Deutsche sees small windfall for EDS convertible if dividend cut but still advises caution

By Sara Rosenberg

New York, Oct. 16 - Holders of Electronic Data Systems Corp. 7.625% mandatory convertibles due 2004 may experience a "small windfall" if the company reduces its common stock dividend, according to a Deutsche Bank Securities Inc. research report.

However, despite this possibility of an upside, Deutsche analysts Jeremy Howard, Jonathan Cohen and Robert Barron still view EDS as unappealing and recommend investors take a cautious stance due to the possibility that the payment of the Oct. 10, 2003 put may be problematic, the company's credit risk and the yield to put of 10.24% which the analysts say is not adequate compensation for these risks.

Examining free cash flow in detail, the analysts noted that EDS defines free cash flow from operations as consisting of net cash from operations, proceeds from investments and other assets, payments for purchases of property and equipment, payments for investments and other assets, payments for purchases of software and other intangibles and other. According to the Deutsche Bank analysts, the more traditional definition of free cash flow from operations does not contain the proceeds from investments and other assets or the other categories.

Under EDS' definition, free cash flow from operations was $1.62 billion for 1999,

$330 million for 2000, $197 million for 2001 and $33 million for the six months ended June 30, 2002. Under the "traditional definition," EDS' free cash from operations was $915 million for 1999, $116 million for 2000, negative $58 million for 2001 and negative $54 million for the six months ended June 30, 2002.

"Under the company's own definition, EDS posted free cash flow of just $33 million in the first six months of 2002. This is well below the $200 - $400 million the company has targeted for 2002," the report noted. Using the traditional measure, the analysts say EDS has "struggled" to generate free cash flow since 1999.

Another issue plaguing the company is its $625 million 364-day revolver. In a previous report, the Deutsche analysts had raised the possibility that the current informal SEC enquiry would trigger the MAC clause in the revolver or that a first quarter loss would do the same. Although EDS has not yet made public the documentation for its current loan agreement, the Deutsche analysts said EDS management told them there is no substantive change from the previous agreement. Examining the terms of that revolver, the analysts concluded an informal SEC inquiry is unlikely to trigger the MAC provision. They also believe expected future changes in the company's situation are not covered nor is the term-out option.

Electronic Data Systems is a Plano, Tex. provider of strategy, implementation and hosting services and solutions for clients managing the digital economy.

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