Schaff is watched closely by the IT community. Says EDS is on the way back in the market. Dan, do you know this guy?
Turning Point For EDS? -- After Several Years Of Slow Growth, The Outsourcing Giant May Be On The Verge Of Winning Back Investors
March 2, 1999
INFORMATIONWEEK via NewsEdge Corporation : As one of the leading IT services companies providing outsourcing, systems integration, and consulting to almost every major public and private sector organization, EDS (EDS-NYSE) is familiar to most IT managers. But as an investment, it's been something of a dog for the past couple of years. The company has struggled with internal changes and external competition. But given the volatility of many other technology stocks, I've taken another look at EDS and have found some things to like.
What's changed my attitude toward this behemoth? One thing is its recent deal with MCI WorldCom (WCOM-Nasdaq). EDS will buy MCI's Systemhouse IT services subsidiary for $1.65 billion. In the process, EDS will absorb Systemhouse's 120 offices and 12,000 employees. In return, EDS will take over the majority of MCI WorldCom's IT services, including its application development, maintenance agreements, and infrastructure services in a 10-year agreement valued between $5 billion and $7 billion, from June 1999.
In effect, EDS signed one of the largest outsourcing deals in the telecom sector. This is one way to offset declining revenue from former parent company General Motors. But EDS also gains in another vital way-cost savings. By outsourcing its network services to MCI WorldCom in a 10-year deal worth $6 billion to $8.5 billion, EDS could reduce its overall network costs by $60 million to $70 million a year.
MCI WorldCom will also help EDS pursue joint networking deals. The potential for cross-selling and joint marketing is obvious. EDS will continue to focus on reducing expenses, but being able to enhance revenue by leveraging a partnership with one of the most aggressive marketers in the telecom sector shows me that the company is looking for more creative ways to win back the confidence of investors.
Ultimately, I believe Systemhouse will achieve more business synergy with EDS than it did with MCI. It remains a reputable provider of network enterprise solutions and IT consulting and integration services. Its primary services include designing, building, and managing systems that integrate computing with data, voice, and Internet networks. It also offers customer-relationship management services related to call centers, E-commerce, and business intelligence.
EDS will probably give Systemhouse more attention than MCI did by providing the people and talent needed to build up telecom services-one of the fastest growth segments in consulting. Initially, however, Systemhouse won't add much to EDS's top-line revenue. It won 13 new contracts in 1998 worth about $266 million; that pales in comparison with the $2.5 billion in new business booked by EDS in the fourth quarter of 1998 alone. (As of Dec. 31, 1998, EDS had $66 billion in business in the pipeline.) But over the long term, Systemhouse may bolster EDS's growth rate.
Of course, there are still risks associated with investing in EDS. The company has been losing market share to IBM and Computer Sciences Corp. The deal with MCI WorldCom was a logical response to the recent IBM-AT&T outsourcing agreement, but EDS's new CEO, Dick Brown, has yet to present a clear vision for his company. Declining GM revenue will continue to put pressure on the top and bottom lines. And EDS is being sued by Xerox, one of its biggest clients. The suit raises concerns about the profitability of mega-contracts in which revenue is fixed but costs rise due to wage inflation and high labor turnover.
At $45 per share, EDS has an equity market capitalization of $23 billion. Total revenue for 1998 was $16.9 billion, up 11% over 1997. The company had operating earnings of $1.70 per share in 1998 and is projected to earn $1.85 this year and $2.10 in 2000. My fair value for the stock is $50. That's not a lot of upside potential, but remember, it's hard to find high-quality tech companies at a reasonable price these days.
William Schaff is chief investment officer at Bay Isle Financial Corp. in San Francisco, which manages the InformationWeek 100 Stock Index. You can reach him at bschaff@bayisle.com.
Copyright c 1999 CMP Media Inc.
By William Schaff
<<INFORMATIONWEEK -- 03-01-99, p. PG103>>
[Copyright 1999, CMP Publications]
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