CSC: Big Eyes for Uncle Sam's IT Pie
STREET WISE
By Arlene Weintraub
CSC: Big Eyes for Uncle Sam's IT Pie
Computer Sciences is betting that its DynCorp acquisition will help it clean up as the feds keep outsourcing more of their tech needs
The fortunes of technology-services outfits swing from feast to famine with the economy's tides, and over the past year, business belt-tightening has decreased demand for the outsourcers that help design and manage Corporate America's tech infrastructure. One giant customer, however, is about to create a windfall for the tech-services industry: the U.S. government.
Post-September 11 efforts to boost defense and homeland security should drive an 11% annual increase in info-tech spending, predicts Input, a Chantilly (Va.) consulting firm. In 2003, Uncle Sam will spend $63.3 billion a year on technology, up from $37.1 billion in 2002.
Computer Sciences Corp. (CSC ) has made a major play to get a piece of that government pie. On Dec. 13, the El Segundo (Calif.) outfit announced that it would buy DynCorp for $950 million in cash and stock. The private, employee-owned company in Falls Church, Va., derives most of its $2.3 billion in annual revenues from government contracts. In August, DynCorp was one of three companies chosen to supply the Transportation Security Administration (TSA), the agency overhauling airport security, with telecommunications technology and services.
DELAYED IMPACT. The contract could generate $1 billion in receipts for DynCorp and its partners, Unisys (UIS ) and IBM (IBM ). CSC -- which provides a wide range of services, from systems integration to payroll processing -- estimates that it'll derive $6 billion a year in revenues from the federal government after the DynCorp acquisition. That will boost its government business from 27% to 40% of annual sales.
Despite CSC's increased clout in the federal sector, Wall Street remains blasé. CSC's stock fell 5%, to $33, the day following the announcement, way off its one-year high of $53. Only 7 of the 22 analysts who cover CSC recommend buying the stock, saying the potential upside from the DynCorp acquisition will take at least a year to realize. Until then, CSC will remain a slave of the struggling private sector. Notes A.G. Edwards & Sons analyst Gregory Gieber: "CSC's core market is suffering."
DIVERSIFIED REVENUES. The pain showed in CSC's most recent quarter. Sales on the commercial side dropped 7%, to $1.96 billion. CSC's federal business, meanwhile, skyrocketed 17%, to $772 million. For the fiscal year ending in March, 2003, analysts expect CSC's revenues to remain relatively flat, at $11.6 billion. Thanks to cost-cutting, earnings should rise 28%, to $443 million, or $2.57 per share -- but that's still far below the $2.88 per-share profit, or $496 million, it had earlier estimated it would reach.
Overall, though, analysts agree that in the long run, the new member of the CSC family will diversify its parent's revenue stream and improve its position against its two major competitors, IBM and Electronic Data Services (EDS ). From a valuation perspective, CSC falls right in the middle, trading at a price-earnings ratio (p-e) of 15. EDS, which has been stung by a billing dispute with bankrupt WorldCom (WCOEQ ), is trading at a p-e of 8, while market favorite IBM enjoys a p-e of 24.
DynCorp seems just what CSC needs to turbocharge its bottom line, especially since CSC already has some cachet in the federal sector, having scored contracts with the Navy, NASA, the Centers for Disease Control, and several other government agencies. Now, DynCorp can fill in some important gaps. It's stronger than CSC in aviation and telecom and, as CSC spokesman Mike Dickerson puts it, DynCorp has "a bigger presence in some agencies, such as the State Dept."
HAPPY FAMILY? The acquisition doesn't come without risks. John Jones, an analyst for SoundView Technologies Group, estimates DynCorp's operating margin at a mere 3%, vs. CSC's 6%. "This gives CSC the opportunity for more revenue, but it's going to put pressure on margins," he says. Clearly, a big challenge for CSC will be to squeeze enough efficiency out of the marriage to boost profits.
The bottom line: Risk-averse investors and those looking for short-term gains will most likely choose to stay away from CSC. But those willing to ride out the lull in CSC's commercial business and the post-honeymoon integration of DynCorp could see some upside, starting in 2004. If all goes as planned, CSC could become a major beneficiary of the government's technology buying binge.
Weintraub is a BusinessWeek correspondent in Los Angeles
Edited by Beth Belton
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