Annex Newsflash 2005-35                                November 1, 2005

An OPEN Client Edition



Updated 11/04/05, 8:20AM PDT (adds Fujitsu, EDS Form Server Alliance)

Analysis of EDS's Third Quarter Business Results

Tap Dance Lifts Stock

EDS Ekes Out Meager Profit; Stock Rises on Surge in New Bookings, Bullish Executive Forecasts

NEW YORK, Nov 1 - The boogie-woogie tap dance that EDS executives performed after the markets closed today would have made Fred Astaire proud.  The company's third quarter earnings provided the musical backdrop. By contrast to the year ago results (whose actual release was delayed twice), when the Plano, Texas, IT services company lost $153 million or 20 cents per share, EDS executives claimed this evening a "pro forma" net income of $101 million, or 19 cents per share.  This compared to third quarter 2004 "pro forma" net profit of $57 million, or 11 cents per share, EDS said.

But when you strip away all the boogie-woogie "steps" with which EDS finessed its latest results (see the Note below), the net profit was only $8 million, or 2 cents per share.  In short, meager.  How meager?  That's a 0.16% profit margin.  (Beats a loss though).  Third quarter revenues were $4.9 billion, up 3% from the year before.  Again, not much to write home about.

But there is always the blue sky ahead.  That's what EDS has been promising for the last two-and-a-half years since Jordan took over as CEO.  This time, however, even Barron's picked up the chant this weekend, in advance of the latest earnings release.

Recognizing that EDS is trading at 22.8 times next year's earnings compared with 17.4 times for rival Accenture and 15.1 times competitor Computer Sciences (CSC), the Barron's nevertheless concluded that "its (EDS) earnings are poised to rapidly rise, while its rivals are probably near their peaks."

Buoyed by such endorsements, and undaunted by a lack of logic in Barron's assertions, the EDS stock rose 2.5% today before the earnings release.  Given the meager actual profits, and a tepid revenue rise, how do you suppose the stock market reacted to the news this evening?  

It tacked on another 4% to EDS's market cap in after-hours trading, setting a new high for the year!  No surprise there.  Check out our 2004 year-end Annex Bulletin titled "EDS: Titanium Stock."  Here's an excerpt:

EDS: Titanium Stock Revisited

WESTERN AUSTRALIA, Dec 31, 2004 – It’s always good to have friends in high places, the kind that pull you up when you’re falling through thin ice.  Well, Michael Jordan, EDS’ CEO, evidently has lots of them on Wall Street.  Together they’ve build EDS into a “titanium[1] stock” while skating on thin ice.  And that’s quite a circus act…

Nothing seemed to faze the EDS investors this year.  Not a slew of additional bad news about its Navy deal.  Not the credit downgrades.  Not the new job cuts.  Not even the twice-delayed release of quarterly results by its auditors.   And certainly not a poor business performance.  The EDS shares kept going up in the second half of 2004 as if the company were a thriving concern.  

Text Box:

How’s that possible?  It is.  If you have friends in the right places.  Even last year, when the EDS stock exhibited the same trading pattern (see the chart), the company had the highest institutional shareholding of any IT firm we follow (91% vs. 56% for IBM or 66% for HP, for example).

(Excerpt from Annex Bulletin 2004-27, Dec 2004)

As you can see, what Barron's predicted was merely a pattern that has been repeating itself in each of the three years that Jordan has held the EDS helm.  The stock went down early in the year, and then rose at the end, so institutional shareholders that own over 90% of the company can report nice portfolio valuations at calendar year end.

As for EDS' meager business results... what's that got to do with anything?  Clearly, EDS is tap-dancing to a special Wall Street drummer playing off a different sheet of music than its competitors. 

“Our results demonstrate continued progress as we execute efficiently, deliver for our clients, win new business and secure renewals,” said Michael Jordan, EDS's CEO, in a statement worthy of the industry's top spin masters and "fluff maestros."

The boastful comment comes across as something the Accenture CEO, for example, would have had good reasons to make, as the company reported last month arguably the best quarter of all times ("Accenture: A Whopper Quarter", Oct 2005).  But Accenture prefers to let the results speak for themselves, leaving the chest-beating and shouting to its less successful competitors. 

New Bookings, Cash Flow - Two Success Stories

New Bookings.  Speaking of success stories, there have been two in particular that stood out in EDS's today's release.  First, the new bookings surged to $5.3 billion, up 83% since a year ago on a "pro forma" basis (excluding A.T. Kearney).  They were up 61% as reported.

But as you can see from the above chart, the EDS new contract sales in the three years under Jordan are dwarfed by those between 1999 and 2003, when Dick Brown was ousted as CEO.

Furthermore, despite EDS' latest quarterly surge, IBM continues to outsell its second largest competitor by a wide margin (see the above chart; the 2005 figures are our estimates based on 9-months' of actual results).

Free Cash Flow. Second, EDS posted free cash flow of $440 million in the third quarter, an improvement of $126 million versus the year-ago period.  And cash flow has been a bane of EDS when its "megadeals" went sour.  For the full year, the company expects free cash flow of about $600 million, assuming the planned sale of A.T. Kearney to its officers goes through.


As a result of this divestiture, EDS adjusted its full-year 2005 guidance for revenue and EPS as follows:

  • Adjusted full-year revenue of $19.9 billion to $20.1 billion (as we had predicted before - see the chart below);
  • Full-year new bookings of approximately $20 billion; and
  • Adjusted "pro forma" EPS of 55 to 60 cents

The company also confirmed its guidance for 2006 full-year free cash flow of $800 million to $1 billion.

As good as this cash flow forecast sounds (EDS had missed several such forecasts in the last two years), one should put even this success story in perspective.  A much smaller Accenture, for example (about three-quarters of EDS size), generated $1.6 billion in free cash flow in its last fiscal year (ended Aug 31, 2005).  That's double the low end of the EDS forecast for next year!

Meanwhile, the EDS stock is now trading at about 24 times next year's projected earnings (vs. 15.5 times for Accenture's).  So given all the foregoing, which stock is a better buy?  

Hm... that's a tough question. J

Fujitsu, EDS Form Server Alliance

Two companies to challenge IBM, HP along new technology front

NEW YORK, Nov 4 - Fujitsu and EDS formed a new server alliance today as the two companies announced that EDS would become an integrator and distributor of Fujitsu's Intel-based servers.  Calling it a global Technology Alliance Agreement, the two companies said Fujitsu would provide EDS with its "high-performance computing platforms such as the PRIMEQUEST line of mainframe-class servers," along with its Stylistic and LifeBook Tablet PCs.  Under the agreement, Fujitsu platforms will be incorporated in EDS' solutions and are expected to be available to enterprise customers worldwide starting in North America.

Fujitsu plans to sell 2,000 units of its Primequest servers to EDS over the next three years, a Fujitsu spokeswoman told Reuters in Tokyo.  That is part of Fujitsu's plan earlier this year to sell 10,000 units of the new servers using Intel Corp.'s Itanium 2 processors in three years, bringing in some 150-200 billion yen ($1.28-$1.71 billion) in revenues, Reuters said.

Tokyo investors reacted favorably to the news, boosting Fujitsu's shares by almost 4.5 points to 785 yen, close to the 52-week high of 819 yen.

"Our goal is to deliver the latest innovations in mainframe application migration to our clients," said Larry Lozon, vice president, Data Center Services, EDS, in a statement. "With the Fujitsu PRIMEQUEST Intel Itanium-based servers, EDS expects to deliver the most reliable and cost effective solutions in an open environment with the same level of performance and reliability previously enjoyed by our customers in a mainframe environment."

"Intel welcomes the technology alliance between Fujitsu and EDS,"
said Kirk Skaugen, General Manager, Server Platforms Group, Intel

"Fujitsu looks forward to seeing our mission-critical technology being incorporated in solutions from EDS, a company with a wealth of global outsourcing and system integration experience," said Akira Yamanaka,
Corporate Vice President, Fujitsu Limited.

Sounds like a challenge to IBM mainframe, at least on paper?   Except that calling the Itanium-based servers "mainframes" doesn't make them mainframes.  That's a distinction that one earns in the IT industry by delivering the mainframe-class performance and functions.

Meanwhile, the formation of this technology alliance is a step in the direction we suggested back in July 2004 Fujitsu might take if it is to be considered a truly global player.  Here's an excerpt from that Annex Bulletin:

...Setting its sights on EDS as a possible acquisition target could be a way for Fujitsu to kill two birds with one stone.  It could become the second largest IT services provider in the world, practically overnight.  And it could acquire a widely recognized global brand name.  With some spit and polish, and with new (American) leadership, EDS could easily regain its former luster.  And Fujitsu would finally break out of its 25% to 30% overseas market share barrier.  It would be a win-win deal.

Do Messrs. Akikusa and Kurokawa have what it takes to carry out such a bold play? Time will tell… 

(An excerpt from "Back in the Black," Annex Bulletin, July 26, 2004)

Well, this new technology alliance is certainly not an acquisition.  Only fools or the ignorant would be buying EDS at its current inflated stock prices.  But it is a second step that the two companies have taken which is bringing them closer together.  The first one took place back in March when they partnered in a major win of a U.K. Defense "megadeal" (see "Whitehall Rumor lifts EDS, Fujitsu shares," Mar 1, 2005).

As a Technology Alliance Partner, Fujitsu said it is "looking forward to working closely with EDS to provide outstanding platforms for EDS' solutions."  And we can see why there is much upside in the relationship for Fujitsu from a global market share viewpoint.

From an EDS standpoint, however, the company may be losing one of the important marketing advantages that a "pure" IT services firm has over IT conglomerates, such as IBM or HP.  The EDS customers may no longer consider it to be "color blind" when it comes to technology selection.  

Whether or not such a "penalty" is worth the price will depend on how good a deal Fujitsu is offering EDS on its new servers.  One would hope, for the sake of EDS shareholders, that they are priced considerably lower than the competitors' offerings to make business sense.  As for the Fujitsu shareholders, well... they can always applaud the market share gains.  For now.

Either way, Fujitsu-EDS-Intel seem to be forging a new technology front along which they may challenge IBM and HP.

Happy bargain hunting!

Bob Djurdjevic

NOTE re. EDS 3Q05 Financial Moves: Third quarter 2005 pro forma net income excludes after-tax losses of $105 million (20 cents per share) for discontinued operations on the planned sale of A.T. Kearney; $31 million (6 cents per share) for expensing stock options and the issuance of performance-based restricted stock units; and $15 million (3 cents per share) for reserves related to shareholder litigation. It also excludes pre-tax divestiture-related gains of $85 million (10 cents per share) and a $9 million (1 cent per share) reversal of previously recognized restructuring expenses.

Third quarter 2004 pro forma net income excluded a 46 cents per share NMCI asset impairment charge and an aggregate 5 cents per share positive impact related to restructuring charges, discontinued operations, divestiture gains, and contract termination costs true-up.

For additional Annex Research reports, check out... 

2005 IT:  Big Blue Thinks Small Is Big (Oct 2005); Fujitsu's Cautious Optimism (Oct 2005);  Global Investments: Yin-Yang Pacific Tsunamis (Oct 2005); IBM: Springboard Quarter (Oct 2005); Top Wall St Firms Bump Up Investments  (Oct 2005); Accenture: A Whopper Quarter  (Oct 2005);  Global Investments: New "Drang Nach Osten" (Sep 2005);  HP: Sweet Turnaround (Aug 2005);  Dell Spooks Street (Aug 2005); 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 2005-35
November 1, 2005

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

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