EDS’s Cash Woes

After a series of events that has drained computer services giant EDS of some of its near-term cash on hand, the IT computer services company late Tuesday said raised $1.1 billion in debt as it moves to put a turnaround strategy into motion.

On Friday, Standard & Poor’s cut the Plano, Texas, company’s debt rating to just above “junk” status — making it more expensive for EDS to borrow money on the open market. Moody’s followed suit on Tuesday evening.

The downgrades forced EDS to use about $227 million of its cash on hand to pre-pay obligations on a software subscription agreement from an undisclosed vendor. The company warned in its previous quarterly Form 10-Q filing with the SEC that any downgrade could accelerate its commitments under this software agreement.

As a result, the company has now placed $1.1 billion worth of 10-year senior notes and another $600 million worth of convertible senior notes due in 2023. EDS disclosed its intentions to make the debt offering at last week’s analysts meeting in NY.

At the heart of the problem for EDS is the sharp drop in IT spending plus larger-than-expected upfront costs on major outsourcing contracts. In fact, the downgrades by S&P and Moody’s were triggered moreso by concerns over EDS’s reduction in its outlook for operating cash flow — as well as higher restructuring charge — rather than any sort of liquidity problems or pre-payment obligation.

EDS has listed about $1.5 billion in cash as of the end of the first quarter.

EDS practically wrote the book on data processing and IT outsourcing. But now, the company is struggling to compete against an increasingly aggressive Hewlett-Packard in the IT services realm, along with its usual rivals IBM and CSC .

During the last quarter of 2002, EDS signed about $3 billion worth of
contracts, roughly half as much than the same time in 2001. For 2002, EDS’s
profit was down by 18 percent to $1.1 billion on revenues of $21.5 billion,
up slightly from the year before.

As previously reported, EDS last week launched a strategy designed to
stabilize and re-invigorate its core IT outsourcing business, a plan that
includes a focus on the burgeoning market for business process outsourcing
(BPO) services.

The news capped a turbulent six months for EDS, during which it fired its
its Chairman and Chief Executive Richard Brown and installed a seasoned
veteran Michael Jordan as the replacement.

It is also working to put behind it a pending Securities and Exchange
Commission probe of how it booked some stock sales. But overall, analysts
are questioning why EDS’s IT outsourcing contracts are not throwing off more
cash for the company, and what it can do to minimize its up front costs on
some IT contracts.

In a recent research note, Deutsche Bank Securities also questioned the
company’s stabilization plan as one that looked “quite similar to the
turn-around strategy announced by EDS’ former CEO, Dick Brown in April
1999.”

Many of the main themes are the same, the note said, such as laying off
more staff, writing off assets, consolidating overlapping assets, better
integration of the AT Kearney business, and the emphasis on a new business
unit “(in 1999 it was e-business, today it is BPO and Business
Transformation Outsourcing).”

Long term, DB analysts said, is still the question of how EDS
fundamentally will improve its competitiveness in the marketplace and be
able to differentiate itself against IBM — and increasingly — HP — who enjoy
bigger balance sheets, wider costs bases and presumably lower costs of
capital.” Shares of EDS on Tuesday closed 7 percent lower at $21.02.

An EDS spokesman Kevin Lightfoot told internetnews.com that it sees business process outsourcing as a key growth area for the company, as it makes strides to strengthen its balance sheet, a plan that was outlined last week with analysts. “In this environment, every company has to get their houses in order,” he said. Companies are trying to streamline their internal systems, such as human resources paper management and purchasing, he said, which is why the company is keen on BPO.