WSJ.COM: Refuge-Seeking Fund Managers Burned By EDS
19 Sep 19:27
By Ian McDonald
THE WALL STREET JOURNAL ONLINE
NEW YORK (Dow Jones)--Mutual-fund managers who thought they'd finally found a
warm dry play in the stock market found their trust ill-placed once again
Thursday.
That's when shares of Electronic Data Systems Corp. (EDS), the world's second
largest computer services outfit after International Business Machines (IBM),
plunged 52% to $17.40. Late Wednesday the company slashed its third-quarter
earnings and cash-flow estimates, citing significant shrinkage in corporate
technology budgets over the past two months. EDS executives added that
fourth-quarter earnings would be well below Wall Street analysts' expectations
and that weakness could bleed into next year as companies struggling to cut
costs are trimming staff and new tech projects.
Until recently the company, founded by Ross Perot in 1962, had seemed like a
relatively safe way to invest in the reeling technology sector. With a vast
backlog of long-term contracts, its earnings appeared to have rare stability.
The company had weathered the downturn in the economy and corporate tech
spending better than most.
Shares of EDS gained 20% in 2001, compared to a 33% fall for the Nasdaq 100,
an index of the 100 largest non-financial companies traded on the Nasdaq. That
year the percentage of the nation's more than 400 large-cap growth funds owning
the stock more than tripled to 22%, according to Chicago research house
Morningstar Inc. Overall, the number of funds owning shares of EDS stands at
589, up from 442 at the end of 2000.
But after reassuring investors in meetings last month, Chief Executive Dick
Brown lowered the boom saying that discretionary corporate spending on
consultants and new software projects "came to a screeching halt."
"This was a safe hiding place in technology," says William Schaff, manager of
the $20.3 million Berger Information Technology Fund, which has 0.5% of its
assets invested in EDS. "You had a stable cash-flow stream and you hoped not to
get blind-sided. But you did. I think the sell-off is a bit overdone, but no
one is going to care about valuation after this news."
If many managers added EDS to their books seeking stability, it's easy to see
why given management's recent assurances.
"The company did a roadshow a month ago raising their free cash flow
forecasts," says Mike Trigg, a Morningstar analyst who covers the stock and
doesn't own shares. "It's accurate to say people were blind-sided. The
magnitude of the miss was huge and there wasn't any indication the business was
going down the tubes."
EDS now expects to earn $58 million to $74 million, or 12 cents to 15 cents a
share, in the third quarter, for instance. That's down sharply from its July
estimate of $364 million, or 74 cents a share, and from earnings of $212
million, or 44 cents a share, a year earlier.
A look at the list of funds with sizable bets on the stock also shows that
many mangers believed it was a bargain prior to Thursday's tumble. Of the 10
funds with the highest percentage of their assets invested in EDS, three are
run by value-oriented Chicago asset manager Harris Associates: MassMutual
Focused Value (5.9%), CDC Nvest Select (4.5%) and Oakmark Select (3.4%).
Bill Nygren, reigning Morningstar Manager of the Year and lead manager of the
Oakmark Select Fund, didn't immediately return a call for comment. The firm
made EDS its "Focus" stock pick at the end of the first quarter, saying it was
cheap given its growth prospects and cost-cutting efforts. On March 29 the
stock traded at $57.99.
Harris was among the five largest institutional holders of EDS shares on June
30 according to regulatory filings. The top holder was price-conscious Capital
Research & Management, the Los Angeles manager of the American Funds. The firm
doesn't comment on its holdings, but at the end of the second quarter its $43.9
billion Washington Mutual Fund and the $47.2 billion Investment Company of
America owned more EDS shares than any fund in the nation with a cumulatively
eight-million share stake.
One value manager who rarely owns tech stocks and owned EDS shares before
Thursday's losses admitted he bought during Thursday's selloff, believing the
economy and not the company was mostly to blame.
"I was just putting in a buy order," says Edwin Walczak, manager of the
$68.6 million Vontobel U.S. Value Fund which has about 1.5% of its assets
invested in EDS. "I don't think anything has changed with this business. Yes, a
lot of spending has been deferred, but I'm taking the plausible explanation
that it's mostly a cyclical issue. There might be some company issues, but it's
not cancerous."
His thesis is that the company's expected earnings of $2.25 should make the
stock worth at least $30, assuming the shares trade at 15 times the company's
earnings, which happens to be the S&P 500's historical average
price-to-earnings multiple.
EDS's shortfall weighed on shares of competitor IBM, which fell 4.72 to
64.80, or 6.8% in sympathy. Some investors are waiting for other large tech
outfits to ratchet down expectations as corporate tech budgets stay flat or
shrink.
"It's all tied to corporate IT [information technology] spending and
companies just aren't spending," says Berger's Schaff, who routinely polls
corporate tech buyers in evaluating tech companies. "People might be shocked by
how much spending will continue to decline. Revenues are falling and IT
budgets are tied to them."
If EDS's shortfall and tumble is testing value managers it's also testing the
"buy the leaders" mantra many tech investors have adopted - only to see leaders
like WorldCom (WCOEQ) implode.
"There will be values out there in technology and you want to be with leaders
coming out of this decline," says Alan Loewenstein, co-manager of the $371.6
milliion John Hancock Technology Fund which owned EDS at the start of this
month. "Then again people would've lumped EDS and WorldCom in that group."
-Write to Ian McDonald at ian.mcdonald@wsj.com
(END) DOW JONES NEWS 09-19-02
07:27 PM |
