Credit analyst sees more downside for EDS with volatile trends in credit

By Ronda Fears

Nashville, Feb. 7 - Electronic Data Systems Inc. perhaps pleased some investors to the upside with its earnings report, but Carol Levenson, director of research at Gimme Credit, was not impressed.

"Should we be cheering the fact that EDS (A3/A-) exceeded its free cash flow forecast for the fourth quarter by a stunning $600-$800 million?" Levenson posed in a report Friday.

"Perhaps, but we believe unpredictability in either direction is symptomatic of a volatile credit and we find it disconcerting."

Besides, she added, none of the upside surprise came from better-than-expected operating results as adjusted fourth quarter earnings were down 40% from last year and adjusted revenue dropped 7%.

"We should note this deterioration wasn't nearly as bad as the third quarter's," Levenson said.

"Nevertheless, earnings for the year fell 30% while operating margins diminished by 240 basis points."

Other areas of concern focus on the downgrade to EDS' short-term and long-term ratings by both major rating agencies and the upgrade to formal from informal of the investigation by the SEC.

"The company faces substantial additional calls on its cash if its ratings are severely downgraded, but thus far the agencies have been relatively easy on EDS, lessening this risk somewhat," Levenson said.

And, she added, despite the downgrades of its commercial paper ratings, it appears EDS retains some access to the commercial paper markets, as it ended the year with over $200 million outstanding.

At the end of the year, EDS had $1.5 billion in unrestricted cash and $1.2 billion in short-term debt, which includes the "infamous" putable convertibles, while its bank lines remained undrawn.

"Unless free cash flow takes another 180 degree turn, EDS should be able to meet its short-term obligations," Levenson said.

Despite slightly lower earnings, EDS expects operating cash flow to be essentially flat this year, with substantially higher capital spending leading to lower free cash flow.

"It's not a euphoric outlook, and management's predictive powers have been unimpressive lately," Levenson said.

"We continue to see additional downside in this name."

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