Credit analyst recommends investors continue to avoid EDS paper

By Ronda Fears

Nashville, Tenn., Sept. 19 - As Electronic Data Systems Corp. feels the impact of spending cutbacks, compounded by two big customers going bankrupt, Carol Levenson, director of research at Gimme Credit, suggests continuing to avoid the credit.

EDS (A1/A+) made a staggering profit warning Wednesday, citing a falloff in revenues underscored by the bankruptcies of US Airways and WorldCom.

"During [Wednesday's] call, management acknowledged the inevitable downgrade to follow, but reassured investors it would have 'no impact whatsoever' on the company's capital markets access," Levenson said in a report Thursday.

"These are words that could come back to haunt them, but certainly a one notch downgrade - the likely outcome from this warning alone - isn't a dire event.

"However, the drop in EBITDA and cash flow will cause some deterioration in debt protection measures.

"Moreover, after the inevitable stock market reaction, EDS might be tempted to step up its stock buybacks, making things even worse for bondholders.

"We would continue to avoid this name."

Levenson said Gimme Credit turned negative on EDS credit when it embarked on a cash-financed acquisition binge last year, saddling the company with a worrisome reliance on commercial paper and hopes of a friendly equity market in order to stabilize its financial picture.

While the company hasn't exactly been going gangbusters in the debt-reduction mode, it managed to issue some hybrid securities and reduce its commercial paper outstanding and near-term maturities to nearly nothing, she acknowledged.

Nevertheless, she added, EDS could face more than $2 billion in maturities in 2004 and off-balance-sheet obligations are considerable.

Now, with the earnings warning, it appears there will be little, or more likely negative, free cash flow available this year to reduce debt further.

"The company's new guidance implies a 400% sequential earnings increase from the third quarter to the fourth," Levenson said, "but a recovery this swift seems unlikely."

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