Annex Newsflash 2005-17                         May 3, 2005

IT SERVICES

Updated 5/03/05, 8:15 AM PDT (adds "Charts")

Analysis of EDS' First Quarter Business Results

Misfiring on All Cylinders

Yet Stock Up in After-Hours Trading!?

PHOENIX, May 3 – His ship is listing and misfiring on all cylinders, but the captain is talking from the bridge of blue skies and prosperity.  At least that's what Electronic Data Systems (EDS) CEO would have his unfortunate passengers and uninitiated spectators believe.

“EDS got off to a solid start in 2005, as our operational improvements continued to gain traction,” said Michael Jordan, the CEO, in a statement. “...At this point, we believe EDS is on track to deliver on our long-term turnaround goals.”

"Long-term turnaround goals?"  The EDS captain has had more than two years to turn his ship around, yet the vessel keeps taking on more water each passing quarter.  The only kind of turnaround talk that's appropriate when it comes to Jordan's EDS is one of a failed turnaround.  

Yet the stock market keeps giving both Jordan and EDS more rope.  In after-hours trading on May 2, the stock was up about half a point following its first quarter earnings release.

And what a 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.

Business Segment Analysis

Was there some good news about the quarter?  There was.  The U.K. megadeal win hasn't yet kicked in.  When it does, it will bleed some more red ink to the bottom line for at least the next two years.  Wall Street analysts expect it to lower 2005 profit by about 20 cents, according to a May 2 Wall Street Journal report.  The company is estimating it at 10 cents per share in 2005, along with $250 million in negative cash flow.

Another upside is the business process outsourcing segment (BPO), according to the company.  It's the only business segment that grew in the first quarter.  As you can see from the EDS chart, it grew by 1%, and it accounts for only 13% of the total business.  And that's worth sinking $450 million into? (the amount of Towers Perrin acquisition price and related costs, according to Bob Swan, the CFO).

By the way, when EDS first reported its BPO revenues in fourth quarter 2003, they were about $0.7 billion of 12% of the business.  Now they are 13% of revenues, which is only $0.6 billion, down 7% since 4Q03.  

In fact, since the first quarter 2003, the last one under the Dick Brown administration, EDS revenues are down 8%, led by a 24% decline in outsourcing.

So what else is EDS doing about its declining business; its shrinking profitability and its negative cash flow?  It's selling off assets - 22 real estate properties to be exact - hoping to raise about $200 million.  That's some "strategic" fix for "long-term turnaround goals!"

As we've said before, given a myriad of negative factors that are evident in EDS' business, the only way we can explain the rise in its stock price in after-hours trading is because of its extraordinarily high institutional ownership (see "EDS Booster Club Fees Rise," Mar 2005).  Take that away, and EDS would be a $6 to $9 stock, instead of the current $19.43 price, just as we said three months ago.

Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2005 IT: 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); 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); IBM PC Deal Okayed (Mar 10, 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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