Credit analyst sees more downside in EDS

New York, Oct. 31 - Electronic Data Systems (A1/A) is likely to see additional downside, Carol Levenson, analyst with Gimme Credit, warned Thursday.

She said she is "less sanguine" than management about the company's liquidity situation and added she believes EDS should be renegotiating its bank lines to provide a greater liquidity cushion in case its rosy cash flow projections don't come true. The facilities include a net worth covenant that could come into play if the company had to take an impairment charge for some or all of its $5.5 billion in goodwill and intangibles.

Levenson's comments come in response to EDS' third quarter earnings, reported after the close Wednesday.

She described the results as "dismal," noting that adjusted earnings fell a "sickening" 70% and contract signings were deeply depressed.

Nonetheless the earnings were better than the company had previously warned, helped by lower-than-expected costs related to WorldCom - although Levenson warned those costs could still materialize in the fourth quarter.

Levenson's concern, however, is focused on financial flexibility and shareholder enhancement pressure.

Since Gimme Credit's last report on the company on Sept. 20, Moody's Investors Service has joined Standard & Poor's in reviewing its commercial paper ratings for a downgrade.

Levenson noted the company had previously lessened its reliance on the "skittish" CP market but now it appears its CP issuance may have risen markedly in the September quarter. Management said Wednesday the company was having no problem issuing CP but is being forced to pay Tier 2 rates.

Also concerning Levenson was possible stock buybacks after EDS's stock price plunged on the earnings warning. "We were amazed to see the company had spent more than $300 million in the quarter buying back its own stock," she commented. "Unless this all took place in the last week of the quarter, EDS was not exactly repurchasing its stock at bargain rates."

She added that the buybacks explain why net debt increased by $450 million in the quarter, despite modestly positive free cash flow and no acquisitions.

"Even more disturbing, we believe this was financed with commercial paper, a less than prudent move," Levenson continued. "Not only does this reduce the company's liquidity, but it also subjects it to refinancing risk at a time when the capital markets are not exactly enthralled with this name."

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