EDS Braces for Spending Drought in IT
Electronic Data Systems Corp., hit with a triple whammy of bad financial news in the last two weeks, is hunkering down to weather what CEO Dick Brown characterized as a "screeching halt" in IT services spending. But questions persist over where EDS missed the mark and how well it is responding to changes in the IT services business.
After drastically lowering earnings and revenue projections for the third quarter, EDS was hit last week with criticism of its employee stock options program and questions about its liquidityall leading to a steep drop in its stock price.
"We expected clients discretionary spending to tighten, not stop. We expected to get our share of contracts, and we did, but there were far fewer awarded," said Brown in a meeting with analysts last week. He said that he expects client spending to remain soft until mid-2003.
Despite the shortfall, the Plano, Texas, company has no plans for layoffs, according to sources, even though its major competitorIBM Global Servicesthis summer let go thousands of its own workers.
Observers see the earnings warnings as curious in timing and symptomatic of problems beyond slow sales. "The big surprise isnt that they took a hit in the third quarter but that they didnt earlier in the year," said Julie Giera, an analyst at Giga Information Group Inc., in Cambridge, Mass. Giera pointed out that EDS major competitors, IGS and Computer Sciences Corp., both missed earnings and revenue projections earlier this year.
The news coming so late for EDS suggests that the company was overly optimistic about the third quarter and that there is a lack of foresight in the executive suite. "How does it get that close ... before you recognize that things are not good?" asked Giera. "Its a big deal when they miss this big and this late."
EDS also revised downward its projections for free cash flow for the quarter from $700 million to $900 million to $200 million to $400 millionraising questions not only about its liquidity. Questions have also been raised about its ability to secure big outsourcing contracts, such as the $6 billion business process outsourcing deal it is negotiating with Procter & Gamble Co., as well as an $8 billion deal expected to be awarded next month by J.P. Morgan Chase & Co., industry insiders said.
As EDS is the only player negotiating with P&G for its outsourcing proj- ect and given P&Gs investment in the project, free cash is not likely to prevent EDS from winning the deal. But the issue still raises concern, Giera said. Because large, long-term deals require cash upfront for the outsourcer, which reaps expected margins only later in the deal, the liquidity concerns could change the structure of the contract.
"My guess is the parties are looking for ways to make the deal less onerous for EDS without compromising the economic benefits to P&G," said Bob Zahler, a partner in Shaw Pittman LLP, a Washington law firm that specializes in client-side outsourcing contracts. "They may be moving money aroundchanging what the charges are in the early years versus the middle and back years."
Others think it could mean another subcontractor will be brought in to take on some of the work. "EDS may just do the infrastructure operations and subcontract the business process services," said Bruce Caldwell, an analyst at Gartner Inc., in Lowell, Mass. "There are lots of business process outsourcers that want to have an alliance with someone who has the human resources to deliver administrative tasks."