second highest-ever (he also holds the record for the highest profit – in 2000 - see the chart and "EDS CEO Replaced", Mar 2003).  

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Yet Jordan sounded contented after losing $1.7 billion in his first year at the helm.

“We now have the resources, leadership and sales capabilities in place to re-establish EDS in the market,” he added.  “Our 2004 focus is squarely on growing the business.”

Well, that’s indeed something that the EDS shareholders sorely need.  But can Jordan deliver?

Credit agencies didn’t think so.  They didn’t wait for the dust to settle following EDS’ fourth quarter release before taking action.  Moody’s, for example, said it might cut EDS credit rating to “junk.”  Standard & Poor placed its “BBB” rating for EDS on watch for a potential cut.  Fitch also said it may cut EDS’s credit rating.

Since EDS' business is based on long-term contracts, a “junk” rating is likely to make it extremely difficult for it to secure long-term contracts, Reuters noted in a report about the possible downgrades (Reuters, Feb 6).

So not only was EDS’ 2003 sales performance dismal, the company now faces an added challenge in the future - overcoming the stigma associated with its potential “junk” credit rating.

The stock market was kinder to EDS.  Its stock only dropped 6% to $21.90 on a day the Dow was up 97 points, and all of EDS’ major competitors’ shares also increased.  The reason we are saying “only,” is that it could have declined much more if the company’s fundamentals had anything to do with it.

When EDS first disclosed even a hint of trouble in September 2002, its stock dropped like a stone - from $36 to $17 in one day (see EDS Issues Surprise Earnings Warning, Sep 19, 2002).  The company went on to make $1.1 billion in profit that year, but the stock never really recovered.  And now, after the biggest loss in its corporate history, the EDS stock is still trading around $22.  A reprieve fueled by gullibility?

Reprieve, because the EDS shares may be ready to hit the slopes.  It is the winter season, after all, at least in the northern hemisphere. J  And it’s going to be a steep downhill ride, we figure, provided, of course, that business results figure in stock market valuations.  And that, as you have seen before, is not always the case on Wall Street.

Like IBM of Old, Like EDS under Jordan…

What’s happening now at EDS is reminiscent of what occurred at IBM in the waning years of the John Akers administration (1990-1992).  The Big Blue emperor sat in his Armonk ivory tower, and kept issuing optimistic proclamations divorced from reality of the state of the IBM business.

The IBM board did nothing, complacently backing the CEO until the bottom fell out of the stock.  Then it was each man for himself.  The IBM directors finally fired their hapless CEO, but not before most of the value had evaporated from the IBM stock (from $30 to $11 in today’s prices).

Does such a fate await EDS?  It would not surprise us, unless a miraculous turnaround occurs in the next six months or so.  Based on what we are seeing in the marketplace, that is not very likely.  The EDS customers are obviously voting with their thumbs down (with new sales being down 47% - see the chart). 

So the question is: how long will the EDS board wait before saving their shareholders from another hapless CEO?  Hopefully less than the IBM board took (over two years). 

As you may recall, in one of our New Year’s forecasts, we predicted that Jordan might not last the year (see "Five Most and Least Likely Forecasts for 2004", Jan 2004).

Business Segment Analysis

Geographies & Industries.  The EDS market share losses are particularly discernible in the U.S. market, its biggest geographic region.  A year ago, the U.S. market represented a whopping 75% of the EDS new contracts.  In the fourth quarter of 2003, however, its share plummeted to a mere 47% (see the chart).

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The trend is repeated when one looks at the EDS new sales results by industry.  Government has now surpassed all other segments.  In the fourth quarter, it accounted for 27% of new contract sales.  Manufacturing, including GM, was a distant second with a 13% share.

Ironically, the U.S. revenue share has actually gone up on the EDSText Box:  
latest scorecard (from 53% to 59%), even though it actually declined 4% in the fourth quarter.  That’s mostly due to the new stream of income coming from the loss-ridden U.S. Navy megadeal - the kind of revenues you would only wish for your worst enemies.  So the government sector was up 24% in the period, by far the highest growth rate of all industry sectors.

What’s worrisome is the 1% decline in European revenues.  That geographic segment has been one of EDS’ strongest during the last decade or so.  The loss of the big Britain’s Inland Revenue contract last December will further exacerbate EDS’ revenue woes in 2004 (see “Biggest Feather in Cap’s Cap,” Dec 2003).

Europe’s share of the new business contracts is now 39%, much closer to the U.S. than ever before.  But that’s because the overall sales have dropped so severally (down 47%).  So 39% of the 2003 fourth quarter total is still less than the 22% of the new contract sales EDS recorded in Europe a year ago ($1.7 billion vs. $1.8 billion).

EDS’ consulting arm, A.T. Kearney, whose results the company has now chosen to break out as a separate subsidiary, experienced another declining quarter (down 8% from 4Q02).  Even worse, however, was the decline in its profitability (operating profit was down 89%).

So is there some good news amid all this fourth quarter gloom and doom?  Yes there is.  There are at least two business segments where it’s not all black (or red at the bottom line).

UGS PLM Solutions, another unit whose results EDS has chosen to report as a separate subsidiary, had an 8% increase in fourth quarter revenues, and a 49% jump in operating profit.

The Asia/Pacific region also had a fairly good quarter.  Its revenues rose 8% from a year ago, but its operating profit took a tumble (down 26%).

Horizontal LOBs.  Among EDS’ horizontal lines of business, outsourcing, its biggest LOB that accounts for 61% of the total revenues, was up 8% in the fourth period.  The growth was largely due to the U.S. Navy contract’s 65% surge (which we’ve already explained are “bad revenues,” as they bleed red ink to the bottom line).  

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The Solutions Consulting segment, or Application Management, as EDS has renamed it recently, was down 13% in the fourth quarter.

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The Business Process Outsourcing (BPO), the IT services industry’s hottest horizontal activity, was also down (-1%).  EDS broke out the BPO as a separate entity for the first time in this quarter.  And it showed it accounting for about 12% of its total revenues.

Fixing What’s Not Broken

Amid slumping sales, EDS’ Jordan said last October that his goal was to have a 7% SG&A expense-to-revenue ratio (see “Pain Without Gain,” Oct 2003).  And in the course of pursuing it, he has slashed about 5,200 jobs, and is planning to export many more, mostly to India.  (EDS has predicted it would have 20,000 employees providing offshore IT services in various countries by the end of 2004, according to a Dow Jones July 22, 2003 report - see “A Passage to India,” July 2003).

That’s fixing something that’s not broken, as we also said back in October:

To us, it seems that EDS is trying to fix something that isn’t broken.  Instead of adding to the sales firepower in order to grow the business, it is reducing it.  That’s like rationing ammo to poor marksmen, or removing radars from airplanes and X-rays from hospitals in order to cut costs.


What does seem to be broken at EDS, however, is its low gross margin.  At 10.4%, which is what it was in the latest quarter, it is up from 9.8% a year ago (restated).  But both figures are pitifully low compared to IBM’s 25% gross margin in the latest quarters, or Accenture’s 36%, for example.

(And EDS’ gross margin just got even lower - it was 9.2% in the fourth quarter, Ed. 2/06/04).

Which means that EDS is either pursuing too many big deals where price competition is intense and margins are low, or is discounting its prices across the board.  Or both.  Whatever the problem, the solution seems to selling smarter, not cutting costs.  What EDS needs to do is develop new and different markets which would yield higher profit margins, not gloat over improving win rates with customers that are already bleeding EDS sales people dry.

(from Annex Bulletin 2003-18, Oct 2003)

If a company were in a commodity-type business, perhaps it would make more sense to equate lower costs with lower prices, and thus potentially higher sales.  But EDS is in a value-added business that requires creativity and salesmanship in order to produce greater value, both for the client and for EDS shareholders (see “IT Industry: Whither Goeth It?,” Jan 2004).

Jordan evidently doesn’t seem to understand that.  His overpaying for the Feld Group, and bringing on board a bunch of technologists instead of sales leaders, only reinforces that impression (see “Cronyism Is Alive and Well at EDS,” Jan 2004).

Furthermore, we wonder if he and his teal really understand how severe a price EDS will pay in 2004 for sales failures in 2003?

Assuming that the new contract sales end up down $10 billion in 2003 (which did happen, Ed. 2/06/04), and given a seven-year average contract term, the annual negative revenue impact would be about $1.4 billion.  Of course, that’s before any expirations, cancellations or “rescoping” – all of which could only exacerbate the EDS growth challenges.

(from Annex Bulletin 2003-18, Oct 2003)

In other words, EDS has entered 2004 about $1.4 billion of revenues in the hole.  Its first $10 billion of new contract sales will put it at just a break-even point with 2003.  No wonder credit agencies were skeptical about Jordan’s optimism (“Our 2004 focus is squarely on growing the business”).

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So what’s in the cards for EDS?  Struggle to keep its chin above water. 

And what if it doesn’t?  Then somebody will buy it – probably at a stock price significantly lower than it is today. 

Who might that be?  Perhaps somebody who is already in the IT services business, has the money to acquire a $20+-billion company, and has proven that it can digest mega-acquisitions successfully.

If giving you an extra clue - that such a company’s name is a two-letter acronym is not enough, maybe we can hint that this vendor is headquartered in California, and is led by a female CEO.  And if that’s not enough, well, ask Michael Jordan who he thinks his major competitor is.  If he says LA Lakers, you’ll know what time it is…. time to head for the hills.  But if he replies Big Blue, then pick that competitor’s major competitor. 

Happy Pickings!

Happy bargain hunting!

Bob Djurdjevic

[1]  The U.S. Navy and Marine Corps Intranet contract

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

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: “Biggest Feather in Cap’s Cap,” (Dec 2003); "Pain without Gain" (Oct 2003), "EDS CEO Replaced" (Mar 2003);  Rebuilding Trust and Confidence (Feb 2003)

2002: Wall Street Legal Vultures Descend Upon EDS (Sep 27, 2002),  EDS Issues Earnings Warning (Sep 18, 2002),  Wall Street-Main Street Chasm Widens (July 3, 2002),  Analysis of EDS 4Q01 Results (Feb 8, 2002)

A selection from prior years: Annex Research Analysis of EDS 4Q00 Results (Feb 7, 2001),  EDS Takes Over US Navy (Oct. 10, 2000),  EDS Second Quarter Results (July 28, 2000),  Annex Bulletin - 2000-02 (EDS' e-Price Clubs).

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

Volume XX, Annex Bulletin 2004-04
February 6, 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
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