EDS Still Swimming Against the Current

The new star player at Electronic Data Systems ( EDS) -- CEO Michael Jordan -- is already struggling to score points with investors and customers.

During a timeout meant to finalize earnings, EDS saw at least one analyst jump ahead and predict the final numbers for Jordan's first quarter of play. The results weren't pretty.

Smith Barney analyst Patrick Burton, who already doubted Jordan's team could deliver on the promises made by past management, has grown even more pessimistic in recent days. In a research note issued Friday, Burton predicted that EDS might hit consensus estimates for the first quarter, but will drop the ball immediately afterward. Burton had already cast doubt on EDS's full-year earnings power, but he now believes the company will join him by shaving guidance when it releases its delayed financial update on Wednesday.

"At its analyst day, CFO Bob Swan (then on the job for only a few weeks) had not indicated a great deal of confidence in the estimates," Burton pointed out. "We also believe that EDS' last public projections are too high."

Current guidance, issued before former CEO Dick Brown got booted, calls for EDS to deliver full-year earnings of $1.80 to $2 per share. Wall Street, in general, was already looking for EDS to miss with full-year profits of $1.70 per share. But Burton has been particularly bearish, projecting that EDS can generate full-year profits of only $1.55 per share -- and warning, through his latest update, of challenges that can threaten even that modest performance. On Monday, EDS fell $1.06 to $17.98.

Target Practice

When calculating his guidance, Burton admittedly looked past a number of potential setbacks that could still materialize.

For now, he is assuming that the American Airlines unit of AMR ( AMR) -- a major EDS customer -- won't file for bankruptcy protection and trigger write-offs like those accompanying the bankruptcy of rival UAL ( UAL). He also stopped short of predicting any further asset sales that could cut into earnings going forward.

But he's laid out an entire list of reasons why he expects EDS to miss its targets, adding that the stock could suffer when EDS acknowledges the shortfall.

"In our experience ... guiding estimates down generally causes the stock to be weak," he said. "We also believe the ongoing Securities and Exchange Commission inquiry and investors' 'show me' attitude toward EDS' cash-flow projections are likely to limit upside in the stock."

Burton has a market-weight recommendation and $18 price target on the stock.

Sudden Underdog

For EDS, the computer services game -- not to mention the competition -- just keeps getting tougher.

Sales from General Motors ( GM), EDS' largest customer, continue to decline. Revenue from the GM contract, which expires in less than two years, is expected to drop 22% to $534 million in the latest quarter.

But GM isn't the only customer hammering out better terms. In a broad survey, industry executives recently highlighted EDS as the company with the "most favorable" pricing for information services. As a result, Burton believes EDS may be discounting its services to keep existing customers as its new business continues to fall off.

EDS has intentionally scaled big on revenue-pumping, but cash-draining, "megadeals" in an effort to protect cash flow. But the company, which ranks second behind IBM ( IBM) in the computer services industry, has also lost out on some lucrative contracts that it really wanted.

Though EDS recently snagged a big, high-profile deal with the Pentagon, it has come up short on other bids. The company has lost big deals to both IBM and Unisys ( UIS). In addition, it has watched Hewlett-Packard ( HPQ) -- once an underdog contender for megadeal contracts -- become a serious contender by winning $4.6 billion worth of business in three recent deals.

Meanwhile, EDS is fighting an uphill battle just to keep some of its current deals in place. The company is clearly negotiating with some challenged customers. It provides service, for example, to many state Medicaid programs that are reeling from budget shortfalls. Burton, for one, expects EDS to keep much of that Medicaid business -- but only by cutting the state agencies a price break of up to 25%.

EDS could hit other snags as well. After weathering several recent credit downgrades, EDS cannot afford to see its credit fall much further. A one-notch downgrade would trigger $238 million in cash obligations, while a two-notch fall taking EDS to junk would sever the company's access to a $500 million credit line. Already, the company faces the very real likelihood that it must pay $800 million -- perhaps a full year's cash flow -- to satisfy a put-able option that comes due in October.

Still, even Burton believes some of these risks have already been priced into EDS shares. The stock, which fetched $54 last summer, has lost two-thirds of its value in the past year alone.

Like Burton, most analysts recommend holding the stock for now. But on average, they expect the stock to remain at current depressed levels for at least another year.

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