Annex Newsflash 2005-26                             July 30, 2005



Updated 8/04/05, 1:10 PM PDT (adds New Mañana Banana, Research Zigs, Investors Zag)

Analysis of EDS' Preliminary Second Quarter Results 

EDS Ups Its Forecast

PR Spin Tries to Mask Sales Debacle: Worst Quarter in Seven Years; New "Mañana Banana"; Research Zigs, Investors Zag at Two Wall Street Firms

PHOENIX, July 30 - "Speak softly and carry a big stick," the famousTheodore Roosevelt Teddy Roosevelt quote, seemed to be the guiding principle of Fujitsu's and Capgemini's recent forecast upgrades.  Both companies did better than expected in the marketplace, and lifted the guidance for the short-term earnings outlook.  But electing prudence over ebullience, they left the full year forecasts intact.

Now compare that with today's EDS earnings "pre-release," for example.  It seems to have chosen ebullience over prudence.  EDS has all the earmarks of a company that shouts loudly and carries a small stick.

How small?  Take the new contract sales, for example (see above chart).  The company said it sold only $2.8 billion of new business in the second quarter.  Which makes it EDS' worst three-month period since the fourth quarter of 1998 that precipitated the then change of EDS leadership (from Les Alberthal to Dick Brown).

EDS' new contract sales were dismal in the last two years even before the latest debacle (2004 new bookings were down 39% from 2002, the last year of the Dick Brown administration).

During the last two years, IBM has outsold EDS by about 3-to-1 despite some woes of its own.  So EDS' second quarter sales debacle only exacerbates an already bad situation.

Yet Wall Street gulped up the medicine that EDS dished out and lifted the company's shares on Friday by about five points.  It's nice to have friends in high places that cannot be placated by bad business results.

And why did EDS feel compelled to raise its forecast? (besides the obvious PR reason - to mask its dismal sales record).  The company's release was short on details.  "Based on the company’s analysis to date, EDS expects to report second quarter 2005 net income of $26 million, or 5 cents per share and pro forma net income of $45 million, or 9 cents per share," the release said.

Wall Street was expecting a loss of about 5 cents per share, mostly based on an earlier EDS release that said that a significant portion of the $166 million of assets associated with a problem contract may be written down.  Now EDS has said it would record a charge of only $37 million, or 5 cents a share.

EDS also said it intended to raise pro forma earnings per share guidance for the full-year 2005 by 10 cents to a new range of 50 to 60 cents per share.  This excludes the impact of approximately 23 cents per share for stock option expensing, 6 cents per share for the issuance of performance-based restricted stock units, 3 cents per share related to first-half 2005 net gains from prior year divestitures, discontinued operations, and the reversal of a portion of previously recognized restructuring expenses, and potential one-time gains or losses from planned divestitures in the second-half of the year.

Bottom line?  EDS expects full year 2005 earnings per share of 24 to 34 cents per share.  Wall Street analysts were expecting an average of 42 cents per share.  So a possible 8 to 18 cents per share earnings forecast reduction is being cast as a 10 cent per share forecast upgrade.  And gullible Wall Street lapped it up.  At one stage on Friday, the EDS shares were up as high as seven points (see the chart).

Which means that EDS' PR spinners deserve an "A" for the number they've done on Wall Street.  But investment analysts also rate an "A" - for gullibility.  They've let fluff win over substance once again.

Stand by for EDS' actual second quarter release which is expected on Wednesday, Aug 3... of course, barring any more "pre-releases" between now and then.

EDS: New Mañana Banana

PHOENIX, Aug 3 - In the 1980s, IBM used to be known for overselling and underdelivering.  EDS has now become the new "mañana banana."  The company has been promising a better tomorrow for over two years now while delivering a today worse than yesterday.  

EDS' "official" second quarter release, issued after the markets closed today (Aug 3), is the latest case in point.  "EDS profit sinks, revenue dips," read the CBS MarketWatch headline.  The company's second quarter earnings fell to $26 million, or 5 cents a share, from $270 million, or 54 cents a share a year ago (on an "as reported" basis - the second quarter of 2004 included the proceeds of the sale of UGS PLM Solutions).  Organic revenue, which excludes the impact of currency fluctuations, acquisitions and divestitures, declined by 4%.  GM revenue declined 8% on an organic basis.

In our last week's report (see above), we also pointed out that EDS' $2.8 billion-second quarter new contract sales record was the worst three-month period since the fourth quarter of 1998 that precipitated the then change of EDS leadership (from Les Alberthal to Dick Brown).

So you'd think the stock would also sink?  Think again.  Wall Street may be producing more bananas than even the Central American "banana republics."  EDS shares were up 9.5% in after-hours trading (Aug 3) following the earnings release.  They had gained 3.7% to close at $21.29 in regular trading today. 

The reason?  For the first time, the IT services company gave "directional" 2006 pro forma EPS guidance, pegging it $1 or more.  That's far higher than the 66 cents per share consensus estimate, noted in its initial report.  It is this "mañana banana" forecast that lifted the EDS shares to $22.89.  That put them just under the 18-month high set in late December 2004 (see the above chart).

EDS CEO, Michael Jordan, said in a teleconference with analysts following the earnings release, that he was confident the company would meet its new contract sales guidance for 2005 of about $20 billion.  He added that he could see $5 billion alone coming from sole-sourcing deals that EDS has in the works, and another $5 billion from "churn."  EDS closed $9.9 billion in the first half of the year, but that included the $3.85 billion British Department of Defense megadeal (see "Rumor Lifts EDS', Fujitsu's Shares," Mar 2005).  Without that contract, EDS' new bookings were down 22% from the first half 2004.  Which was down 42% from the first half of 2002, the last year of the Dick Brown administration (the 2004 new bookings were down 39% from 2002 - see the above chart).

The company also said its full year 2005 revenues would be in the $20 to $21 billion range, matching our forecast at the lower range.  EDS expects an improved free cash flow of $500 to $700 million this year.  That appears to be a substantial jump from the $305 billion level in 2004.  But as we said back in February, "that excluded the $522 million 'pay-down on the NMCI securitization facility,' for reasons that remained unclear even after the EDS executive tap dance" (see "EDS: Grossly Overpriced Stock," Feb 2005).

Overall, it is clear that the EDS leaders are bullish about the company's future.  What else could one expect from an executive team that has promised so much and delivered so little in the last two years?  Since there is not much to boast about the past, so why not dream about a better mañana?

Annex Clients: Click here for detailed EDS 2005 forecast

Happy bargain hunting!

Bob Djurdjevic

Research Zigs, Investors Zag

PHOENIX, Aug 4 - EDS shares continued to rise this morning.  They were up 11% by noon EDT Aug 4, setting a new 52-week high of $23.95.  There is evidently no shortage of "mañana banana" buyers on Wall Street.  But not everyone was swayed by EDS' confidence, writes's Ronna Abramson in her today's column.

"The timing and precision of the calendar 2006 estimates and the high confidence level of a team often criticized for missing guidance targets has us puzzled," quotes a UBS analyst who maintained his neutral rating. "There wasn't anything incremental to help us form a more logical path to EDS' big improvement projected in 2006."

Consequently UBS said it was discounting the company's 2006 projections, "prefer(ring) to sit on the sidelines until we get a better understanding of the drivers of the improvement and are able to make some sense of the conflicting data points," the UBS analyst summed up his assessment.

Goldman Sachs also downgraded the EDS stock to "underperform" on July 20. "Our rating change is based on our concern that IBM's more competitive posture could pressure share performance in two phases: First, increasing investor focus on the changing competitive landscape, and then second, potential pressure on contract signings, margins and then earnings," said Goldman, according to an Aug 4 Forbes report. "The former should dampen near-term price performance, while the latter may take a year or more to materialize. As a result, we've retained our EPS estimates, but there could be a downward bias over time."

As of March 31, UBS Financial Services owned 2.71 million EDS shares, while Goldman Sachs Asset Management held 2.47 million shares.  Both institutional investors added to their positions in the first quarter (1.02 million and 1.42 million EDS shares respectively).  The trading data for the second quarter is not yet available.  

So while research zigged, the "buy" side of these two investment firms zagged.  It's refreshing to see something like that on Wall Street [by contrast to Merrill Lynch, for example - see "Merrill's New Bull" (EDS), May 2005].

For additional Annex Research reports, check out... 

2005 IT: EDS Ups Its Forecast (Aug 2005); Capgemini Beats Forecast (July 2005);  Fujitsu: Losses Reversed; Forecast Upgraded (July 2005);  IBM: Polaris Eclipses T-Rex (July 2005);   IBM Bounces Back (July 2005); Accenture: Smashing Records (July 2005); 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);  Fujitsu Revenues Flat, Lower Net (Apr 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)

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

Volume XXI, Annex Newsflash 2005-26
July 30, 2005

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

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