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Analysis of Computer Services Corp.’s FY03 Business Results

Less Than Meets the Eye

Stock Rose Nearly 10% after Earnings Release, But Look Under the Hood

PHOENIX, May 16 - The fact that Computer Sciences Corp.’s (CSC) stock rose nearly 10% following its fourth quarter and full fiscal year 2003 earnings release on May 13, goes to show you how easy it is to pull the wool over Wall Street analysts’ eyes.  Goldman Sachs, for example, one of the most respected Wall Street firms, even upgraded the stock the following day, giving the CSC shares’ rise additional impetus (see a May 14 Reuters wire report). 

An even greater PR yarn-spinning feat for CSC was that its market cap soared by over $600 million on the day the Dow Jones, IBM, EDS and other major competitors’ shares declined (see “CSC Zigs as IBM, EDS Zag…”-chart).

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So what’s wrong with that?  Well, take a look under the CSC hood… 

·     What you will see is a growth engine that is losing market share in the commercial sector not just to bigger rivals, such as IBM, EDS, Accenture etc., but even to the companies half its size (CGE&Y, for example). 

·     What you will also find is a competitor who is trying to mask its lack of success by spending big money on big acquisitions of bigger fellow-“death merchants” (such as DynCorp - see “Back to the Future,” Feb 5 and the Pentagon Top 50 list).

·      What you will see is a company whose only growth engine is the federal government business - that CSC had been de-emphasizing in the 1990s.

·      What you will find is a vendor with some of IT services industry’s lowest profit margins.

·      What you will see is a company with the lowest price/earnings ratio (14) among the rival IT services firms (IBM - 28, Accenture - 20; EDS - 16.4, etc.).

In short, check under the CSC hood for additional flaws, and you will find an engine that’s a lot less than meets the eye.

Declining New Contract Sales

Take CSC’s new contract sales, for example, perhaps the best indicator of what’s ahead for companies with annuity-type income streams, such as IT services firms.  The company reported $7.7 billion in new business awards during its latest fiscal year (ended Mar 31), versus $11.4 billion during the previous 12 months.  That’s a 32% drop!

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Worse, that’s a poorer sales record than even that of a competitor half CSC’s size (CGE&Y - $7.5 billion revenues; $9.4 billion new contract sales in 2002), who is having problems of its own.  CSC’s latest Book-to-Bill ratio was 0.7 versus 1.3 for CGE&Y.  But unlike CSC, which is being rewarded by Wall Street for its apparent “successes,” CGE&Y is being punished for its shortcomings by the Paris bourse (see “The Ten-year Glitch,” Mar 3).

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A broader comparison of CSC’s latest sales record with IT services industry’s top competitors shows that this California-based company has by far the worst Book-to-Bill ratio of the Top 5 competitors.  In fact, CSC’s FY03 ratio was only about half that of the other top four vendors (see the above charts).

Shrinking Commercial Revenues

This means that CSC’s past is looking better than its future when it comes to internal growth.  And that its expected FY04 revenue growth (to between $14.3 billion to $14.7 billion, according to the company’s release, or to $14 billion, per our forecast), will come basically from its DynCorp acquisition.  Strip that away, and you have a shrinking company. 

Without DynCorp, CSC’s FY04 revenues would be $11 billion, down from $11.3 billion.  Its commercial business will decline by about 5% from FY03 (it had already dropped by 6% in FY03).  And its erosion will be even steeper in the U.S. (down 9%).

That leaves the U.S. government as CSC’s only real growth business.  “With the increasing demand for IT services within the U.S. federal government, and our recent acquisition of DynCorp, we are very well positioned to benefit from the opportunities this market presents,” CSC’s CEO Van Honeycutt agreed in a prepared statement.

He added that the 35-month federal pipeline (of new contracts) now exceeds $39 billion, of which about $23 billion is scheduled to be awarded by March 2004, the end of CSC’s fiscal year.  The implication being, of course, that CSC will get its share of this business.

As is often the case with CEOs who cannot boast about current or past sales achievements, Honeycutt and other CSC executives who spoke during the May 13 teleconference with Wall Street analysts talked a lot about “opportunities.”  He used the word no less than three times in three successive paragraphs of the CSC release.

What CSC didn’t say is how it planned to convert these “opportunities” into profitable future business, given its dismal past sales record and the market share losses in the global and U.S. commercial IT services arena.  And that is what sets successful CEOs apart.  Or conversely, that is what sets up opportunities for more successful companies to try to gobble up their less fortunate rivals (see “IBM: Save, Spend and Split,” May 5 and “IGS Investing in Growth,” Apr 20).

Slim Margins

Such takeover opportunities are usually accentuated if the target company loses money or has meager profit margins.  Enter CSC, again.  Its FY03 net margin of 3.9%, although up from 3% in FY02 and 2% in FY01, is still less than even that of beleaguered EDS in a “bad” year (5.2% in 2002), a company whose stock has been also severely punished by Wall Street.

And the more CSC becomes dependent on its federal government business with its strict competitive tender rules, the less likely it is to improve its profit margins.  If in doubt, just check out again EDS and its once ballyhooed U.S. Navy “megadeal,” that has just cost the company $334 million in first quarter 2003 pretax charges.  Profit margins?  That’s a dirty word in this instance.

Also, as CSC is trekking “back to its future,” it’s facing a “death merchant’s” worst nightmare - that peace may break out.  In which case CSC would once again look like fish out of water among the top global IT services competitors, as it did when the Cold War ended. 

Granted, this may be a far-fetched fear given Dubya’s imperialistic agenda.  But governments change, as do their policies.  Prudent business leaders take that into account when devising long-term strategies.

In short, CSC is a lot less than meets the eye.  But as usual, it will probably take Wall Street some time to discover it.

Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2003:  "Less Than Meets the Eye" (May 16), "Back to the Future" (Feb 5)

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

A selection from prior years: Analysis of CSC calendar 2000 results (Mar 26, 2000), CSC's FY2000 Business Results (May 10, 2000), Business Is Humming Nicely (Nov 3, 2000),  CSC 3Q2K, CIO Survey (Feb. 29, 2000), CSC: A Mouse That Roars? (Nov 1998)

Or just click on and use appropriate  keywords.














































Volume XIX, No. 2003-11
May 16, 2003

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

P.O. Box 97100, Phoenix, Arizona 85060-7100
TEL/FAX: (602) 824-8111

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