Credit-Suisse Smiles on Data Processors Accenture, Cognizant; Frowns on EDS, Affiliated

There was a massive coverage review of professional services and data processing firms Friday by Credit-Suisse’s Bryan Keane, drawing a sharp line between winners and losers. Keane is dropping Electronic Data Systems (EDS) from Outperform to Underperform, initiating coverage of Affiliated Computer Services (ACS) with a Neutral rating, and taking up coverage of both Accenture (ACN) and Cognizant Technology Solutions (CTSH) with Outperform ratings.

The skinny:

EDS: The company’s transition from turn-around story to growth is “difficult,” writes Keane, noting there are downside risks to the company’s forecast for 2007 and 2008 results, starting with the Street estimate of 59 cents per share in earnings for the fourth quarter, which, to achieve, will require “considerable margin improvement” on EDS’s part. The company’s free cash flow is questionable, too, as it has been boosted by a variety of one-time items. Keane thinks the stock is worth $21, below Friday’s price, or 4.1 times enterprise value-to-EBITDA based on 2008 estimates.

Affiliated: ACS is in the middle of a buyout engineered by Cerberus Capital, notes Keane, and the fact that the review of the deal is “lingering” for a substantial period is likely pressuring ACS’s contract bookings in the meantime, writes Keane. Those bookings, on a trailing twelve-month basis, are down 21%, and he thinks the current quarter will produce another round of “soft” bookings results, at about $150 million. His target is $55, not far from Friday’s price, based on an EV/EBITDA multiple of 7 times.

Accenture: Worries about a global credit crunch hurting IT spending are “overblown,” in Keane’s opinion. He expects companies will continue to seek outsourcing help. The company has beaten its own forecast in its most recent quarter, he writes, bringing in 14% revenue growth, ahead of its forecast of 12%. Its consulting business, roughly 60% of sales, “continues to lead the charge, with fiscal year 2007 consulting bookings up 19% year-over-year versus 9% year-over-year in fiscal year 2006.” Keane’s price target of $48 represents an EV/EBITDA multiple of 11 times.

Cognizant: A similar argument to Accenture holds for Cognizant, to wit, the Offshoring move by companies continues full steam, and Cognizant should benefit as a leader in the category. The big “headwinds” are now safely behind the company, Keane believes, with the 10% rise in the rupee this year and the big wage hikes in India unlikely to continue as a factor. He expects profit margin for the company in its fiscal third quarter to rise “slightly” from the prior quarter. Keane’s $53 price target on the stock represents a P/E of 35.5 times calendar 2008 earnings per share of $1.48.

EDS vs. CTSH vs. ACN vs. ACS 1-yr chart:

Comments

[market master:]

Bryan Keane is an idiot. He just looked at a relative chart like the one referenced in the story and then wrote a story to justify the past (last 12 months') performance of the top two.

ACN's recent signings have been far more heavily concentrated in IT (Capital Intensive) deals, which will seriously squeeze margins and put a sleeper hold on future mega deal pursuits. They can't afford to sign many more deals like they've been signing, and access to capital in the current environment will hamper growth in the low-lying fruit of IT-heavy deals.

As for EDS, he apparently hasn't bothered to understand what's been going on behind the numbers. EDS has made some huge investments in its own infrastructure and built out its global delivery capacity, over the last several years. Free cash flow was constricted as a result, but it is now in position to digest a much higher rate of new contract signings over the next decade. With its strategic partnerships, EDS has trumped IBM by standardizing other outsourcers' "custom" solutions.

I agree that Cognizant is a formidable contender in some regards, but no matter what happens to the Rupee or wages in India, the economic impact will affect all major players in this field, since all have built up a sizeable presence there. I personally believe the price/wage gap between India and the west will continue to close quickly, eventually eliminating much of the benefit of off-shoring to India. Other places (i.e., China, Vietnam, the former Soviet Bloc countries) will become the future low-cost providers. It is too early to tell which of the major outsourcing firms will be able to catch the bouncing ball, but I seriously doubt that a cash-strapped ACN will be able to keep up with the leaner -- and much more experienced -- EDS.

Time will tell... but as far as investments are concerned, picking the two most expensive stock valuations (who are not industry leaders) is a recipe for financial ruin. Do your own due diligence, and never take advice from a bozo like this guy.

2007 Nov 19 09:32 PM