Turnaround efforts at troubled Electronic Data Systems (NYSE:EDS), the world's second-largest computer services company, hit another snag yesterday with the announcement of plans to slash dividends by two-thirds and issue up to $1 billion in new equity capital. Investors reacted harshly to the news, sending shares 6% lower in trading yesterday.
The embattled Plano, Texas-based information technology (IT) outsourcing company has suffered myriad financial difficulties recently, including a series of bad contracts, a slowdown in new business, and plummeting earnings. A complete overhaul of top management could not prevent ratings agencies such as Moody's (NYSE:MCO) and McGraw-Hill's (NYSE:MHP) Standard & Poor's from questioning the financial stability of the company.
Electronic Data Systems' debt of $3.48 billion currently rests at the lowest rung of the investment-grade spectrum, teetering precariously on the threshold of junk status. It was an intense round of discussions with Moody's that prompted yesterday's plans to raise capital to avoid a possible debt downgrade.
Even with a reported $2 billion in cash and investments on the balance sheet, the move can hardly be considered proactive. Any further credit downgrades could be disastrous for the company. The concern is not over an increase in debt expenses, which would impact earnings by less than a penny per share, but rather heightened fears from future customers over Electronic Data Systems' perceived deteriorating financial condition.
Ongoing viability is of vital importance; few companies will hand over their network operations or data-center management to a company that can't meet its financial obligations. It would be much easier to place multibillion contracts with secure competitors such as IBM (NYSE:IBM) or Computer Sciences (NYSE:CSC).
With 480 million shares outstanding, plans to raise $1 billion in capital by issuing roughly 60 million new shares of stock, or possibly convertible securities, will have a dilutive effect in the 12-13% range. Nevertheless, the move may still be beneficial. Maintaining investment-grade debt is critical to winning future business, and the dividend reduction will save the company $192 million annually. Given the capital-intensive nature of the business, and the sometimes enormous start-up requirements, this is money Electronic Data Systems desperately needs.
Regardless, considering all the problems that beset the company, even bold investors might want to adopt a wait-and-see approach.
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Fool contributor Nathan Slaughter owns none of the shares mentioned.
