IT services slip as tech spending slumps

By Franklin Paul

NEW YORK: The computer services sector, where contracts are signed well in advance and there is a suit-wearing, old-economy style, had always seemed a predictable stock market bet. But a warning by Electronic Data Systems Corp., a top player in the computer services field, has turned that bit of optimism on its head.

Fear that corporations may further pinch pennies for technology spending shook the computer services sector on Thursday, sparking a sell-off. EDS warned late Wednesday that spending by its existing customers had virtually stopped and that a lack of new deals would erase a huge portion of its expected profits. In response Thursday, ratings agencies Standard & Poor's and Fitch cut EDS' debt ratings.

Technology outsourcing -- in which companies like EDS and International Business Machines Corp. are paid to manage organizations' computer operations -- and consulting had been considered among the last safe havens for technology investors, analysts said. "It appears that demand for services appears to be weakening and the third-quarter recovery in (contract) signings that many had hoped for is unlikely to materialize," said J.P. Morgan analyst Bill Shope.

This comes as quite a disturbance to technology market watchers. Many had hoped services and consulting would stay afloat as long as companies sought to cut their own costs by handing over their computer operations to the care of others. IBM, which derives more than 40 percent of its sales from services, did not comment on whether it would issue a similar warning about its own business.

But a spokeswoman said, "The factors which resulted in a substantial miss by EDS appear to be unique to that company, based on what we can see from their announcement."

EDS customers, which have already slashed spending on new computer hardware and systems, are putting off new deals for services as well, as they work to recalibrate their operations with market demand. Moreover, customers are no longer expanding deals to include extra consulting or additional systems as they often had in the past, analysts said. In fact, many customers are looking for ways to restructure deals to reduce their scope.

"There aren't really any pockets of strength in the economy, so it's safe to assume customers in other industries are looking to reduce the scope of signed contracts to the extent that they can," said Marty Shagrin, research analyst at Victory Capital Management, with $75 billion in assets.

What's more, with the growing anxiety over possible armed conflict in Iraq, and with a possible deterioration in consumer confidence looming, experts say spending is unlikely to perk up and could be further constricted.

"Business conditions in financial, communications, and manufacturing have shown no meaningful signs of improvement, and are continuing to erode in certain instances," said Lehman Brothers analyst Dan Niles. "Meanwhile, government spending, a positive offset for many of our companies, could be at risk beyond the federal sector's October fiscal year-end."

Indeed, slower-than-expected growth in services contracts, combined with a decision to increase investment in its sales activities, accounted for about 25 cents to 28 cents of the lowered earnings per share estimate, EDS said. In addition, EDS cited write-downs related to the US Airways Group Inc. bankruptcy filing and the poor financial performance of some European contracts.

Analysts said that IBM's consulting business has already been hit by a gradual decline, in contrast to the apparent abrupt slide experienced by EDS. Other related companies were also dragged down after EDS's warning. Computer Sciences Corp. , the No. 3 services supplier, tumbled 15 percent, to trade at $30.00 on the NYSE. KPMG Consulting Inc. plunged more than 16 percent to $7.88 after credit ratings agency Moody's gave the company's senior unsecured bank facility its lowest investment grade rating.

Shares of Accenture Ltd., which has been aggressively pushing into the outsourcing market, fell more than 10 percent to $14.30, and Perot Systems Corp. slipped to $10.73, off 12 percent. Affiliated Computer Services Inc. lost 8 percent to trade at $41.32, while Keane Inc. declined 4 percent to $7.67.

(C) Reuters Ltd.