EDS Shares Fall Further

Electronic Data Systems Corp. shares plunged anew Tuesday after the world’s No. 2 computer services company said it spent $225 million to close out a failed hedging strategy on its own stock--prompting a Merrill Lynch & Co. analyst to cut his rating on the stock to “sell.”

The settlement of the stock bet could wipe out the company’s free cash flow this year and may hinder its ability to compete for business, Merrill analyst Steve McClellan wrote in a report. He downgraded the shares from “neutral” to “sell.”

The stock tumbled $4.84, or 29%, to $11.68 on the New York Stock Exchange. The price had dived 53% on Thursday, after the company’s warning of a steep profit shortfall that management blamed on weak capital spending.

EDS, like many major companies, buys its stock in the open market to offset issuance of shares under an employee stock options program. Beginning last year, EDS took out a hedge against a rising market price for its shares, using a combination of stock purchase and sales contracts with other parties.

EDS in effect bought a form of insurance it didn’t end up needing and partly financed that purchase by selling a kind of insurance that another party collected on.

The unanticipated plunge in the stock left the company with a $225-million bill to close out the transactions. EDS said it paid the bill by borrowing $225 million through the issuance of commercial paper.

Moody’s Investors Service said it may cut EDS’ P-1 short-term credit rating, citing the company’s reduced financial outlook.

Separately, Rod Bourgeois, an analyst at investment research firm Sanford C. Bernstein & Co., raised the possibility that the Securities and Exchange Commission may open an investigation of EDS.

EDS, in a statement, said it is not aware of any SEC probe. The SEC declined to comment.

Large computer services contracts, such as one EDS is negotiating with Procter & Gamble Co., require upfront investments, and a restriction in access to capital could make EDS less likely to win such deals, McClellan said in a note explaining his rating change.

EDS denied that it is facing liquidity problems. But some investors on Tuesday decided they couldn’t risk more disappointment.

“I don’t want to be around waiting for the next shoe to drop,” said Brian Eisenbarth, manager of Davidson Investment Advisors’ $200-million Large Cap Value Strategy Fund, who this week sold his remaining 165,000 shares of EDS.

Out of 25 Wall Street analysts following EDS, McClellan’s new rating is one of seven “sells” on the stock, according to data tracker Thomson First Call. Three analysts rate it “buy” and 15 rate it “hold.”