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Analysis of Electronic Data Systems’ Second Quarter Business Results

Sales Soar, Revenue Flat

“Pruning” of Unprofitable Contracts; Stock Buybacks, Leave Some Scars

Text Box: Confident!
 
Dick Brown
PHOENIX, July 28 – Electronic Data Systems (EDS) second quarter revenues were flat, in line with the company’s warning in mid-June that revenues would be “softer than expected.”  That’s when the EDS stock took a huge dive (down 38%, or $11 billion in market value, in about 18 hours - see the chart on page two), following first a selective, then a public, disclosure about slower 2Q00 growth. 

Yet the EDS new contract signings soared to $6.1 billion in the latest period ($10.6 billion for the first half of 2000) - making the 2Q00 the sixth consecutive quarter of record new business sales. 

“Restructuring of EDS is working,” pronounced a confident Dick Brown, the CEO and chairman, during a teleconference with analysts that followed the EDS earnings release.  “We’re hitting on all cylinders.”

That may be.  But one could not glean such a perception without looking under the hood. 

Why not? 

Well, consider our headline: “Sales Soar, Revenue Flat.”  Does that seem logical to you taken at face value?  If so, you may be ready for a job in Madeleine Albright’s State Dept.[1]. 

For those of you who were as perplexed as we were about this apparent dichotomy, there is a good explanation.  But one must look under the EDS hood to find it.  Brown may be right when he also boldly proclaimed during the session with analysts that, “revenue growth is coming.”  Text Box:

And here’s why…

In line with the “new broom sweeps clean”-type Wall Street expectations, when Brown and his new executive team took over the reins of EDS 18 months ago, the company has slashed costs and expenses to the tune of over $1 billion.  Prior to EDS’s mid-June financial PR debacle, the stockmarket applauded and rewarded its shareholders for such deep cuts.

But the new EDS management has slashed a lot more than just costs and expenses.  In what the company called “divestitures and contract pruning activities,” more than $500 million of revenues have also disappeared. 

Over half a billion dollars in revenues is a heck of a lot acreage being “pruned.”  Millions of companies would “kill” for the privilege of being able to grow to the size of the limbs EDS has been severing. 

Yet in the global IT services business jungle, eliminating low-margin or unprofitable contracts may be even more important for EDS’s long-term longevity than slashing costs and expenses.  It’s kind of like getting rid of bad blood - the medieval doctors’ remedy “for all patients and all seasons.”

Still, more than $500 million in revenues is a heck of a hole to fill with new business just to be flat with prior year’s results.  Even after six record quarters.  That’s more than $4 billion in new business sales, assuming an average contract length of eight years.  That’s about half of the much-ballyhooed Perot Systems, for example, the “second coming” of the EDS’s founder, Ross Perot [“much ballyhooed” - because having shot up to nearly $70 per share following its January 1999 IPO (initial public offering), the Perot Systems stock has now sagged to about $9].

If EDS’s new management is to be faulted for anything, it is for not explaining this more clearly to analysts, investors and shareholders.  As they had done so well, for example, with their cost and expense cuts. 

This was no “pruning.”  This was evidently a long overdue “slash and burn” activity. 

You fight fire with fire.  You burn the underbrush to deprive the nature of the “fuel” that can destroy mature trees in uncontrolled forests fires.  And what follows such a “controlled burn” is life; a life richer than the one that had preceded it.  As EDS is showing.

Any farmer or forestry engineer can tell you that.  But we can see why the EDS management may have been reticent about using such analogies on Wall Street.  When was the last time you saw a farmer or a forestry engineer there?  J 

So what kind of a growth can we expect in the future, now that the smoke is clearing, and the “slash and burn” activities are winding down at EDS?

Look for a mid- to high-single digit “organic” growth in the third quarter, according to the company’s CFO, Jim Daley.  And for a low- to mid-teen double digit increase in the fourth quarter.

“Organic” growth?  So EDS may be into trees and forests, after all?

Not really.  It is just the term the Plano, TX, company concocted.  It is supposed to connote an apples-to-apples (here we go, back to nature again! J) growth, after adjustments for one-time events and currency translations.  It’s an “EDS speak” term, so to speak. J

Kind of like another EDS only expression - “base” revenues. 

“Base?  What sort of a base?  Army, Navy or Air Force?”, uninitiated observers may be wondering. J

Actually, the “base” revenues are supposed to mean all EDS commercial business except for General Motors revenues, its erstwhile owner, and now still the company’s largest customer.

Don’t ask us why GM business was evidently considered “off base,” or “baseless” by the previous administration.  At $3.4 billion in 2000 revenues, despite the recent declines (down 8% in 2Q00), and its shrinking profitability, GM is still more of a “home base” for EDS than any other customer - new or old.

Whatever… Food for thought, perhaps, for the next EDS global “PR” meeting?

For what it’s worth, the company did announce last week that Tom Mattia had been named the head of the EDS Global Communications.  Guess this former Lincoln Mercury “PR” executive ought to know the difference between GM and Ford, as well as between being on or off base… J

Business Segment Analysis

Meanwhile, in terms of geographic regions, the growth in Latin America, especially in Brazil, is “exploding,” the CEO Brown said.  Indeed. 

EDS’s Latin American new contract signings soared by 1,250% over those a year ago.  Europe and Canada weren’t too shabby, either, surging by 96% and 88% respectively.

The Asia/Pacific new business growth was only 2%, but that’s the next area the EDS CEO said he was expecting to explode.

Which leaves the good old and slow United States of America.  For EDS, anyway.  The new business sales in EDS’s largest market (58% of revenues in 1999) were flat in the second quarter.  Which can help explain the “explosive,” $20 billion IBM new sales in the second quarter.  At EDS’s expense in the U.S. market?

Some Stock Buyback Scars

The stock buyback program that EDS had announced in the third quarter of last year (see "EDS Earnings Down, Stock Up," Oct. 1999), and which it has since mercifully abandoned (at the end of 1999 - see "A Real 4Q Slam Dunk", Jan. 2000), did leave some scars on its financial statements.  

Some $54 million of the $160 negative free cashflow in the second quarter was due to increased long-term debt used to finance the 1999 buybacks.  As a result, EDS's debt-to-capital ratio jumped from 28% a year ago, to 38% in the latest period.  Over time, however, this should start to decline, now that the company is no longer repurchasing its shares, the CFO Daley said.

Happy bargain hunting!

Bob Djurdjevic


[1] As the Russian president, Vladimir Putin, shook Madeleine Albright's hand before a Sunday (June 4) meeting during the Moscow summit, Bill Clinton tried to explain the meaning of the three brown pins depicting monkeys on the lapel of her jacket. He said they represent, "see no evil, hear no evil, speak no evil." "That's Madeleine's entire foreign policy," Clinton added.  He could have also said, “monkey see, monkey do.”  But that would have been too much truth for a Slick Willy.

NOTE: The print edition of this report, of course, contains additional charts and tables not included here.

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Volume XVI, No. 2000-19
July 28, 2000

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

P.O. Box 97100,      Phoenix, Arizona 85060-7100
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