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Confidential Annex Research Client Edition


Analysis of Electronic Data Systems 1999 Business Results

A Real 4Q Slam-Dunk!

EDS Forsakes Stock Buybacks after Spending $1.8B in 1999 on Them

PHOENIX, Feb. 4 – When IBM reported its 1999 business results a couple of weeks ago, we called the “smoke and mirrors” performance by its CFO “A Slam-Dunk of Bunk!”  That’s because the Big Blue couldn’t even touch the rim in the fourth quarter, let alone slam the ball down the hoop.  And every NBA basketball coach, player or a fan knows that real winners make their “slam-dunks” in the fourth quarter, when the chips are down.

Well, let us present to you a real fourth quarter slam-dunk contest winner: EDS.  This IT services company was supposed to be on the ropes in 1998, amid executive turmoil and underwhelming sales. 

Forget that.  That was last season.  That’s ancient history.  EDS outsold and “out-dunked” the Big Blue in the fourth quarter of 1999 for the first time in recent history.  Final score: EDS $11.2 billion; IBM $10.3 billion.  In new contract sales, of course. 

Neither figure is too shabby a performance.  For IBM, that’s also its record quarter.  Except that even the Big Blue’s best still wasn’t good enough to beat a resurgent EDS. 

In IBM’s case it meant surrendering at least for one quarter the lead the world’s No. 1 IT services vendor had held for most of the 1990s.  And which had enabled IBM to overtake EDS as the world’s largest IT services company five years ago (see the chart on the front page). Guess “it ain’t over till it’s over,” to paraphrase the proverbial “English language expert,” Yogi Berra. 

But EDS will have to execute a few more “slam-dunks” before its 1999 comeback can be taken as a tell-tale sign that a former IT services champion is trying to reclaim its crown in the future.  Because for all of 1999, IBM Global Services (IGS) did outsell EDS by a wide margin ($38.8 billion vs. $24.9 billion in new contract sales).

Nevertheless, both companies exited the 20th century with backlogs of just over $60 billion, up about 20% in each case over the year before (1998).

Wall Street Cheers

So just as one “swallow does not a spring make,” one big slam-dunk does not win Text Box:  championships.  Only some games and lots of new fan cheers.  Which is what EDS got today on Wall Street following its release of the fourth quarter results.  Cheers and applause.  Lots of both... 

By the time the trading closed on Feb. 4, one day after the release of the EDS 4Q99 earnings, the EDS stock was up more than five points on the day at $75, just under its 52-week high of $76.

Since January 1999, when Dick Brown, the new CEO took over the reigns of EDS, the company’s stock has risen 43%, beating the Big Blue’s rise during the corresponding period of 26%.  Which means that the EDS chairman beat his Big Blue counterpart even in their one-on-one game in 1999.  No wonder Gerstner sounded an alarm last month. Since 1996, however, when IBM went on its stock buyback binge, the “fluff” continued to count more than substance.  IBM’s share are up 271% since September 1996, while EDS’s, even at the current high levels, are up only 22% since that time (see the chart)

Text Box:

Pullback from Buybacks

Which is why perhaps the most significant indication that EDS was on the road to try to recover its lost global IT services crown was its pullback from the stock buyback fad, with which the company flirted for the last two quarters in 1999, to the tune of $1.8 billion - at an average share repurchase price of $56. 

There will be no more such buybacks, except for those necessary to meet the internal needs of the company, such as stock option exercises, said EDS CFO, Jim Dailey, during the 4Q99 teleconference with analysts.

Judging by the deafening silence about the stock buybacks issue during the Q&A period, the significance of this quick and momentous reversal in EDS’s leaders’ attitude has evidently been lost on those on Wall Street whose job it is to deal in “fluff,” not substance.

Yet, EDS’ buyback reversal was quite simple and logical from the business fundamentals standpoint.  Thanks to EDS’s “sudden urge” to repurchase its own shares in the second half of 1999, the com/pany’s cash and equity dropped by 44% and 23% respectively, while its long-term debt shot up by 87%.  Just as IBM’s did after that company went on the buyback binge in 1996 (see Annex Bulletin 98-14, Mar. 28, and Annex Bulletin 98-38, for example). 

Text Box:  Which propelled the EDS long-term debt/equity ratio to 49% - roughly the level at which it was in 1996, when the first signs of trouble became discernible at this once conservatively managed company (see the chart and Annex Bulletin 96-51, Oct. 23). 

EDS shareholders should be grateful to the company’s management and its Board had the wisdom and the courage to back off from  stock buybacks, before following the Big Blue and other Wall Street lemmings off the cliff.

Business Segment Analysis

No that long ago, after the Southeast Asian financial crisis in 1997, some former EDS leaders sounded almost boastful that EDS was so weak in that market (and thus avoidedText Box:  


being hurt, like IBM, for example, the Asia/ Pacific market leader - see Annex Bulletin 98-07, Feb. 5).  Well, the current EDS management seemed more than pleased with the strength which the company showed in that market, especially during the fourth quarter, when the Asia/Pacific revenues surged by 18%, more than double the rates of growth EDS experienced in other world markets (U.S. grew by 6%, Europe by 9%).

“One of the biggest surprises for me personally” was EDS’ strong performance in the Asia/Pacific market, said Dick Brown, EDS’ CEO, during the teleconference with analysts.  He hailed EDS’s big wins in New Zealand and Australia, which Brown termed “a great success.”

For all of 1999, the U.S. business, still EDS’s biggest at $10.8 billion or 58% of worldwide revenues, was dragged down by the expected decline in its GM business.  As a result, the U.S. grew by only 4%.  European 1999 revenues increased by 14% to $5.4 billion, while the Asia/Pacific and Non-U.S. Americas’ business volumes exploded by 30% to $2.4 billion.

Why Smaller Is Better

But we were just as impressed with something the EDS executives did not stress during the teleconference, except in an oblique way, when they pointed out that EDS’ $24.9 billion in new 1999 sales consisted of more than 2,500 contracts.  Which puts the average contract value at about $10 million, over five times less than the corresponding figure in 1996, and more than an order of magnitude smaller than the average contract value in 1995.

Which is exactly what we suggested EDS should try to do, if it is to win back its IT services crown from IBM over the long hall:

“So what should EDS do instead?  Reach deeper DOWN in its customer pyramid, and try to woo smaller and medium size businesses, especially in Europe. 

Why especially in Europe?  Because Europe has many more smaller and medium size companies than does the much bigger U.S. IT market, where the concentration of wealth and market power is far greater.”

(Annex Bulletin 99-20, 6/26/99)

Why did we suggest that? Because IBM is only paying a lip service to the small and medium companies market, while milking its cash cows - the Fortune/Forbes 500 companies - for all they are worth.  Except that they are worth less and less every year, as smaller companies and even individuals, empowered by the Internet and the PC revolutions, are winning an increasing share of business from the giant incumbents (see “Death of the Corporation,” July 1999).  So smart executives who play to win over the long haul, will focus on faster growing small company and consumer markets.

Another reason we suggested this change of tack for EDS was that IBM leaders obviously have their Fortune 500 blinkers on.  Which means that EDS would face less competition and, thus enjoy, higher gross margins from such smaller deals.  And this, in turn, would help offset the higher SG&A expenses of business with smaller companies.

Text Box:  Once again, here comes the Internet to aid such business visionaries.  E-commerce is a natural cost and expense-cutting tool when doing business with large numbers of companies or individuals.  And that is a new business opportunity that EDS is also pursuing.

Of course, so is IBM and everyone else in business, big or small, is doing the same thing.  Except that IBM is once again focusing mostly on large enterprises, leaving the small companies’ market wide open to opportunistic competitors.  And the results are already favoring the brave and the far-sighted.

In 1999, both EDS and IBM boasted about their e-business successes.  IBM said it had done $3 billion in e-business, up 60% from the year.  EDS said it did $1 billion, and that it expected to grow this line of business by 20% to 25% in the future (a very “conservative” estimate, by the way).

So it would appear that IBM has a big edge over EDS?  Not necessarily.

First, because it’s been our experience with IBM executive pontifications which tend to cross the results of its operating units and reported results, that they should be taken with a grain of salt.  Jim Clippard, IBM’s former director of investor relations, told this writer several years ago, when we were trying reconcile some of the IBM business unit leaders’ claims with the numbers reported in the company’s financial statements, “if your added up all such figures, IBM would instantly double in size.”

Second, because even if you take both e-commerce figures at face value, they mean that after six years of IBM’s pushing its “network-centric computing” (which has now evolved into e-commerce), only 3% of the company’s revenues come from it.  And its 60% growth in 1999, implies that after the first five years of Gerstner’s and his lieutenants’ preaching from the pulpit, IBM’s troops in the trenches had converted only 2% of the Big Blue’s revenues into e-commerce.  No wonder Gerstner sounded an alarm last month, when he reportedly gave his subordinates six months to turn things around.

Happy bargain hunting!

Bob Djurdjevic

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

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Volume XVI, No. 2000-06
February 4, 2000

Editor: Bob Djurdjevic
Published by Annex Research;

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