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IT SERVICES

Analysis of Computer Sciences Corp.’s Third (Fiscal) Quarter Results

Back to the Future

Revenue, New Contract Sales Down, Profits Up; DynCorp Acquisition to Propel CSC into a Pentagon Top 10 Supplier

PHOENIX, Feb 5 - Computer Sciences Corp. (CSC) was the first major IT services company to reports its business results for the calendar fourth quarter 2002 (its third fiscal quarter) since IBM’s encouraging Jan 16 earnings release.  And the CSC picture wasn’t so pretty. 

CSC’s revenues were down 3.5% while its earnings jumped by 20%.  But its new contract sales - a good indicator of what revenues can be expected ahead - were down sharply.  The third (fiscal) quarter new business closings were only $1.8 billion, down from $3.2 billion a year ago, and only one-tenth of IBM’s in the same period ($18.1 billion - see “IBM: Start of a Real Turnaround?,” Jan 2003). 

Undaunted, Wall Street cheered CSC’s results the day after they were released.  After boosting the company’s shares by almost 10% at one point today, investors settled for a 5.3% gain on a down Dow Jones day.  The CSC stock closed Wednesday at $32.38.

Not even delays in signing of the two CSC megadeals (with the German Army and with Consignia, a British mail delivery service) dampened Wall Street’s enthusiasm.  Nor a warning by the CSC chairman and CEO, Van Honeycutt.

“The decision cycle continues to be elongated,” Honeycutt said. “We're quite confident there will some significant decisions made in the near term. We're equally confident they'll be made in our favor. The pipeline is as good as it's ever been, but it's a little difficult to get them closed.”

This, of course, sounded like similar stories we have been hearing throughout 2002 from various IT services vendors.  The fact that CSC is still singing the blues, while the Big Blue seems to be facing bluer skies, suggests that IBM may be gaining share in the high end corporate market.

Indeed, while CSC’s revenue from federal government contracts rose 7% in the latest quarter, the revenue from commercial customers fell by 7%.  The latter comprises 71% of CSC's total revenue, with the rest coming from the federal government.

Back to the Future

The growth of CSC’s government business and the contraction of its commercial revenues implies that the company may be making a trip “back to the future.”  During a seven-year period in the 1990s (1991-1998), CSC underwent one of the most dramatic transformations in the computer industry.  Its business changed from a 66% government vs. 34% commercial, to 25% government 75% commercial.  

The change was driven by the belief that, with the end of the Cold War, the growth in the commercial sector will outpace that in government spending.  This was true, of course, in the early and mid-1990s.  But now things have changed.  As we’ve noted before, after the 9/11 events, the world has been becoming one giant global war economy.

So CSC is changing its tack, too.  It’s going back to its roots.  CSC’s $950 million acquisition of DynCorp, the 13^th largest supplier on the Pentagon Top 50 list, announced in December and expected to be completed this quarter, will make CSC one of the Top 10 Defense Department vendors.  And it will change its FY04 revenue mix to 43% government vs. 57% commercial.

We expect CSC’s FY04 revenues to be about $14 billion, up 25% from FY03 (which ends March 31).  Its earnings are likely to grow by 22% to $3.12 per share. 

Perhaps that was the main reason for Wall Street’s optimism despite the woes CSC is experiencing in the commercial sector.  The company’s CEO also played up the health of the government business in his remarks that accompanied the third quarter release. 

“The U.S. federal government is one of the world's largest spenders for IT services and our competitive position in that market is excellent,” Honeycutt said. “The total federal IT budget for the government's fiscal 2003 is materially greater than last year… the Department of Defense budget shows the largest increase in approximately 20 years.”

Of course, such a big boost in spending at a time of lean pickings elsewhere in the commercial sector is also attracting other IT vendors to the government market like flies to honey.  EDS is No. 40 on the Pentagon Top 50 list, for example, while Dell is No. 34.  Even IBM, the company that got out of the federal market when it sold its Federal Systems Division to Loral in 1994, has now staged a comeback to the Top 50 list.  The Big Blue ranks as the 49^th largest Pentagon supplier, having received $380 million in the Department’s 2002 spending.

All these vendors and others, too, are hoping to win a slice of the federal government pie that CSC’s Honeycutt characterized as “a 26-month federal pipeline of approximately $24 billion, which is about evenly split between civil agencies and the Department of Defense.”

Sector Analysis and Outlook

For the full fiscal year 2003 (which ends March 31), we expect the CSC worldwide revenues to be down by about 2% to $11,200 (without any DynCorp revenues).  The U.S. commercial sector will likely drop by about 8% to $3.2 billion, while the international business, except for Europe, will decline by about 9% to $1.15 billion.  European revenues are expected to shrink by about 1% to $2.9 billion.

CSC’s government business, on the other hand (once again excluding DynCorp), is likely to rise by over 9% to $3.2 billion.  After the DynCorp purchase, CSC’s federal government revenues are likely to be about $6 billion in the fiscal 2004.

So once again, CSC is poised for growth by acquisitions.  And once again, it is returning “back to the future.”

Happy bargain hunting!

2002:  Analysis of CSC FY02 results (May 17, 2002), "A Disastrous Quarter!" (Apr 17, 2002), “Tough Times, Soft Deals,” (Apr 25, 2002)

Volume XIX, No. 2003-03
February 5, 2003

Editor: Bob Djurdjevic
Published by Annex Research
e-mail: annex@djurdjevic.com

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