EDS Tests a Remedy for Enronitis
By Andrew Park
An amazing thing happened at Electronic Data Systems's annual meeting with securities analysts on Feb. 11: Nothing. No fireworks. No surprises. Not much of anything, really. And that could signal a buying opportunity for investors interested in this computer-services giant.
You might have expected an outcry from the analysts, given the drubbing EDS (EDS ) shares have taken of late. Fears that third-party financing deals that EDS arranges for clients are Enron-esque had helped shave more than 20% off the value of EDS's shares, which hit a 52-week high of $72.45 on Nov. 27.
Instead, after lengthy presentations by top executives, analysts said they were satisfied with the company's explanations of its accounting. One even asked why EDS didn't do more of the deals about which accounting questions had been raised. After all, the deals have represented just 2% of the total value of contracts EDS has signed since 1995. Says Goldman Sachs analyst Greg Gould: "I'd love it to be 100%."
The question now is whether EDS stock values will start to recover -- and here savvy investors will be watching closely. Shares had fallen to $57.50 by the time the meeting kicked off at EDS headquarters in Plano, Tex., despite repeated assurances that investors had no reason to lump the company with Enron and other outfits hit by high-profile accounting woes. "EDS's financial foundation is rock solid," CEO Richard H. "Dick" Brown said when the company made its earnings announcement on Feb. 7. "Our accounting is conservative, clear, concise."
EDS shares have inched back up, now trading around $60. But many investors still seem to be spooked. Typically, when EDS agrees to manage computer systems for a client, it acquires hardware on behalf of the company and wraps the cost of financing it into the contract. EDS saves the customer money on the gear, and the customer keeps noncore assets off its books. In 1995, in a bid to offload what it said was a less profitable part of its business, EDS began arranging for banks to finance some of those purchases separately with the customer. Since then, banks have financed about $2.8 billion worth of gear for its customers, which has reduced EDS's credit risk and offered customers cheaper loans, the company says.
Critics discerned something more sinister. In the deals, if the client cancels the contract due to nonperformance, EDS is required to buy the assets that haven't yet been paid off. EDS says this almost never happens and notes that it runs the same risk under the deals it finances itself. Moreover, EDS has bought back only $30 million worth of contracts since 1995 -- and did so voluntarily. Still, the total value of these "contingent liabilities," $514 million at the end of 2000, showed up only in a footnote to EDS's financial statements, not on its balance sheet, and the liability nearly doubled to $900 million at the end of 2001.
EDS insists that the deals don't represent a hidden liability and are being accounted for properly -- and many analysts agree. "There's nothing shifty about it," says Sanford Bernstein analyst Rod M. Bourgeois. Goldman's Gould likes these contracts because they "help get [EDS] out of the equipment business."
Trouble is, in the post-Enron environment, such distinctions aren't always clear. Now, EDS is mounting a full-court press. In its next annual report, EDS will discuss the transactions in more detail than ever. "We as a company are really taking this to heart," says Treasurer Scott J. Krenz. EDS will follow that up with disclosure of the contingent liability every quarter. It even created a new name for the deals -- customer-financed transactions -- to discourage analysts and reporters from calling them "off-balance sheet."
Still, some concerns remain. Despite strong fourth-quarter sales, the company's new bookings were on the low end of the range analysts expected. And a higher-than-normal percentage of those contracts were renewals. Analysts are also scrutinizing EDS's cash flow, which fell off in 2001, and its rising unbilled receivables.
And, one analyst cautions, EDS should be careful not to take on too many third-party financing deals. Says SoundView Technology Group analyst Gary Helmig: "I think they want to be careful of not going overboard." The company says that while the practice will grow, it will be limited because only a portion of the capital expenses in such contracts can be financed separately. And negotiating each transaction has proven time-consuming, Krenz adds.
The biggest question, though, is whether EDS's efforts at fuller disclosure can lift the stock. Says William R. Hackney, managing partner at Atlanta Capital Management (which owns 2 million shares): "The pullback from $70 down to the high $50s was a buying opportunity." That's one vote of confidence suggesting that maybe Eronitis has a cure after all.
Park covers technology for BusinessWeek from the Dallas bureau
Edited by Beth Belton
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