While investors are bracing themselves for a big internal shake-up that could continue to boost EDS's sleepy stock, CSC will face the pressure as Wall Street's latest darling with a full plate of new outsourcing contracts worth several billion dollars that has swayed even the most hard-nosed analysts over to its side.
With CSC, the biggest surprise is how the stock has recovered from a 52-week low of 39 per share to 67.5. The company capped the year with the win of a $3 billion to $5 billion contract to revamp the Internal Revenue Service's botched computer system. As lead vendor on the IRS project, CSC is expected to reap as much as 35 percent of the total contract value, with the rest divided among its partners.
"They're set up for having a take-off here," said Gary Helmig, analyst at SoundView Financial Group in Stamford, Connecticut. Morgan Stanley expects CSC's revenue to grow 18 percent in 1999, fueled partly by ongoing revenue from outsourcing contracts with General Dynamics ($24 million), Dupont ($5 million), and others, and by a 15 percent increase in federal government contracts.
On the other end, stock struggler EDS found holiday cheer with its appointment this month of Richard Brown, former Cable & Wireless CEO, as chief executive and chairman. Brown has been positioned as an agent of change for the company.
Under Brown's halo, EDS is watching its stock steadily climb out of a hole. The company was trading at about 50 a share today--nearly reaching its 52-week high.
"They've crossed an important threshold with their new management," said Bill Martorelli, analyst at the Hurwitz Group. "They're in a position to make substantial changes. It's easy to forget how big they are. Their stock is shaky but they're still a massive company."
Wall Street, however, remains split on the company. For example, while BT Alex. Brown raised its rating on EDS from "market perform" to "buy" on December 10. Morgan Stanley Dean Witter and others have held their rating at neutral.
Merrill Lynch analyst Steve McClellan, who picked CSC as the most promising stock of 1999, said he expects EDS will take about a year to start turning around. McClellan raised his rating on EDS from neutral to near term accumulate today.
"EDS was disappointing throughout '98," missing earnings forecasts and reducing estimates throughout the year, he said.
However, expect "new major thrusts in 1999," McClellan added. "I think a lot of actions will be taken pretty quickly--divestitures, acquisitions, and cost-cuttings." EDS also will continue to move away from its dependency on former parent company General Motors, from which it garners 25 percent of its revenue. That revenue is dwindling as GM looks outward for outsourcing partners.
Morgan Stanley expects EDS to post $3 billion to $4 billion in contract signings in the fourth quarter of 1998, compared to a record of $5.8 billion in the year-ago quarter. For the year, the company should post up to $13.3 billion in contract signings, compared to $16.3 billion a year ago.
New EDS leader Brown, who, while at the helm of Cable & Wireless, made 21 deals within 29 months at a value of more than $20 billion, is expected to turn some more magic at EDS. However, several financial analysts questioned whether Cable & Wireless investors will reap the rewards of Brown's deals. Brown, who starts at the EDS helm in mid-January, has told company executives he will spend the first 100 days learning the company and then move aggressively to make changes and reenergize EDS.
"EDS is still a broken story," said SoundView Financial's Helmig. "I'm surprised that an analyst would go immediately to a 'buy' with EDS when nobody really knows [Brown]. You look at his track record and he has not had long staying power with the firms he's been with and EDS is not a one-year turnaround story."
EDS must control its costs and establish a plan for lower performance in the short term to gain higher long-term gains, he added.
But Alex Brown analyst Ed Caso noted in a report that Brown, with 28 years of telecommunications experience, changed 70 percent of the top 100 management positions at Cable & Wireless. Caso said he wouldn't be surprised by a similar shake-out at EDS aimed at getting the company on a new path.
In the meantime, McClellan expects CSC's services earnings growth to be about 20 percent in 1999.
"Investors will want to pay premiums for reliable, predictable earnings growth," he said.
While the multibillion-dollar outsourcing contracts grab headlines, they typically make up less than half of CSC's revenue. The company's bread and butter is in systems integration and consulting services revenue, which have grown in North America from 25 to 30 percent to more than 45 percent in the past year, according to Goldman, Sachs.
The company said it expects CSC to sustain 20 percent of worldwide growth in systems integration and consulting--in part because it is focusing on the lucrative and fast-growing ERP market, e-commerce, and Web-enabled technology.
"It's historically a great time to be a systems integrator," said Martorelli, who expects the market to become much more crowded and competitive next year. "We're just scratching the surface."