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Updated 5/11/04, 11:30 a.m. EDT (adds "Dividend Cut")

Analysis of EDS Stock Performance

On a Wink and a Prayer

Seventeen of Top 25 EDS Institutional Holders Added to Their Positions Just Before Stock Took a Dive

PHOENIX, Apr 29 - So you think big institutional investors know which end is up in companies into which they pour billions of their own and their clients' money?  Well, think again.  Seventeen of the Top 25 Electronic Data Systems (EDS) institutional shareholders actually added hundreds of millions of dollars to their positions just before the stock took a dive in 2004 (see the charts and the table). 

That's at least one startling discovery that emerged from our latest analysis of institutional holdings as of December 31, 2003 (also see "Hedging the Bets," Mar 2004).  

So who are these Wall Street "experts" who evidently use a "on a wink and a prayer"-strategy for their investment bets?  Well, the above chart identifies the "ten biggest losers" among the EDS investors.  Lead by Alliance Capital and Smith Barney, these institutional investors ignored the warning signs about EDS, as depicted in our reports, "Pain without Gain" (Oct 2003), “Biggest Feather in Cap’s Cap,” (Dec 2003), and "Cronyism Is Alive and Well at EDS" (Jan 2004), among others.  They bought instead of selling.  And now, they are suffering the consequences.

At $18.20 per share, these and other EDS holders (see the above chart for the Top 10) have plenty of red ink to show for in their portfolios, as the EDS stock dropped 26% since December 31.  By contrast, the IBM stock has declined only 2% since the start of the year, while the S&P Index actually rose in the single digits.

And that's only a start for the EDS stock slide; an intermediate stop on its trip to greater lows, as you also saw us point out in our year-end report on EDS ("Hot Air Jordan" Flaunts Flop as Feat, Feb 2004).  By the time all is said an done, with the stock price of $12 to $13 per share or even lower, EDS would indeed be a takeover target (one of the questions we keep being asked by the media).  And the days of Michael Jordan's emasculating an erstwhile industry leader would be over.

What made EDS particularly vulnerable to institutional investors' whims is their high ownership stake.  As we pointed out in our "Hedging the Bets" report (Mar 2004), EDS has the highest (91%) instructional holders' share of the Top 8 IT services firms we analyzed.  By contrast, Accenture (31%) and Perot Systems (41%) are the least exposed to Wall Street's mood swings (see the above chart).

EDS's first quarter loss, and its continued lackluster sales performance, failed to inspire confidence that its current leaders know which end is up (see EDS endures an anemic quarter, TheStreet.com, 4/27/04).  Given that most Wall Street analysts look for guidance from management of the companies they follow before publishing their own forecasts, is there any wonder institutional investors did not know which end was up, either?

Closing the Barn Door...

As usual, Wall Street analysts are closing the barn door after the horse is already gone.  Fourteen of 25 analysts that Thompson First Call monitors now have the "sell" or "strong sell" recommendations on EDS.  Three months ago, only 10 of them did.  

A year ago, these analysts' earnings per share estimates were 96% higher than the actual profits/losses turned out to be.  Yet they are still seeing blue skies ahead for EDS.  Their forecasts for fiscal years 2004 and 2005 are 148% higher than they were 12 months ago.  We suppose that's also using EDS Jordan's forecasting methodology of "flaunting flop as feat?"

With in-house research like that, is there any wonder institutional investors do not know which end is up, until they realize eventually that the blue sky they were seeing was actually painted on a creaky floor?

Moody's in the Mood to Reduce EDS to Junk?

Moody's seems to be in the mood to reduce EDS' credit rating to junk level, according to a Reuters report published after the markets closed on Friday April 30.  In the last two months, S&P and Fitch Ratings have both already cut EDS' rating to just one notch above junk.  Now, with the company's first quarter red ink still not quite dry, and its negative cash flow continuing, Moody's downgrade could be a stinger for the company's stock and bonds.

Perhaps anticipating a negative reaction by the debt watchers, the EDS Chief Executive Michael Jordan told the Wall Street analysts in February a downgrade would not be "fatal," but would be "inconvenient."  

Well, it remains to be seen just how "inconvenient" it really is.  Which self-respecting Fortune 500 CEO would sign off on a large new outsourcing deal with a provider whose credit-rating is at junk level?  It seems to us that the company's already disappointing new contract sales may take another dive if Moody's mood turns out to be as glum as Reuters suggested today.

As you saw in EDS' first quarter financial release, the new contract sales were $4 billion, up 33% from the year before.  But the first quarter of 2003 was the company's worst sales record in the last five years, as EDS leaders and the market place were preoccupied with the change at the top (see "EDS CEO Replaced", Mar 2003).  Compared to the first quarter of 2002, the last "normal" first period in which the company sold $7.2 billion of new contracts, the EDS' latest sales results were down 44% (see the chart). 

More than just making an "inconvenient" dent in EDS' stock and bond armor, a Moody's downgrade may also rattle the already shaken confidence of the company's biggest customers.  One of them, General Motors, for example, the EDS' largest customer that accounted for $2.3 billion of 2003 revenues, is expected to award at least half of the business that's coming up for renewal this year to other IT services vendors, according to informed sources.  

Ouch!  So the ailing Navy contract isn't the only big headache with which EDS has to deal while protecting its existing business from eroding and trying to sell new contracts.  And that's no small challenge even without the credit rating downgrades.

Dividend Cut, New Ad Campaign

NEW YORK, May 11 -  Moody's may still be contemplating a possible EDS credit rating change to "junk" status, but the company is taking steps to try to ward it off, or at least blunt its impact on its stock.  

EDS said yesterday that it may cut its dividend by two-thirds in order to maintain its investment-grade credit rating, according to a filing with the Securities and Exchange Commission.  The company also said it was considering raising more than $1 billion of additional capital by issuing equity and/or equity-linked securities.

EDS followed up its Monday's financial filings with a news release this (Tuesday) morning, announcing what it said would be "an aggressive, integrated print and broadcast advertising campaign." Using the tag line "EDS. Manpower. Brainpower. Willpower," the campaign highlights the company's ability to face tough challenges and win, EDS said.

And what the the market think of EDS' "ability to face tough challenges and win?"  It turned its thumbs down.  The stock dropped over 8% to $16 per share in this morning's trading on the New York Stock Exchange (see the chart).

Sounds like a rough start for, what appears to be, an expensive ad campaign.  For a company that's 91% owned by institutional investors to be spending large amounts of money trying to convince the public (!) it has got is act together, is like the Yankees trying to win fans by plastering their billboard ads all over Boston or Tampa.

"These ads reflect the strong, can-do spirit and winning attitude that define the way EDS approaches a challenge," said Tom Mattia, vice president, EDS Global Communications and Advertising, in a release. "As our renewed corporate positioning begins to gain traction, we decided it was time to deliver an aggressive, unfiltered message to the business community. EDS is moving forward with confidence, is in fighting form and is here to stay."

Judging by this morning's stock market reaction, rather than convince the "business community" that EDS is here to stay, the new ad campaign may hasten the company leaders' eventual departure.  For, its ill-timed message proves that they are out of touch with reality, and fresh out of new ideas.

Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2004 IT Services: EDS: On a Wink and a Prayer (Apr 2004); HPS Wins by a Nose! (Octathlon 2004); Accenture: Burning the Track (Mar 2004);  IGS: "Crown Jewel" Restored? (Mar 2004); HP: Still No Cigar (Feb 2004); Cap Gemini: Another, Smaller Loss (Feb 2004); CSC: Good Quarter Gets Boos (Feb 2004); EDS: "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); IT Industry: Whither Goeth It? (Jan 2004); Cronyism Is Alive and Well at EDS" (Jan 2004)

2003 EDS: “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 EDS: 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).


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Volume XX, Annex Newsflash 2004-09
April 29, 2004

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

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