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Playing for the Real Money in Homeland Defense

Lockheed, Computer Sciences and Accenture compete for a federal contract said to be worth some $15 billion.

In a move that will deliver a major windfall to the winner, the Department of Homeland Security is expected to award one of the largest federal technology contracts in history to either


(ACN) - Get Accenture Plc Class A Report


Computer Sciences



Lockheed Martin

(LMT) - Get Lockheed Martin Corporation Report

by the end of this week.

The contract calls for building a complicated system of databases and identification devices to monitor visitors crossing U.S. borders. Known as the

United States Visitor and Immigrant Status Indicator Technology program, or US-Visit, the contract could be worth as much as $15 billion and augment the billions already spent by the fledgling government agency to beef up security in such fields as air travel.

"This is the whopper," said Cindy Shaw, an analyst with Schwab SoundView Capital Markets, who has outperform ratings on Accenture and Computer Sciences. (Her firm has done banking with Accenture but not with Computer Sciences.)

Federal information technology services analyst Erik Olbeter in Schwab SoundView's Washington Research Group believes that Lockheed is the likely winner, with a 60% probability of snapping up the US-Visit contract. Accenture has a 30% chance of winning, Computer Services a 10% chance, he estimates.

The rationale behind those odds: Accenture excels at developing a technology vision, but Lockheed has the most experience with legacy systems and managing a project of this scale for the federal government, Shaw explained.

Ultimately, the lead company on the winning team will collect about two-thirds of the contract, Schwab SoundView estimates. With Congress expected to appropriate only $340 million for the contract in fiscal 2005, and typical IT government contracts garnering operating margins in the high single-digit percentages, US-Visit is likely to translate into earnings growth of just a few percentage points in the first year or two, Shaw figured.

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Among the three finalists, Lockheed's top and bottom lines would enjoy the relatively smallest boost from the contract, based on current financials. The world's largest defense contractor is expected to post $2.63 a share in earnings on $34.8 billion in revenue projected in fiscal 2004.

By comparison, Accenture is expected to ring up $1.15 a share in earnings on $13.4 billion in revenue in fiscal 2004, ending in August, while Computer Sciences is projected to earn $3.15 a share on $15.9 billion in revenue in fiscal 2005, ending in March, according to Thomson First Call.

Lockheed, with its shares down 0.8% in the past year, has the relatively weakest stock of the trio. That compares with a nearly 37% jump enjoyed by Accenture and a 13.5% increase in Computer Sciences shares. For that reason, some analysts are bullish on Lockheed, calling the world's largest defense contractor's shares undervalued.

Shares of Lockheed were up 38 cents, or 0.79%, to $48.61 in recent trading Wednesday; Accenture shares were down 17 cents, or 0.72%, to $23.56; and shares of Computer Sciences were up 11 cents, or 0.26%, to $42.80.

On Tuesday, Legg Mason analyst Troy Lahr initiated coverage on Lockheed with a buy rating and included it on the firm's list of compelling ideas. Lahr noted that the stock is trading at an enterprise value-to-earnings ratio of 8, below the median multiple of the

S&P 500

of 11.

Last month, meanwhile, Jefferies analyst Sam Pearlstein noted that several near-term contract competitions, including US-Visit, will determine whether Lockheed will have to raise 2005 revenue and earnings guidance in July, when it reports its second-quarter results. He has a buy rating on the stock and his firm hasn't done any banking with Lockheed.

Ultimately, though, the US-Visit contract would be most important to Computer Science's future, analysts said.

"CSC, I think, has less significant long-term prospects in its commercial consulting and outsourcing business, whereas Accenture has more opportunity in consulting and business-process outsourcing that makes it less reliant on winning these large federal contracts," said Bernstein analyst Rod Bourgeois, who has an outperform rating on Accenture and market perform rating on Computer Sciences.

"And it's probably a more important deal for CSC because its future is dependent on continuing to penetrate the government sector," Bourgeois added. (His firm doesn't have an investment banking business.)

In fact, it's those differences that have prompted John Rutledge, portfolio manager of the Evergreen Technology Fund, to favor Accenture over Computer Sciences.

"I like to invest in Tier 1, Class A

companies within an industry, and clearly Accenture is a Class A company by all measures," said Rutledge, whose fund counts Accenture as its sixth-largest holding. "CSC has a long history of disappointing investors once every six quarters."

Strong government sales at Accenture -- a 29% increase year over year in the February quarter -- have helped offset weakness in such sectors as communications and high-technology, Rutledge noted. But Rutledge is expecting those sectors to pick up as the economy improves, a thesis supported by an 18% year-over-year jump in communications and high-tech sales in the February quarter vs. a 6% increase in the November quarter.

The Remora Factor

Given the billions in revenue already collected by the leading companies, the contract could, in fact, have a bigger impact on a smaller subcontractor such as


(U) - Get Unity Software, Inc. Report

, Shaw noted.

Just last week, her colleague, Schwab SoundView analyst John Jones, upgraded his rating on Unisys to outperform from neutral, in part because it's a subcontractor on Lockheed Martin's US-Visit bid.

"US-Visit could represent the best near-term opportunity in Unisys," Jones wrote in his May 19 note. With about one-third of the total contract set aside for subcontractors, he figured that if Lockheed wins, Unisys could gain $800 million in revenue over 10 years, with the bulk of the contract starting in 2007.

Unisys earned $29 million, or 9 cents a share, on $1.5 billion in revenue in the first quarter. (Schwab SoundView hasn't done any banking with Unisys.)

But Shaw cautioned against reaching a similar conclusion about

Electronic Data Systems (EDS)

, another subcontractor on Computer Sciences' team. A win by that team would probably help EDS stock, but the beleaguered computer-services giant has other

problems, Shaw said.

"I wouldn't get too excited about EDS on this one," said Shaw, who has a neutral rating on EDS. (Her firm hasn't done any banking with EDS.)

Ironically, EDS' own federal megadeal to create a Navy-Marine Intranet -- a contract that has drawn comparisons to US-Visit -- has turned into a disaster for the company. Time will tell how that comparison bodes for the winner of the US-Visit deal, but for now, analysts are clearly looking at it as a positive for whoever that turns out to be.