Moody’s cited its concern over EDS’ main markets, its contract exposure to troubled companies, and the effect that such troubled contracts and EDS’ cash-consuming US Navy contract will have on free cash flow over the next year relative to debt.

The rating on EDS’ senior unsecured debt was lowered from A1 to A3, while the rating on its senior unsecured shelf was lowered from (P)A1 to (P)A3, and on its commercial paper from Prime-1 to Prime-2. Moody’s also lowered EDS’ subordinate shelf from (P)A2 to (P)Baa1, and its Preferred Shelf from (P)A3 to (P)Baa2. Despite the downgrades, EDS’ ratings remain squarely in investment grade territory.

Yesterday’s move caps a grim Fall for the Plano, Texas-based services giant, which has seen it forced to lower its third and fourth quarter forecasts, lay-off staff, sell assets and lose out on some major contracts.

Moody’s said it was continuing its review of EDS, and will focus on contract quality, both where customers pose a credit risk or face performance pressures that could prompt them to scale back their business with EDS. It will also look more deeply at the services giant’s free cash flow and its liquidity.

According to Moody’s, EDS’s free cash flow (cash from operations minus capital expenditures and dividends) to debt measures have weakened considerably over the last several years. Free cash flow has been negative under this definition, said Moody’s, even as the company has to fund large upfront costs to support mega contracts such as the US Navy deal. At the same time, said Moody’s, EDS’ debt has increased.

In Moody’s favor are its credit lines, which Moody’s said provided a significant source of liquidity, as long as EDS was in compliance with a minimum net worth covenant. Moody’s added that 40% of the $614m in cash, cash equivalents and marketable securities on EDS’s balance sheet was unencumbered and serves as an additional potential liquidity source.

A spokesman for EDS said yesterday that it was working closely with Moody’s to ensure the review was concluded as quickly as possible. At the same time, said the spokesman, as a company EDS was still solid investment grade.

We maintain complete access to long-term debt and equity markets, said the spokesman. He added that unless the company wanted to issue new debt, any increased expense [as a result of the downgrade] will be minimal.

Meanwhile, according to reports yesterday, the company is increasing its focus on smaller deals which will deliver cash flow upfront. News agencies quoted EDS’ chief sales officer Steve Smith, as saying that megadeals would remain a cornerstone of its business, but that it would be more selective in which large deals it chased. At the same time, he said, the company will also target more small and medium sized deals. The company wanted to strike more deals that delivered immediate cash flow, said Smith.

Source: Computerwire