Copy of "Computer-service companies..." article from Barron
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Golden Days
Business is booming for the computer-service companies
Harlan S. Byrne
or the companies that put together, maintain and run computer systems for
others, a Golden Age has arrived. With outsourcing still on the rise throughout
Corporate America, the market for computer services has boomed to perhaps
$100 billion a year. And it shows no signs of leveling off.
The boom is being aided by the march - or, in some cases, spring - of
technology. As each new generation of hardware and software arrives, keeping
up with it becomes increasingly daunting to retailers, restaurant chains,
publishing firms, manufacturers, wholesalers and other businesses with sizable
computer networks.
At the same time, the specialists in computer services have been able to move
beyond their traditional markets into new ones. Many have taken on roles
formerly filled by business consultants, focusing on boosting productivity,
improving marketing or bolstering the overall efficiency of their clients'
operations.
With demand rising sharply, hundreds of companies, big and small, have jumped
in, often searching for a niche. But right now, and probably for the immediate
future, the market's growth will allow many players to thrive even as more turn
up.
The recognized leaders among veterans in the field are Electronic Data
Systems, spun off in June by General Motors; Integrated Systems Solutions,
a subsidiary of IBM, Computer Sciences, and Andersen Consulting, which in
1989 split from Arthur Andersen, the accounting firm.
Hot on the leaders' trail are some relative newcomers - an AT&T subsidiary,
AT&T Solutions, and General Electric. Another giant with computer
knowledge gained in the defense and aerospace industries, Lockheed Martin,
is vying for more outside jobs.
Notable among a flock of fast-moving smaller competitors are a couple of
Dallas outfits, Affiliated Computer Services and Perot Systems. The latter's
founder, Ross Perot, is a pioneer in the field, having founded EDS in 1962.
Today, EDS has nearly $15 billion of annual revenues, of which about $8
billion, strictly speaking, comes from outsourcing. Perot, who has run as a
third-party candidate in the past two Presidential elections, sold EDS to GM in
1984 and departed in 1986 after a falling-out with his bosses in Detroit. He
started over in 1988, creating Perot Systems ($600 million in annual revenues
and growing fast), but turning over operations to his aides after diving into
politics in 1992.
The industry's rise has been marked by acquisitions aimed at bolstering market
share and acquiring skilled personnel. Still, the computer-services universe
remains fragmented. George Logemann, an analyst with Yankee Group, which
tracks technology firms, says a lot more mergers lie ahead.
Outsourcing of data centers, the original springboard for the computer-services
business, was born out of businesses' desire to cut costs. Clients typically would
sell or transfer their computer operations, including personnel, to companies
such as EDS and IBM, which then would run them under long-term contracts.
Landmark deals included multibillion-dollar contracts that IBM signed with
Eastman Kodak and EDS with Xerox.
Recently, companies have been asking the computer-service organizations to
design and set up systems, as well as run them. Today, an EDS may be called
on to establish and maintain a global network of computers vital to a
multinational corporation's operations. But it's not simply a matter of picking
hardware and software, or holding down outlays. The overall aim is to sharpen
the client's competitiveness.
Then there's that pesky problem of getting computer systems to overcome the
much-feared cyber-confusion the approach of the year 2000 threatens to bring.
``If a company is struggling on its own with a computer system today, it may not
even survive by the year 2000,'' warns Rick Roscitt, managing partner of AT&T
Solutions.
Although such warnings may contain a bit of hyperbole, a lot of potential
customers are taking them seriously. The industry is buzzing with new contract
signings, and many mega-deals ($1 billion-plus) are in the works. That may
include the mother of all deals, a plan by DuPont to turn over its computer
networks to an outsider on a long-term contract worth several billion bucks. A
decision on that deal, coveted by virtually every major member of the
computer- services tribe, is expected soon.
Investors have caught on to the opportunities ahead for computer-service firms.
As the market has roared ahead this year, buying interest in the stocks of such
companies has been brisk.
Oddly enough, the leader in outsourcing, Electronic Data Systems, has lagged
recently. In fact, the company threw Wall Street into a tizzy in October by
announcing a slowing of new business in the third quarter, a trend expected to
continue through the current one. The slippage compared with a red-hot
showing a year earlier, and the news caught Wall Streeters off-guard. Result:
EDS stock plunged 19% on the day the announcement was made. Before the
selloff ended, the shares had dropped to around 40 from a record high near 64
earlier in the year (nearly quadruple the stock's price five years ago). The shares
rebounded somewhat, to around 47.
EDS probably will end this year with its total of new business falling well short
of the record $10 billion (non-GM) booked in 1995. Not to worry. Gary
Fernandes, EDS's vice chairman, sees plenty of new business ahead. While it's
impossible to determine how many deals EDS will land, Fernandes says the
company currently is bidding on nine contracts in the $1 billion class, 16 valued
at $500 million-$1 billion and 100 in the $100 million-$500 million range.
Thanks to past ties with GM (which at one time accounted for a very
high percentage of its business), EDS has a whopping $75 billion backlog of
work. This year, for the first time, net income is expected to top $1 billion, or
just under $2.10 a share. That would be down a bit from earlier analyst
estimates, but still would exceed last year's $939 million, or $1.96. Total
revenues, as noted, will be around $15 billion, up from $12.4 billion in 1995.
Analysts' estimates compiled by First Call put earnings at around $2.40 a share
for 1997 and $2.80 for 1998.
Analysts were ticked off by what they believe was the company's failure to warn
them of second-half trouble on new orders. EDS officials trekked to Wall Street
in November to try to offset what they felt was an overreaction by major
investors. Despite the problems, many analysts have ``buy'' ratings on the stock.
They like EDS's dominant position in traditional forms of outsourcing, such as
managing data centers, as well as its moves into newer arenas, such as setting
up computer systems.
The spinoff from GM has put EDS in position to go after big potential contracts
from competitors of the giant automaker and its Hughes Electronics subsidiary.
(It has also freed the company from pricing pressures it encountered on General
Motors contracts when it was part of that company, although much of the work
it now does for the automaker is being done under contracts signed before the
spinoff.)
Electronic Data Systems also has positioned itself to better address its clients'
strategic goals by acquiring A.T. Kearney, a major management-consulting firm.
EDS has made other acquisitions, too, to broaden the scope of its services. At
various times, speculation has linked it to various merger or joint-venture
partners, namely Sprint, British Telecom and AT&T. But only a possible
tieup with Sprint, it appears, ever reached the serious-negotiation stage.
While EDS has stumbled a bit recently in its pursuit of new business, its two
main competitors, IBM's Integrated Systems Solutions Corp. unit (ISSC) and
Computer Sciences have been racing ahead.
ISSC's 1996 contract signings probably will exceed $7 billion. The IBM unit
boasts that it has nailed down more than $40 billion in new commercial
outsourcing contracts since it was formed in 1991. In fact, ISSC's success has
been a key contributor to the revival of IBM (and the spectacular rebound in the
computer maker's stock price).
Much of the new business is coming from Europe, where IBM has a major
presence and loads of marketing prowess. That's helped ISSC in its battles
there against rivals such as British Telecom and France's Cap Gemini.
ISSC's recent major outsourcing triumphs include contracts abroad with British
Steel and at home with the Prudential Insurance Co. of America. ISSC
currently is bidding on 10 projects, each valued in excess of $1 billion, says
Douglas Elix, the company's president and CEO. As of Sept. 31, ISSC's
contract backlog stood at $37 billion.
Computer Sciences, the other member of the industry's Big Four, is having a
banner year, with new business contracts running three times higher than they
were last year. More significant is the company's decreasing reliance on
less-profitable government outsourcing contracts, at one time the focus of its
business.
While shares of Computer Sciences and Affiliated Computer Services have moved up
steadily, those of Electronic Data Systems have been hurt by a slowdown in its
acquisition of new business.
To expand, Computer Sciences has made a number of acquisitions. None has
been more important than this year's purchase of Continuum, which inked a $2
billion, 10-year pact with a major insurer, CNA Financial. Though Computer
Sciences' stock lagged earlier this year, it has picked up and recently was
around 80, up nicely from its 1996 low of 64 and five times higher than its price
five years ago. ``We don't see slowing in demand anytime soon,'' happily
predicts Thomas R. Madison Jr., president of the Integrated Business Services
unit.
The consensus analysts' estimate puts Computer Sciences' earnings at $2.93 in
its fiscal 1997 year, which ends on March 31, and $3.49 in the following year.
In fiscal 1996, net came in at $142 million, or $2.48 a share, on $4.2 billion of
revenues.
The successes of EDS, IBM and CSC haven't escaped the notice of some large
and wily new competitors.
Just this year, General Electric put together a group of units, mostly acquired, to
create GE Capital Information Technology Solutions. Starting with $5 billion in
revenues, the GE subsidiary is aiming to become a major force in the computer-
services field.
To bolster its operations, GE Capital Information Technology Solutions
acquired the data center of Andersen Consulting and entered into a joint
marketing agreement that already has paid off in substantial new business.
``We're bidding on lots of business, including several large outsourcing contracts
of more than $1 billion apiece,'' declares Steffan Burns, a GE marketing official.
Another potentially big competitor in the commercial outsourcing field is
Lockheed Martin, the leading defense contractor with revenues of more than
$31 billion. The company has a vast store of computer expertise from its
decades in the aerospace business. In years past, it made its mark as the No. 1
systems integrator for Uncle Sam and local governments. And in the past year
or so, Lockheed Martin has moved into commercial outsourcing, nabbing a
couple of fair-sized deals. Its commercial outsourcing revenues now are $120
million annually, and its leaders hope to steadily push up the total.
Telephone companies also have entered the fray. Their forte: meshing
telecommunications with computers, a growing need at many businesses. AT&T
Solutions' main targets are corporations having trouble coping with large
computer networks. Formed in February 1995, the unit now has about $700
million in annual revenues. ``We'll be a multibillion-dollar company by the end of
the decade,'' predicts Rick Roscitt, the managing partner. One prized contract
was a $1.1 billion deal signed in September with Textron, which hopes to
realize $125 million of cost savings over the contract's 10-year life.
Last year, AT&T's archrival, MCI Communications, bought SHL
Systemhouse to bolster its information-services operation. And Alltel, a much
smaller telephone company based in Little Rock, Ark., also is a player.
Among the smaller publicly-traded companies in the field, Affiliated Computer
Services is ``a real comer,'' according to Allie Young, an analyst with the
Dataquest unit of the Gartner Group. Started in 1988, Affiliated has shown
strong growth over the past five years. Revenues are rising rapidly, currently
running at about a $600 million annual clip. Net income in the company's fiscal
1997 year, which will end in June, is expected to exceed $1 a share, versus 83
cents in fiscal '96. The strong results have helped Affiliated's shares triple in the
past two years.
Other small publicly-traded computer-services outfits include Technology
Solutions, Vanstar and Whittman-Hart. All have seen their businesses - and
stock prices - move up nicely in recent years.
Privately-owned players also have staked out important niches - particularly
Andersen Consulting, Perot Systems and PKS Information Services, a unit of
Peter Kiewit Sons. It's a fairly good bet that in time all of these operations will
become publicly owned.
Andersen has shown a keen ability to forge ties with other companies to go after
business. Under a deal announced in May, it linked up with Computer Sciences,
AT&T Solutions, Bell Atlantic and J.P. Morgan to manage part of Morgan's
global technology infrastructure. ``I think more alliances of this scope will be
formed,'' declares Joellin Comerford, an Andersen official. ``It's no longer
unthinkable to join with a competitor to stretch the capability of the partners.''
The value of the seven-year agreement was put at more than $2 billion.
With major companies willing to pay such huge sums for computer services, the
industry's future is burning bright.
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