Annex Newsflash 2005-21                                  May 26, 2005



Updated 5/30/05, 10:45 PM PDT (adds Accenture, CSC, BearingPoint)

Analysis of Institutional Shareholdings of Top 8 U.S. IT Services Companies: Conflict or Confluence of Interest? 

Merrill's New Bull

Merrill Lynch Boosts EDS, Sees Virtue in Dismal Results of Company in Which It Has Vested Interest

Institutions Dump IBM

HP New Institutional Favorite, But Not Merrill's

Accenture Boosters Outnumber Doubters

BearingPoint Gets New Cheerleaders

PHOENIX, May 26 - Isn't Wall Street research supposed to be blind? (i.e., independent of each brokerage firm's investment interests).  If so, Merrill Lynch would have a hard time making such a claim stick.  Its today's EDS upgrade, that lifted the EDS stock by 2.7% to $20, sure smacks of a self-serving recommendation (see the chart). Why?

Because Merrill owned nearly 10 million EDS shares as of March 31, and has been a major accumulator of this stock.  Acting as "white knight," Merrill acquired about 88% of its EDS portfolio in the last six months, as EDS came under pressure due to its dismal business performance.

As you can see from the above chart and from our earlier reports ("EDS Booster Club Fees Rise," Mar 2005), Merrill was the most aggressive buyer of EDS shares in the fourth quarter of last year, topping all other major institutional shareholders.  The brokerage firm acquired another 1.56 million EDS shares in the first quarter of this year.  And now, it's plugging the EDS stock.  A "coincidence," a conflict, or a confluence of interests?

But Merrill was not alone in rushing to the defense of the EDS stock, and of its own interest in it.  As EDS shares dropped in the first three months of the year, there was a buying frenzy among the institutional investors.  Only one major holder - Capital Research - the fourth largest EDS shareholder, reduced its holding by an appreciable percentage in the first quarter (Capital Research sold off 3.7 million shares or about 10% of its EDS portfolio).  Some have added massive amounts of stock (see the above chart).  

Yet before the Merrill upgrade, the EDS shares were still down about 16% since the start of the year.  So you can imagine the blood bath that would have occurred with EDS shares had the market been allowed to work freely, without such massive interventions by large holders with self-serving interests.

As you can see from the client-only ownership tables, the EDS sellers outnumbered the buyers 197-172 in the first quarter.  But there were enough big institutional buyers to swing the pendulum upward - by 9.38 million shares.

Merrill Toots EDS', Own Horn, Disregards Facts

Meanwhile, if you still have some reasonable doubts about the Merrill bias, few should remain after you read what the company said about the latest EDS business results.  Merrill analysts tooted EDS' horn, and therefore, their own firm's interests, with complete disregard for objectivity and facts.

"While EDS is still in the midst of a multiyear turnaround, we now see less downside risk in the shares," Merrill researchers said, according to a Forbes May 26 report. The research firm cited EDS' continued progress with restructuring as well as better visibility into free cash flow. 

"In contrast (to its competitors), EDS reported an inline first quarter with no specific contract issues," the Forbes quoted Merrill about its upgrade.

"An inline first quarter?"  Check out our contemporaneous report on the EDS first quarter ("EDS Misfiring on All Cylinders," May 2005).  Looks like Merrill Lynch is also misfiring on all cylinders.  Here's an excerpt:

And what a (first quarter) release it was... All of EDS business segments were sputtering and declining.  No exceptions.  Here's a 13-point sampling:

  1. Revenues were down 5% as reported, or down 7% on an organic basis;

  2. GM revenues were down 8% (down 9% on an organic basis)

  3. Non-GM revenues, the company's supposed "growth engine," were down 5% (down 7% on an organic basis);

  4. New contract sales were down 15% ($3.25 billion vs. $3.8 billion), excepting the one megadeal the company won in the U.K. (worth $3.85 billion), on which EDS may see no profit until 2007 at the earliest, while the contract puts a new strain on its already strained cash flow (see "Rumor Lifts EDS', Fujitsu's Shares," Mar 2005);
  5. Speaking of cash flow, free cash flow was a negative $82 million even before the new U.K. cash drain/strain hits the bank;

  6. Net earnings were a meager 1 cent per share.  The company predictably lowered its forecast for 2005 to 40 to 50 cents per share from 50 to 60 cents per share (see "A $6 to $9-Stock?" Feb 2005);

  7. Operating margin was 1%, one-ninth of what it had been in the last year under Michael Jordan's predecessor (Dick Brown);

  8. America's revenues were down 3% from the year-ago quarter;

  9. European revenues were down 12%;

  10. Asia/Pacific revenues were down 2%;

  11. U.S. government revenues were down 5%;

  12. The U.S. Navy contract revenues were down 27%.  The contract posted an operating loss of $57 million;

  13. A.T. Kearney revenues were down 12%.  The unit posted an operating loss of $11 million, and has been put on the chopping block.

Now, compare the preceding 13 facts about EDS' first quarter performance with its CEO's bullish proclamation, and then you'll see just how much bull can come out of some executive bullhorns.

(An excerpt from "EDS Misfiring on All Cylinders," May 2005)

And not just out of executive bullhorns... Wall Street's, too.

Merrill New Bull

In 1971, the famed Wall Street firm launched the advertising tagline, "Merrill Lynch is bullish on America."  For better or worse, the firm has been linked to its bull mascot ever since.  It still graces its corporate logo (right).  Some 34 years later, however, what remains of it is just the bull the company serves out.  Such as its EDS upgrade.

Bull or not, the Merrill recommendation put about $275 million into EDS's market cap, and proportionately added a share of it to its own $190 million+ EDS portfolio.  But the stock is still down 13% for the year.  So self-serving advice can be expensive, as we pointed out in "EDS Booster Club Fees Rise" (Mar 2005).

Institutions Dumped IBM Well Before April Crisis

PHOENIX, May 27 - IBM problems became widely discernible on April 14, the "Black Thursday," when the company made a surprise announcement of its first quarter results ("IBM: Slammed and Dunked," Apr 2005).  But major institutional shareholder had been dumping Big Blue shares well before that.  Our analysis of the Top 10 Big Blue holders as of March 31 shows that nine of them had reduced their IBM portfolios in the first quarter (see the charts).

The sellers of the IBM stock outnumbered the buyers by 700-521.  More importantly, they were big sellers.  Overall, the institutions reduced their IBM holdings by over 22 million in the first quarter (see the client-only ownership tables for more details).  And then came the Black Thursday (April 14 - see "IBM: Slammed and Dunked").

Despite the recent recovery in the value of its shares, IBM's market cap is down 24% since the start of the year.  It's the steepest drop of any among the Top 8 U.S. IT services companies whose institutional ownership we analyze.  We see no reason for it in IBM fundamentals (see "Tweaking Big Blue," May 2005).

Selling IBM and buying EDS?  It's an investment strategy likely to backfire in the long run.  It's an upside-down view of the IT world.  But then, Wall Street's is sometimes an upside-down view... (see "An Upside-Down View," Mar 2005).

HP New Institutional Favorite, But Not Merrill's

PHOENIX, May 27 - There is no better time to look for value than in the middle of a storm.  That seems to be the message institutional buyers and sellers of Hewlett Packard's shares are sending from the first quarter.  Both believers and doubters took active and strong positions amid executive turmoil (see "Carly's Fickle Fans," Feb 2005).  They placed big bets both ways.

In the end, the believers prevailed - by about 96 million shares - even though the institutional sellers outnumbered the buyers by 541 to 371 (see the client-only ownership tables for more details).  As a result, HP is the only stock among the Top 8 U.S. IT services firms whose value has risen since the start of the year (up 5%).  And so has the institutional ownership share (from 67% to 70%), as the public preferred to stay out of the storm.

Within that big picture, there are some sub-plots that boggle the mind.  "Merrill Lynch, for example, HPs favorite broker in the stock buyback transactions", as we put it in our HP 4Q04 report, as well as in our Institutional Shareholdings 4Q04 (Mar 2005), dumped 8.8 million shares in the first quarter of the stock whose buybacks it was supposed to be plugging.  This reduced Merrill's HP holdings by 18% - the fourth most aggressive seller among the major institutional shareholders.  With fickle "friends" like that...

The top three big sellers of HP shares in the first quarter were Banc of America, Putnam Investments and Morgan Stanley.  The top three boosters Capital Guardian Trust, Private Management Capital and Brandes Investments Partners.  Capital Research, HP's largest shareholder, also added to its positions by acquiring 18.5 million shares, up 12%).

Accenture, CSC Boosters Outnumber Doubters

PHOENIX, May 29 - Accenture was another stock that attracted active trading in the first quarter, with a number of its largest holders taking opposite views.  Some sold it off, some added to their positions.  

Morgan Stanley, for example, the fifth largest Accenture shareholder in early 2004 and the company that helped Accenture go public and lead secondary financing offer, has sold off most of its holdings.  On April 8, the day after Accenture's latest earnings release (see "Accenture: Roaring Ahead," Apr 2005), Morgan Stanley also downgraded the stock.  Deutsche Bankers Trust, another company that downgraded Accenture in early April, also reduced its holdings by 8%, while JP Morgan sold off 17% of its portfolio.

Mfs Investments, on the other hand, the second largest Accenture shareholder, increased its stake by 16% during the first quarter.  So did American Century Investments, Blair (William) & Co., and Fidelity - each of which added over three million shares to their Accenture portfolios.

Overall, the boosters outnumbered the doubters by 180 to 129, and outbid them by a total of 2.3 million shares (see the client-only ownership tables for more details).

The CSC boosters also outnumbered the doubters, though by a narrower margin than in Accenture's case - by 234 to 216.  And 13 of top 15 CSC shareholders added to their positions in the first quarter, giving the company a resounding vote of confidence.  But that was not enough to keep the stock from falling by 16% to-date in 2005 (see the client-only ownership tables for more details).

The fact that CSC's institutional ownership increased from 80% to 86% in the first quarter may give us a hint as to why the stock dropped despite the strong institutional support.  It appears that while the large holders generally stayed loyal to the company, the "public" and smaller institutional owners voted with their feet.

BearingPoint Gets New Cheerleaders

BearingPoint, the only Top 8 IT services stock to rise in our last report on institutional shareholders ("EDS Booster Club Fees Rise," Mar 2005), slumped in late April before recovering some of the lost ground in May, on the news of some of its new contract sales.  But this still leaves it down 17% for the year (see the chart).

But there was no shortage of cheerleaders among BearingPoint's top institutional shareholders in the first quarter, when Harry You, formerly of Oracle, Accenture and Morgan Stanley, took over as CEO (see "BearingPoint's $3.4 Billion-Man", Mar 2005).  Eleven of top 15 holders added to their positions, some massively.  Brahman Capital, Columbia Management Advisors and Glenview Capital, for example, all three new to the top 15, placed four million shares or higher initial bets on BearingPoint's recovery under the new management.  Overall, the institutional buyers outbid the sellers by 16.6 million shares, and outnumbered them 90 to 81.


The top 10 institutional shareholders of the top 8 U.S. IT services firms mostly held their ground in the first quarter at about a $54 billion investment level.  IBM and HP continue to be the most popular choices, though there is some evidence that some investors have shifted their money from IBM to HP.

As a result, HP is the only stock among the top 8 whose market cap actually increased (by 5%) since the start of the year.  Given the robust market conditions that most of these companies are reporting, they may be good buying opportunities in the current quarter.

Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2005 IT: Merrill's New Bull (EDS) (May 2005); IBM Trumps Trump (May 2005);  Tweaking Big Blue (May 2005); Hurd's First RBI (May 2005); Dell Rings the Bell (May 2005); Stock Buybacks: The Phantom Is Back (May 2005); EDS Misfiring on All Cylinders (May 2005);  HP Surges, Dell Slumps; Lenovo Completes IBM Deal (May 2005);  Capgemini Jettisons Healthcare in N.A. (Apr 2005); HP: From India to Poland (Apr 2005); IBM: Slammed and Dunked (Apr 2005); Hurd Advice: Up Mount Market Cap (Apr 2005); Accenture: Roaring Ahead (Apr 2005);  Fujitsu Unveils New Servers (Mar 2005);  EDS Executive Suite; HP's New CEO (Mar 2005);  An iSeries Revival (Mar 2005); EDS Booster Club Fees Rise (Mar 2005);  An Upside-Down View (Mar 2005);   The Worst of Both Worlds (Mar 2005);   Octathlon 2005: Accenture Wins (Mar 2005);  IBM Global Services: Smaller, Shorter - Better? (Mar 2005);  IBM 5-yr Forecast: Quality over Quantity (Mar 2005); Rumor Lifts EDS', Fujitsu's Shares (Mar 2005); Capgemini: Turning the Corner (Feb 2005);  IBM Servers to Grow Again (Feb 2005);  Carly's Fickle Fans (Feb 2005);  CSC: Gearing Down on Purpose (Feb 2005);  EDS: Grossly Overpriced Stock (Feb 2005);  IBM Historical Update: 2004 Shot in the Arm (Feb 2005); New HeadTurners Series #1 (Feb 2005); IBM: A Crescendo Finale! (Jan 2005); Accenture: Strong Finish, Better Start (Jan 2005); Annex Coverage 2004: IT Services Dominate (Jan 2005)

2004 IT: EDS: The Titanium Stock (and other Wall Street tales) (Dec 2004); IBM PC: Good Riddance (Dec 2004); Fujitsu: Recovery Continues (Nov 2004);  IBM Server Renaissance (Nov 2004);  HP Hits Home Run (Nov 2004); Capgemini: Revenue, Stock Soars (Nov 2004); EDS: Jordan's Swan Song? (Nov 2004);  To Russia with Love and $ (Oct 2004); IBM: Slow Quarter No Longer (Oct 2004); Accenture: Revenues, Profits Up, Stock Down (Oct 2004); Capgemini: A Takeover Target? (Oct 2004); Sellout of America (Oct 2004); Spy Wars (Sep 2004); Outsourcing Boomerang (Sep 2004); EDS to Cut Up to 20,000 More Jobs (Sep 2004); Capgemini Stock Plummets on Unexpected Loss (Sep 2004); HP Savaged by Wall Street (Aug 2004); Moody's Lowers the Boon on EDS (July 2004); HP: Delivering Value Horizontally (June 2004); Accenture: Revving Up a Notch (June 2004); Beware Your CFO! (May 2004)IBM: Changing of the Guard (May 2004); Capgemini: Texas-size Home Run (May 2004); Following the Money (May 2004);  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)

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Volume XXI, Annex Newsflash 2005-21
May 26, 2005

Bob Djurdjevic, Editor
(c) Copyright 2005 by Annex Research, Inc. All rights reserved.

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