Investors who tuned into Electronic Data Systems Corp.'s (EDS) fourth-quarter earnings call on Feb. 7 didn't hear a lot to cheer about. Sales and free cash flow at the troubled technology-services giant had fallen from the year before. New contract signings were way below expectations. Worse, the company offered a bleak outlook for 2005, with sales flat to down 3%. The next day shares of EDS sank 6%, to $20.05.
But there was one bright spot. After three years of putting out fires, the Plano (Tex.) company finally unveiled a plan to revive growth. The centerpiece: $1 billion in spending in 2005 to expand its service offerings, upgrade its technology, and beef up partnerships with Microsoft Corp. (MSFT) and other tech leaders. That includes $420 million EDS is plunking down in a joint venture with human-resources consultant Towers Perrin that will let corporations outsource their human-resources departments. This marks the first time Chief Executive Michael H. Jordan has backed up his vision for growth with an investment plan, a move some analysts think will improve EDS' competitiveness. "They need to spend," says analyst Cindy Shaw of Moors & Cabot Capital Markets. "They're coming from behind."
Way behind. EDS has failed to increase sales in the past three years amid intensifying competition from giants such as IBM (IBM) and low-cost rivals in India. Winning new business has been particularly tough since EDS' financial woes have scared off prospective clients. EDS' new-contract signings were up 13% last year, to $14.9 billion, but that's well below the 25% goal it had set a year ago.
Making matters worse, EDS may soon lose its grip on its largest client. General Motors Corp. (GM), which accounts for 9.5% of EDS sales, is renegotiating its decade-old outsourcing deal this year, and analysts say EDS could lose as much as two-thirds of its $2 billion in annual fees from GM. A GM spokesman declined to comment. Jordan says that estimate is far too high but concedes that "we have a lot to prove."
Jordan may have more to prove than most. The former chairman and CEO of CBS (VIA) came out of retirement two years ago to turn around the ailing company founded by the legendary Ross Perot. Jordan has little to show for his efforts so far, and the $1 billion investment plan may be his last best shot. If it doesn't work, says analyst Gregory Smith of Merrill Lynch & Co. (MER), EDS may enter a "downward spiral" from which it won't be able to recover.
The plan does look like a solid step toward improving EDS' finances. Wall Street expects net income to rise 88% this year, to $297 million, as revenues slip 2%, to $20.1 billion. That's mainly because of cost-cutting and lower losses from problem contracts, such as a cash-draining outsourcing deal with the U.S. Navy. Next year, as Jordan's investments begin to generate higher margins from existing contracts and deals with new customers, analysts think net income will jump an additional 53%, to $453 million. "It's taken a lot longer than we would have liked, but we've got a lot of confidence" EDS can rebound, says Clint A. Opperman, research director for Wisconsin Capital Management, which owns 2.1 million EDS shares.
Jordan is counting on more than a little help from his friends. He has a novel idea to sell EDS as the leader of a federation dubbed the Agility Alliance. The group features 10 key partners that have strengthened their ties to EDS since Jordan took over, including Cisco Systems (CSCO), Dell (DELL), Microsoft, and Oracle. (ORCL) They have vowed to help EDS design new services in joint development labs, give it previews of future products, and lend their clout by jointly pursuing key contracts. An example: Storage giant EMC Corp. (EMC) is working with EDS to develop a service to help customers manage their sprawling storage networks. "Our past alliances were meeting for a drink at a bar," says Jordan. "This is settling down, sharing an apartment."
EDS also is showing a new level of commitment. In the past it installed hardware and software from rivals such as IBM and Hewlett-Packard Co. (HPQ) if that's what customers chose. Now, EDS is encouraging customers to switch to its alliance partners' products, though it will support rivals' systems if customers demand it. Sun Microsystems Inc. (SUNW) and EMC stand to gain hundreds of millions of dollars in hardware sales if EDS clients switch from IBM and HP.
EDS' plan is about more than sales and marketing. Its tech staff is now teaming more closely with partners. At Microsoft's partner-development lab in Redmond, Wash., EDS' 50-person unit is the largest of any company's. Jordan meets with CEO Steven A. Ballmer once a quarter. "They are treating us like their own software house," says Simon Witts, vice-president for Microsoft's enterprise and partner group.
EDS is betting that the same collaborative mind-set will juice its fortunes in business process outsourcing (BPO), one of the hottest segments of tech services. The $3 billion human-resources outsourcing market it is targeting with Towers Perrin is expected to grow 21% annually through 2007 and offers higher margins than traditional computer outsourcing. EDS will own 85% of the new firm and consolidate its roughly $600 million in annual revenue. EDS plans to invest $100 million more this year to set up ventures with other partners to move into the outsourcing of finance, accounting, and procurement. Jordan's goal: double the revenues EDS gets from BPO, from $2.7 billion now, over three to four years.
Rivals scoff at Jordan's initiative. IBM and Accenture Ltd. (ACN) have been investing heavily in the BPO market for years and have built up loads of expertise. IBM, for one, jumped into human-resources outsourcing two years ago and cut a 10-year deal with Procter & Gamble Co. (PG) that helped it develop advanced technology for payroll, benefits, and other services. IBM says its combination of hardware, software, and research prowess makes it a stronger partner than EDS. "They don't have the same capabilities we have," says Laurie Tropiano, a vice-president at IBM.
Still, Jordan's strategy appeals to tech buyers' hunger for simplicity and lower costs. Take paper giant Weyerhaeuser Co. (WY) Thanks to EDS' alliance strategy, the company plans to hire EDS to integrate its software, consolidate storage, and deploy Net phone systems. "Bringing all of that together in one place is going to greatly help us," says John Lorentzen, Weyerhaeuser's director for enterprise systems.
One customer a turnaround does not make. Yet Jordan's approach is resonating with some partners, too. When EDS stopped bidding on a contract for auto maker DaimlerChrysler (DCX), a big Sun customer, Sun CEO Scott G. McNealy personally helped bring EDS back to the table. And last year, EDS plucked the deal from Big Blue. "The last thing we want to see is IBM win," says McNealy. For EDS, the enemies of its enemy are now its most important friends.
By Andrew Park in Plano, Tex., with Jay Greene in Seattle