EDS Disclosure Fuels Concerns About Liquidity, New Business
By ELLIOT SPAGAT and GARY MCWILLIAMS
Staff Reporters of THE WALL STREET JOURNAL
Electronic Data Systems Corp., already under fire for shortfalls in its earnings, confirmed that it made a costly bet on the price of its stock, fueling concerns about its liquidity and its ability to pursue new business.
The giant provider of information services said that it borrowed $225 million last week and used the funds to unwind obligations to buy 3.7 million of its own shares at prices above $60 a share. The company said it had lined up the obligations last year in hopes of reducing the cost of its employee stock options.
Instead of rising, its stock price has plummeted. After it disclosed last week that earnings and cash flow would be far lower than expected, its shares fell more than 50%.
The bad bet drains cash at a precarious time for the Plano, Texas, company. Last week, it said its expects free cash flow - or cash from operations minus capital spending -- to run between $200 million and $400 million this year, down from a recent estimate of between $700 million and $900 million. EDS often signs up big contracts that require cash expenses up front; in those cases, it often doesn't see significant cash back for a few years.
EDS, in a statement, said the move to unwind the options won't affect cash flow or earnings estimates beyond what it said last week. It also said it doesn't have liquidity issues. Standard & Poor's cut its debt rating last week to single-A, a decent investment-grade rating.
The unwinding of "put" options to buy its own shares was disclosed in a report by Stephen McClellan, an analyst at Merrill Lynch. Mr. McClellan said last week's payment, by his estimate, "effectively eliminates" free cash flow this year and could result in an earnings charge of 21 cents a share. Mr. McClellan recommended clients sell EDS shares and suspended any earnings estimates, saying the move may have damaged EDS's ability to pursue super-size contracts from the likes of Procter & Gamble Co. and J.P. Morgan Chase & Co. Both are close to awarding two of the largest outsourcing deals ever.
Prakash Parthasarathy, an analyst Banc of America Securities, predicted that options mistake could shave 30 cents a share from EDS's earnings.
According to financial filings, EDS said it agreed in 2001 to purchase 2.6 million of its shares at an average price of $61.58, and issued puts, or an obligation to purchase its own stock from investors at a predetermined price, on 2.5 million shares at an average price of $62.90. EDS entered those agreements to defray the cost of issuing shares under its employee stock-option plan.
EDS shares gradually rose through much of last year, but only briefly traded above $70, reaching a closing high of $71.88 on Nov. 27. But the shares have dropped about 80% so far this year and closed at $17.79 on Friday, the day that EDS covered its obligations to buy stock.
EDS shares fell $4.84, or 29%, to $11.68 in 4 p.m. composite trading on the New York Stock Exchange. Volume was more than 87.9 million shares -- more than 13 times the stock's daily average of 6.5 million. Earlier, the stock was trading at $10.09 -- it's lowest intraday level since Nov. 17, 1988, when it hit $9.88.
The puts were "a statement of confidence in the business," said Tom Mattia, a spokesman for EDS. "We saw it as an opportunity to take action, expecting that the price would go higher."
In issuing the puts, EDS earned a fee of about 75 cents a share.
Thomas I. Selling, an accounting professor at Thunderbird, The American Graduate School of International Management, said the move was nothing more than a gamble. "Management has a view the stock price will go up. This is pure speculation, and it's off the financial statement," he said.
If the company were buying and selling puts in another company's shares, it would have to adjust the puts' value each quarter, Mr. Selling said. But the accounting rules are different for shares in one's own stock. "The accounting treatment is driving the transactions," he said. "If they didn't have this treatment, they wouldn't be doing it.''
EDS isn't the only company to learn the hard way that stocks go down as well as up. Microsoft Corp. faced a similar situation in late 2000 and paid a premium to extinguish puts on its shares after its stock fell below the strike price. In the last two years, Dell Computer has been paying an average $44 a share to buy back tens of millions of its shares under a similar program even though its shares haven't risen above $36 in two years. But both Dell and Microsoft are cash-rich, and EDS clearly isn't.
The second unsettling disclosure in a week prompted Rod Bourgeois, an analyst at Sanford C. Bernstein & Co., to write in a note to investors Tuesday that an SEC inquiry was "very likely" after last week's "seemingly incomplete" explanation for the revenue and earnings shortfalls. The SEC declined to comment.
EDS said it isn't aware of any SEC investigation.
Write to Elliot Spagat at elliot.spagat@wsj.com and Gary McWilliams at gary.mcwilliams@wsj.com
Updated September 24, 2002 4:12 p.m. EDT
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