EDS not out of the woods despite profits

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A day after Electronic Data Systems reported a sixfold increase in quarterly profits, its shares tumbled almost 6 per cent, underscoring the challenges facing the IT outsourcing group as it begins to emerge from a painful three-year shake-up.

When Michael Jordan took over as chief executive three years ago, EDS was in dire straits. The company, which was spun out of General Motors, the US automaker, in 1996, was struggling against low morale and the spiralling cost of administering a huge contract to provide IT services to the US Navy.

Soon after he took charge, Mr Jordan brought in new management talent, launched a cost-cutting drive and set about improving relationships with some of the company’s key clients. But the troubles continued, particularly in the UK.

In January 2004 it lost a long-running £3bn ($5.5bn) contract to run IT services for the Inland Revenue. It later found itself embroiled in a lawsuit with the National Health Service after the health provider scrapped a £90m e-mail deal with the company.

But by early this year, Mr Jordan’s efforts had begun to pay off. In February, he pronounced EDS’s turnround complete, and said the company would focus its efforts on margin improvements and revenue growth.

His performance has won plaudits, even among sceptics. “Mike Jordan and his management team have lived up to every promise they made,” says Allie Young, an analyst at Gartner.

But EDS is not out of the woods yet. Profits were slim last quarter – just $24m on more than $5bn in sales – and while Mr Jordan has dealt with the contracts that had threatened to sink it, EDS has yet to catch up with IBM, its bigger US rival.

Although EDS, whose clients include the UK’s Ministry of Defence, saw a sharp pick-up in new business in the period, including an extension of the Navy contract and several billion dollars of new business from GM, changes in the way big institutions are structuring IT contracts mean that companies such as EDS can expect fewer multi-billion dollar “mega deals” in the future.

“[Big institutions] want more control,” says Nick Nilarp, an analyst at Fitch Ratings. “They want to do [contracts] piecemeal with various companies and on shorter timeframes.”

Not all analysts view this as a disadvantage. “Mega deals are hard for providers to make profitable,” says Ms Young. “When you win a smaller deal, you get a more manageable piece of business.”

A bigger challenge for EDS may be more competition for IT contracts from outsourcing groups in countries, such as India, with a much lower cost base.

Mr Nilarp argues that new growth should help companies such as EDS and IBM keep pace with the upstarts that have begun to eat into US outsourcing groups’ traditional business – a sentiment Mr Jordan seems to share.

EDS has moved to address the threat by building up EDS’s Indian presence. Earlier this year, it said it would take a majority stake in MphasiS, an Indian outsourcing group.

EDS has also been investing heavily in its global IT network to improve the efficiency of its internal teams.

Mr Jordan says the company is moving from developing new technologies and systems to implementing them. But it may be some time before EDS can reveal whether those investments will generate the profits and margin improvements investors are looking for.

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