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News: Analysis & Commentary: DEALS
NO SEPARATION ANXIETY AT EDS
Since its acquisition by General Motors in 1984, Electronic Data Systems Corp. has increased its revenues from $786 million to an estimated $12 billion this year. Its market value has climbed nearly tenfold, and the technology behemoth has snapped up companies worldwide, from management consultant A.T. Kearney Inc. to European outsourcing expert SD-Scicon.
And that's before EDS was cut loose from its staid corporate parent. On Aug. 7, the auto maker announced that it will try to spin off EDS in a tax-free exchange of stock for holders of GM's Class E shares, which represent a stake in EDS's earnings but no claim to its assets. Plenty of obstacles remain before a deal can be completed early next year--primarily approval from the Internal Revenue Service--but independence promises to bring EDS, based in Plano, Tex., even richer growth opportunities.
Everyone should come out a winner if the deal works. GM, which bought EDS from founder Ross Perot for $2.5 billion, is determined to center its focus and its capital on its still-ailing automotive business. It will continue to benefit from EDS's services through a long-term contract. And, with its pension fund holding about 30% of the Class E stock, GM stands to gain if an unbridled EDS can grow faster and boost its stock price.
BIG WINNER. The fund, which still is an estimated $5 billion to $7 billion in the red, will gain $150 million for each dollar EDS stock rises. Already, Class E shares jumped 7%, to around $47, on the spin-off news. GM also may get a one-time dividend from EDS as part of a separation agreement. "[Former GM Chairman] Roger Smith made one of the great investments of the 20th century," says Morton H. Meyerson, chairman of rival Perot Systems Corp. and a former top EDS executive.
But the big winner is EDS and its chief executive, Lester M. Alberthal Jr. "Independence means greater access to capital," says analyst David M. Togut of CS First Boston Corp. That means EDS will be able to finance acquisitions with its own stock, gain flexibility in structuring joint ventures and alliances, and raise capital more easily for its giant outsourcing deals. In those contracts, EDS typically buys out a customers' data processing assets before it takes over operation of the data centers and network. Togut now expects EDS's earnings growth to be several points higher than the 15% annual rate he had projected for the next five years.
Where will EDS flex its newfound muscle first? Telecommunications companies are still at the top of Alberthal's wish list. Indeed, EDS's failure to ink a merger agreement with Sprint Corp. last year helped drive home the need to split EDS from GM. The deal foundered in part over how to value the Class E stock. EDS also failed to reach a deal with British Telecommunications PLC in 1993, also because the two sides wrangled over the value of the shares.
Alberthal-watchers expect EDS to form alliances with telecom partners worldwide, instead of pursuing outright mergers. "I think [EDS] really relishes its independence and wants to run as an independent company for a while," says analyst William D. Rabin of J.P. Morgan Securities Inc. EDS says it will consider all options and all telecom partners, including the Baby Bells, which could soon be free to pursue the long-distance market under deregulation being considered by Congress.
EDS gets 74% of its revenues and 81% of its operating income from the U.S., so it is on the prowl for information management consulting companies abroad, particularly in Asia.
Closer to home, Senior Vice-President Gary J. Fernandes says the company will expand its presence in electronic commerce, serving both corporate and individual customers. For instance, it is working with SpectraVision Inc. to deliver movies and other programming to hotels through a digital, video-on-demand system. EDS hopes such deals will position it to be a major player on the Information Highway.
JUICY DEAL. EDS also plans to expand in one of the industries it knows best: autos. With GM as its owner, it has been shut out by such rivals as Ford Motor Co. and Chrysler Corp. In the past decade, it has won only a small contract with Porsche, says Fernandes. He figures the market for information technology services in the auto business, excluding GM, is a juicy $150 billion worldwide.
Of course, EDS is not cutting all ties to GM. As part of a split-off, the two intend to negotiate a long-term contract, perhaps 10 years, so that EDS will keep its GM business at essentially the same terms it has now. GM is expected to account for about 32%, or $3.8 billion, of EDS revenue this year. That's down from more than 50% in 1990, but still a nice chunk of change. EDS may leave home, but not empty-handed.By Wendy Zellner in Dallas, with David Woodruff in Detroit and Heidi Dawley in London