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Annex Bulletin 2006-44                              December 11, 2006

A CONFIDENTIAL Client Edition

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INDUSTRY TRENDS

Updated 12/18/06, 10:30AM PDT, adds Market Update...

Analysis of Institutional Shareholdings of Top 8 U.S. IT Services Companies

Hedging the Bets

Four Major IBM Institutional Holders Exit the Stock, But New Believers Pick Up the Slack and Then Some

HP Stock Nearly Doubles, Some Major Holders Exit, Taking Profits

Accenture: Value Marries Price, Shares Setting All-time Highs

EDS, the "Titanium Stock", Continues to Confound, Defy Common Sense, Reason

CSC's Roller-Coaster Ride

BearingPoint: Resilience in the Face of Adversity

Major ACS Owners Bail Out amid Options Scandal

Perot Systems Shares at New Multi-year Highs

Summary: Hedging the Bets

SCOTTSDALE, Dec 11 - For decades, this Wall Street institution has been a stalwart Big Blue supporter.  Through thick and thin; through feast and famine; through triumphs and foibles of IBM's able and feeble leaders, this Wall Street institution stuck it out with the company that the Watson's built.  Well, no longer.  Merrill Lynch is out.  No longer among the top 10 IBM institutional shareholders, not even among the top 25, Merrill has been watching the recent rise of the Big Blue shares from the sidelines.  And probably gritting its teeth...

For, IBM shares are up about 30% since their nadir on July 18.  And even the sometimes fickle Wall Street media are now singing praises to "The New IBM," like Barron's, for example, in a Dec 3, 2006 cover story.

But the IBM stock is still down 1% from two years ago.  As you can see from the above chart, the Big Blue shares have not really fully recovered fully from the Apr 15, 2005 shockwave that sent institutional shareholders scrambling like mice before a cat (see "Slammed and Dunked," Apr 2005).  Which means that IBM shares are still relatively depressed compared to some major competitors' stocks that more fully participated in record Wall Street market highs (see "IBM: A $125 Stock?", Nov 2006).  More grit for Merrill's mill.

But Merrill was not alone to desert Armonk.  Deutsche Assets, Northern Trust and Oppenheimer, among some prominent Wall Street firms that have been longtime big IBM fans, have also exited the list of top 25 shareholders.  In fact, net sellers outnumbered net IBM buyers among the institutional holders by 701 to 453 in the quarter that ended Sep 30 (see IBM table).

But, "one man's trash is another man's treasure," they say.  Blackrock Financial, Brandes, Clearbridge Advisors and State Farm, among others, have picked up the slack.  And then some.  The new buyers as a group were more aggressive than the sellers.  As a result, the new IBM stock acquisitions outpaced the sold-out positions by 3.6 million shares (see IBM table).  

In fact, seven of the top 10 IBM institutional shareholders have added to their positions since two years ago.  So it looks like "doubting Thomas's" like Merrill et. al. are being gradually outvoted.  And if the IBM stock continues to climb the charts, as we expect it to, there will be more opportunities for its former owners to grit their teeth in frustration.  Provided, of course, they have any teeth left.  But they may have an ax to grind - for abandoning the Big Blue ship so early.

HP Stock Nearly Doubles, Some Major Holders Exit, Taking Profits

By contrast to IBM's, the HP stock has nearly doubled in the last two years (up 95% to just under $40 per share - see the chart). 

This means that the HP stock has outperformed the Dow, of which it is a part, by nearly six-fold during the same time frame, despite a record overall market surge.  And most of this gain came since Mark Hurd took over as CEO in April 2005.  

Obviously, such a stock performance has given some major HP institutional shareholders a chance to take profits and get out, or to substantially reduce their holdings.  Banc of America, Brandes, Merrill Lynch, Putnam, T Rowe Price were some of them.  The HP boardroom crises that became big headline news in September, may have also played a (small) part (see "New King of the Hill," Nov 2006).  

But others may have seen that as a buying opportunity.  Goldman Sachs, JP Morgan Chase, BNP Paribas, Blackrock Financial, Legg Mason, Wellington... were among the institutions that have substantially added to their HP positions.

Overall, however, the net institutional sellers outnumbered the buyers by 539 to 433 in the quarter that ended in September.  And the sold-out positions also exceeded the new buyers' stock by 188 million to 171 million shares (see HP table).  Nevertheless, the HP stock has maintained its upward momentum since then, perhaps leaving the net sellers wondering if they had exited too soon?

Accenture: Value Marries Price, Shares Setting All-time Highs

It does not happen often these days on Wall Street that value marries price.  Accenture is one such exception.  The company that is regarded even by most of its peers as the "best of breed" in the global IT services market, is also treated as an "MVP" (Most Valuable Player) by the stock market.  

Accenture's shares are up 41% since two years ago, trading near its all-time high of $35, set last month.  And its shareholders seem to know a good thing when they own one. 

Eight of top 10 owners have added to their positions as the stock kept climbing the charts.  And not just the biggest institutional holders.  The net buyers outnumbered the net institutional sellers by 211 to 163 in the latest quarter, grabbing up 37 million shares versus 24 million shares that had been sold (see Accenture table for more details).

Aim Investments, Bank of Ireland, BNP Paribas, Goldman Sachs, Legg Mason, Putnam Investments, Templeton, UBS... are among the institutions that have contributed to the record amounts of new money that has poured into the Accenture stock.  Together with the longtime holders that have also boosted their positions, such as Barclays, Vanguard Group, T Rowe Price and Amvescap, for example, these Wall Street firms are ensuring that value stays married to price in Accenture's case.

EDS, the "Titanium Stock", Continues to Confound, Defy Common Sense, Reason

By contrast to Accenture, the EDS stock is the epitome of divergence between value and price.  As we have been saying for years, EDS shares have continued to confound common sense and reason.  For a while it seemed that the company could do no wrong.  The worse the news got, the better the stock did (see “EDS: The Titanium Stock,” Dec 2004 and "EDS: A $6 to $9 Stock?," Feb 2005).  That was because the company has the highest institutional shareholding percentage of any company we follow (93% - see EDS table).  And Wall Street certainly knows how to cover its tracks and protect its positions.

, EDS

Since that time, the EDS performance in the global IT services marketplace has improved somewhat, but still hardly enough to warrant a 30% jump in its stock market prices since two years ago.  Here's what we said about its fundamentals earlier this year:

Net earnings jumped six-fold to $24 million on revenues of $5.1 billion, up 7% over the corresponding period a year ago.  Alas, even this vastly improved profitability means a mere 0.5% net margin at the bottom line.  Such is the fate of a megadeal-chaser.

EDS's new contract sales make the same point in spades.  The company hailed an apparent 45% boost in new contract signings, from $6.9 billion in 1Q05 (restated from $7.1 billion) to $10 billion in the latest period.  But take away the renewals of the 2006 megadeals (GM, U.S. Navy), and the big U.K. MoD $3.85 billion megadeal win in 1Q05, and what is left is a 23% decline in net new bookings (down 18% from the restated 1Q05 total).

(An excerpt from "Up and Down Quarter," May 2006)

Undaunted by the company's underwhelming fundamentals, top EDS institutional shareholders continued to hang on to their holdings, some even adding to their positions.  In fact, even of the top 10 holders boosted their EDS positions since two years ago. 

Alliance Bernstein, TCW Group, Calamos, Deutsche Investments, Equinox, Templeton and Hotchkis & Wiley were among the biggest EDS boosters.  Of course, there were some detractors or profit takers, too.  Pacific Financial, Capital Research, Lord Abbett and (again) Merrill Lynch, for example, dropped from the top 25 list.

And some smaller institutions also chose to head for the door.  Overall, sellers outnumbered the buyers of the EDS stock in the third quarter by 190 to 172.  And the sold-out positions exceeded the new ones by 47 million shares to 27 million shares.  But then, the bulls seemed to have kicked in again in the fourth quarter, probably from among the existing 93% institutional holders, defending their positions, and pushing the EDS price at close to its two-year high of $28 per share.

Ex-EDS Sales Chief Named Top Dell Services Exec: Market Unimpressed

SCOTTSDALE, Dec 12 - Dell has tapped the former EDS sales chief to lead the computer maker's global services organization.  As senior vice president of global services, Steve Schuckenbrock will report to CEO Kevin Rollins and serve as a member of the Dell Global Executive Management Committee. He will begin work with Dell on Jan. 8.

But the markets were unimpressed by the news.  EDS stock was actually up 0.4% this morning, while Dell's dropped 1.8%.  We think such a reaction was erroneous on both counts.

Schuckenbrock had previously served as COO and EVP of global sales and services for EDS.  He left EDS in May of this year, after being squeezed out by Ron Rittenmeyer, whom EDS promoted a week ago to President.  Before joining EDS in 2003, Schuckenbrock was COO of consulting firm The Feld Group, which EDS acquired nearly three years ago (see "EDS Buys Feld Group," Jan 2004).

While at EDS, Schuckenbrock was well thought of by his peers and subordinates, by contrast to Rittenmeyer, who was evidently Michael Jordan's (chairman) favorite.  

An EDS insider described Rittenmeyer last May as "a junior Dick Brown. Good I/T knowledge, zero outsourcing knowledge, and completely full of himself."  By contrast, "Schuckenbrock was well thought of and had been steadily rounding out his outsourcing knowledge.  Rittenmeyer over-shadowed him with bombastic BS."

"In short, heads dropped (at EDS) with this announcement" (of Schuckenbrock's leaving the company, and Rittenmeyer taking over), this person summed it up.

Well, one main's loss is another man's gain.  To us, it looks like Dell has gained a good man.  But judging by this morning's market reaction, it may take a while for Wall Street to come around to seeing it that way, too.

CSC's Roller-Coaster Ride

The CSC stock has been on a roller-coaster ride in the last two years.  It went down steeply in the first half of 2005, bottomed out by late summer, and rose to a five-year high of $60 in the spring of this year.  

Then a series of disappointing announcements drove the CSC shares down into the $40s by late August (see "Up for Grabs," May 2006 and "Ebb Time Lowers Most Boats," Aug 2006).  The stock has since recovered some of its luster, but it is still down 4% compared to the level two years ago.

The top CSC institutional shareholders have been remarkably steady through all this turmoil.  That is not surprising, considering that CSC is the second most highly held stock, with 91% institutional ownership share (after EDS' 93% share).  Sure, there have been departures from the top 25 list, and newcomers to it, as you can see from the above chart.  But overall, the net sellers and the net buyers were fairly well balanced.

In the third quarter, for example, the net sellers of CSC shares outnumbered the net buyers by 255 to 163.  But the net positions change was only 1.5 million shares (in favor of sellers), out of some 157 million shares owned by the institutions (see CSC table).

BearingPoint: Resilience in the Face of Adversity

For most of the last two years, BearingPoint shares were treading water, trading in the $8 to $9 range.  The stock was as high as $9.6 and as low as $7.4 in the last 12 months, finishing last week down 5% from Dec 6, 2004.

Operating without the published and audited financials for much of the last two years, investors have had to make their bets basically on their hunches and the reputation of Harry You, a former Wall Street executive, whom the company brought on board as CEO in March 2005 (see "Where You-turn Means Upturn," May 2006).  Under the circumstances, we think it is absolutely remarkable that the BearingPoint stock has shown such resilience in the face of adversity.  

But operating on faith and hunches is not everyone's favorite style of investing.  No wonder, therefore, that there has been a wholesale changeover of BearingPoint institutional shareholders in the last two years.  Only nine of top 27 institutions from Dec 2004 were still among the top 25 as of Sep 30, 2006.  

The biggest among the institutions that have kept the faith and have boosted their BearingPoint positions were UBS, Barclays, Vanguard Group and Wellington.  The newcomers included the Wall Street powerhouse Goldman Sachs, as well as smaller institutional investors, such as Thornburg and Glenview.  But the biggest new bet was made by Ariel Capital, which is now the top shareholder of BearingPoint with 29 million shares.  

Overall, net buyers outnumbered the net sellers by 96 to 83.  The new positions exceeded the sold-out positions by 2.85 million shares (see BearingPoint table).

Major ACS Owners Bail Out amid Options Scandal

SCOTTSDALE, Dec 12 - By the time ACS closed its barn door on the options scandal on Nov 27, announcing that its CEO and CFO had resigned, many of its major institutional holders had already bailed out. 

As of Sep 30, the sold-out positions outpaced the new positions acquired by the institutional shareholders by 24 million shares to 9 million shares.  Sellers outnumbered the buyers by 247 to 128 during the third quarter.  As a result, institutional shareholdings now hold only 64% of the total shares outstanding, versus 90% two years ago.  Correspondingly, the insiders' ownership rose from 8% in Dec 2004, to 13% now.

And that's when the ACS shares were relatively stable.  The stock lost most of the 22% value drop in 2006 between March and June (see above chart).  ACS shares are down 16% since two years ago.

ACS said on Nov 27 that its internal investigation concluded that "certain conduct" of CEO Mark King and CFO Warren Edwards "violated the company's code of ethics for senior financial officers." The investigation was initiated in response to an informal inquiry by the SEC, and a subpoena from a grand jury in the Southern District of New York, the company said.  The probe reviewed ACS's stock option practices from 1994 through 2005.

More than 150 companies, including CSC, for example, have launched internal investigations or are the subject of probes by the SEC to determine if the dates of stock options were manipulated, according to a Nov 27 AP story.

Perot Systems Shares at New Multi-year Highs

Perot Systems shares are setting new multi-year highs.  At $16.10, they are up 3% from the price two years ago, which was also a multi-year high.  For the smallest company among the top 8 IT services firms that we have been analyzing, Perot's stock has been a model of stability (see Top 9 chart).

Attitudes of the major institutional Perot Systems' shareholders reflect that, too.  There has not been much change among the top holders, as most institutions chose to hang on to the winner.  In the third quarter, for example, the buyers and the sellers were fairly balanced - 5.5 million shares bought versus 5.3 million shares sold.  Buyers also outnumbered the sellers by 77 to 70.  "Steady as she goes," seems to be the Perot Systems modus operandi.

Summary: Hedging the Bets

As may be fairly obvious by now from the preceding analyses, the HP stock was by far the best performer among the top 8 IT services firms whose institutional shareholdings we have analyzed.  It was followed by Accenture and EDS, in that order.

The cellar was reserved for ACS and BearingPoint.  No surprise there, as each company has had its share of troubles in the last two years.  Ironically, the two are joined in the cellar by IBM, a company that has reported enviable fundamentals lately.  Which is another illustration of just how much the Big Blue shares are still undervalued.  And how unforgiving the marketplace has been to IBM for having missed its first quarter 2005 numbers by such a wide margin (see "Slammed and Dunked," Apr 2005 and "IBM Stock Grossly Undervalued," July 2006).

Overall, the market caps of the top 8 IT firms have risen by 25% since two years ago.  Interestingly, only three companies (HP, Accenture, EDS) actually experienced double-digit increases.  ACS was the only one with a double-digit decline.  

EDS and CSC continued to enjoy the highest institutional ownership shares (93% and 91% respectively).  But ACS, which also used to have a share in the 90s, has now dropped to only 64%.  Accenture continues to have the lowest institutional share at 49%.  The average for the top 8 IT services firms is 61%, unchanged from that two years ago.

That Accenture has attracted the most new money from the top 10 Wall Street institutions in the last two years should not come as a surprise.  The company has had stellar business results.  So the 164% increase in its "mind share" (the investments of the top 10 institutional holders) seems like an appropriate recognition of that fact.

But that EDS should beat out HP for the second spot in "mind share" (85% to 78%) is nothing short of mind-boggling.  It goes to show us just how important the institutional ownership is, and how powerful the largest institutions can be in controlling the stock prices of their favorite investment targets.  One major difference between EDS and HP, besides HP's far superior business results, is that EDS' institutional ownership stands at 93%, while HP's is 77%, up from 70% two years ago.

Finally, hedging the bets as what Wall Street institutions do well.  Notwithstanding the differences in fundamentals of the top 8 IT firms covered in this report, the top 10 Wall Street investors in high tech own a little bit of most of them.  

So Barclays, for example, the biggest high tech player on Wall Street nowadays with $13.6 billion invested in the top 8, has placed $5 billion bets each on IBM and HP each, followed by $1.7 billion on Accenture, $1.1 billion on CSC, and half a billion dollars on EDS.  In fact, Barclays owns a piece of each of the top 8.  Talk about covering all bases!  

Similarly, State Street, the No. 2 technology player, has its biggest bets on IBM and HP, with smattering of other investments in EDS, CSC, ACS and Perot.  Merrill Lynch, on the other hand, No. 9 among the top 10 Wall Street players two years ago, with $1.4 in top 8 high tech investments, is nowhere to be seen, replaced by Goldman Sachs' $2.8 billion+ IT portfolio.  

And so on... the top 10 Wall Street institutions' investments in the top 8 leading IT firms has jumped by 29% since December 2004 to $74 billion (see Top 10 Summary).  

As you can see, you don't have to be a hedge fund to hedge your bets.  The biggest Wall Street players are doing it day in and day out.  It's only the suckers hope to win by making individual bets.  Good luck to them!

For detailed holdings, click on IBM, HP, Accenture, EDS, CSC, BearingPoint, ACS, Perot, Top 10 Summary.

Happy bargain hunting

Bob Djurdjevic

Market Update: Up, Up and Away

IT Companies Lead the Market Surge; Accenture, IBM on Top; Record Dow: Low Man on Totem Pole

SCOTTSDALE, Dec 18 - Major IT companies are leading the latest market surge.  How do we know it?  Take a look at the charts...

Accenture and IBM, for example, which rose again this morning to new record highs, are exceeding the record highs that the Dow is also setting.  In fact, all three are higher than HP, the top IT stock in the last 18 months in terms of stock market performance.

For the year, however, HP is looking on top.  So Accenture and IBM are now only catching up to HP's earlier gains. Meanwhile, the record Dow, of which both IBM and HP are a part, is still the low man on the Wall Street totem pole.

A broader view of major IT stocks shows similar trends.  All but two (Intel and Dell) have outperformed the record Dow in the last 12 months. Clearly, the IT stocks are leading the stock market surge.  Funny you don't see much about that in the financial press... 

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Volume XXII, Annex Bulletin 2006-44
December 11, 2006

Bob Djurdjevic, Editor
(c) Copyright 2006 by Annex Research, Inc. All rights reserved.
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