Should investors buy EDS on directors' lead?

Analysts are taking note of the insider buying by director Ray Hunt, who is adding $14.3 million worth of shares to his holdings.

Dawn Kawamoto Former Staff writer, CNET News
Dawn Kawamoto covered enterprise security and financial news relating to technology for CNET News.
Dawn Kawamoto
3 min read
Last June, Electronic Data Systems issued a warning about second-quarter earnings that sent the company's shares down 25 percent in a single day--their steepest one-day drop ever.

But as a number of analysts issued downgrades and its shares languished in the $40 range in the following two months, one EDS director was busy buying $14.3 million worth of shares--his first purchase in four years.

Does this bode well for EDS shares, and should investors follow the director's lead?

Ray Hunt, a director of the information technology outsourcing company since 1996, purchased 334,750 shares at $42.70 on July 31. That purchased added to the 23,178 shares held by Hunt, chairman and chief executive of Hunt Consolidated and Hunt Oil.

Although the purchase paled in comparison to his already substantial holding, some analysts took note.

"This is the first purchase Hunt has made since 1996...and the size of his vote is fairly large," said Craig Columbus, president of insider-tracking firm ScoreLab.

Hunt declined to answer questions about the purchase, a representative for Hunt Oil said.

EDS, which hasn't traded in this range since 1998, initiated a restructuring about 18 months ago, following the hiring of Cable & Wireless' CEO, Dick Brown, for the top executive spot. The company cut thousands of employees from its payroll and streamlined its operations into four units.

But in June, the company warned its revenues would fall short of Wall Street's expectations, largely due to a reorganization of its sales department. Shares of EDS, which in the first quarter reached a 52-week high of $76.68, fell nearly $15 that day to $43. The shares now trade at about $49.

Hunt is not the only one bullish on EDS' prospects.

"We still think EDS is a good buying opportunity," AG Edwards analyst Joy Mukherjee said. "During the first half of the year, EDS did not have good revenue growth. But we think it was related to post-Y2K spending slowdowns. We believe in the second half of the year, we'll see revenues accelerate given the size of the contracts it's signed and its backlog of orders."

Mukherjee upgraded the stock to a "buy" from "accumulate" following EDS' second-quarter warning. Meanwhile, six other analysts downgraded the stock to either "buy" or "hold" ratings.

Many others do not share Mukherjee's optimism.

Stephen McClellan, a Merrill Lynch analyst who downgraded EDS to a "buy" from a "strong buy," noted in a report that EDS' new contracts are "seemingly being prolonged."

And David Togut, a Morgan Stanley Dean Witter analyst who downgraded the stock to an "outperform" from "strong buy," said in a report that he expects a six-month delay in EDS' transition into a growth investment. He attributed the delay, in part, to EDS becoming less aggressive in cross-selling its services into its existing customer base.

Nonetheless, Mukherjee said the reaction to EDS' warning may have been too harsh.

"We felt the stock drop was an overreaction. Even though they issued that warning, they had always said the first half would be a slow period and the second half would accelerate," Mukherjee said. "We went to a "buy" when the stock started falling."

EDS is currently trading at 18 times Mukherjee's 2001 earnings-per-share estimate, compared with competitor Computer Associates, which is trading at 25 times expected earnings.

Mukherjee, however, noted Wall Street views EDS as a "show-me" story.

The company has previously said it hopes to increase revenues roughly 14 percent to 16 percent by the end of the year, which would put it in line with competitors.

"We think they will get close to it, and that's what they'll need to do to become an interesting (investment) story," Mukherjee said.