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13 Feb 2003
MOODY’S DOWNGRADES EDS’ Sr. UNSECURED TO Baa2 AND SHORT-TERM RATING TO PRIME-3; OUTLOOK STABLE
Moody’s Investors Service downgraded Electronic Data System’s senior unsecured rating to Baa2 from A3 and its short-term rating to Prime-3 from Prime-2.
The downgrades reflect: 1) a history of weak free cash flow to debt measures (adjusted for off-balance sheet obligations including its CSFT program, receivables securitization program, and leases), 2) the expectation for continued cash usage under its Navy contract, which will put a strain on 2003 cash flow, 3) credit weakness among several of the company’s large clients, including Worldcom and several airlines among others, customers for which liquidity and long-term viability is a question, which could put EDS’s cash flow from those contracts at risk, 4) the current environment of reduced demand for IT services, and 5) declines in business under contract with General Motors, which were greater than expected.
The stable outlook reflects Moody’s expectation that a) EDS has improved its new business pursuit process towards outsourcing contracts requiring less capital funding, as evidenced by large new contract awards with the Bank of America and ABN Amro, b) the demand for IT outsourcing and business process outsourcing will present EDS with new business opportunities requiring less capital funding, and c) ramping deployment to 310,000 billable seats under the Navy contract by fiscal end 2003 should turn that contract cash flow positive later in 2003.
EDS’ free cash flow (defined as cash flow from operating activities less capital expenditures and dividends) was $619 million in 2002 (although $200 million was due to a 2002 tax payment that was deferred into 2003) and negative $140 million in 2001. The problems with the Navy contract, the ramp of a large contract with the U.K. government, write-offs on the WorldCom and airline contracts, significant revenue declines in the GM contract, the settlement of derivative contracts for cash, and challenges in obtaining contract add-on assignments have collectively placed pressure on EDS’ cash flow and strained EDS’ balance sheet. At year end, EDS had $5.3 billion of balance sheet debt. While Moody’s ascribes significant equity credit to its $1.6 billion Feline PRIDES, the equity credit is substantially offset by usage under its CSFT and A/R securitization programs. Furthermore, EDS also has significant annual lease expense.
Moody’s expects EDS’s exposure to large customers with weak credit profiles will continue to present a challenge. EDS has large contracts to provide IT services to MCI Worldcom and US Airways, both in bankruptcy, American Airlines (senior unsecured rated Caa2, approximately $400 million revenue annually), Continental Airways (senior implied rated B2), and other airlines (approximately $600 million annual revenue from airlines other than US Air and American). While EDS provides essential services, the tenuous nature of bankruptcy and restructuring, and on-going viability make the cash flows from these contracts higher risk, in Moody’s view.
With regard to EDS’s large contract with Navy N/MCI, Moody’s expects EDS will continue to be challenged to achieve its 2003 targets for deployed Navy seats and for free cash flow, given the magnitude of N/MCI network and 2002 underachievement, when EDS deployed 121,000 seats of its 160,000 target. EDS has targeted achievement of 310,000 seats running by December 31, 2003, given the recent authorization from the Navy to deploy 150,000 seats in addition to the 160,000 already authorized.
Because of GM (12% of 2002 revenue) sector agreement renegotiations in 2002 and automotive industry weakness, Moody’s expects the revenue from GM to decline by 15% or more during 2003 and margins to be negatively impacted, as the EDS-GM business relationship has reached an arms-length relationship subsequent to the 1996 separation of two companies.
The company has built up cash and alternate sources of liquidity, but Moody’s expects a number of calls on that liquidity in 2003. At year end, EDS had about $1.5 billion unrestricted cash ($380 million cash restricted by regulation becomes unrestricted by February 2004). It also has undrawn revolving credit facilities comprised of a $625 million 364-day revolver, which at the company's option may be converted to a term loan maturing September 2004, and a $625 million five-year revolver, which expires September 2004. At this time, EDS has over $2 billion of cushion in its minimum net worth covenant of the revolving credit facilities, and Moody’s currently expects EDS to remain in compliance. EDS also established a one-year accounts receivable securitization facility in the fourth quarter of 2002 (about $410 million drawn). However, Moody’s expects that EDS will need to repay $800 million of zero coupon convertible notes that become puttable in October 2003. Also, it may need to cover about $220 million of commercial paper, as well as the $200 million deferred tax payment, and an amortizing potential prepaid expense obligation ($170 million at September 30, 2002) under a rating trigger triggered by Moody’s rating action today. Other rating triggers not triggered include one on a software contract approximating $250 million if EDS’s rating were to fall below Baa3. The accounts receivable securitization facility established in the fourth quarter of 2002 has an unwinding provision if the rating falls below Baa3.
Moody’s expects free cash flow will be back end weighted in 2003, due to performance on Navy N/MCI, which should turn cash flow positive in late 2003, as well as the company’s recent focus to pursue contracts requiring less initial capital funding. The N/MCI contract consumed $900 million free cash flow in 2001, $930 million free cash flow in 2002, and is expected to consume $300 million free cash flow for the full year 2003. Moody’s expects EDS will face continued competition from other large service providers, including Accenture, CSC, and IBM, which have also increased their focus on outsourcing opportunities.
Senior Unsecured to Baa2 stable from A3
Subordinate Shelf to (P)Baa3 stable from (P) Baa1
Preferred Shelf to (P)Ba1 stable from (P) Baa2
Commercial Paper to Prime-3 from Prime-2
EDS Finance Plc
Bkd Commercial Paper to Prime-3 from Prime-2
Electronic Data Systems Corporation, with headquarters in Plano, Texas, is a leading provider of information technology services worldwide.
No Related Data.
© 2019 Moody’s Corporation, Moody’s Investors Service, Inc., Moody’s Analytics, Inc. and/or their licensors and affiliates (collectively, “MOODY’S”). All rights reserved.
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