Quaker Oats, EDS Still Haunted by the Ghosts of Strategies Past
Quaker Oats (OAT)
Jim: Don’t buy
Mike: Buy
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Jim: Quaker Oats is one of those companies that’s a case study for the Harvard Business School, right Mike?
Mike: You mean in which the left hand didn’t know what the right hand was doing?
Jim: Exactly. A few years ago Quaker Oats committed one of the greatest debacles in corporate history. Or so I’d argue.
Mike: Well, certainly a write-off of $1.4 billion is not chump change. Or maybe it is chump change.
Jim: Quaker Oats for a century has been one of the leading makers of oatmeal and other hot cereals, along with a few cold cereals such as Life and Cap’n Crunch. Then in the early ‘90s it bought Snapple, the eccentric beverage company, for an incredible $1.7 billion.
Mike: And then dribbled the juice all over the linoleum.
Jim: Quaker Oats completely botched the acquisition, took away a lot of the charm and appeal that had made Snapple a sort of cult favorite, fired that nice receptionist lady who had become the corporate spokesperson, and so on.
Mercifully, Quaker Oats finally threw in the towel in 1997, sold Snapple for something like only $300 million and had to write off the remaining $1.4 billion. And to the surprise of no one, it then fired the chief executive who oversaw the whole mess.
Mike: Now Quaker Oats is under new management and is on the rebound. This is mainly on the strength of Gatorade. Now, I don’t know if this strikes you as odd, Jim, but did you know there’s a whole category of products like that called “fitness water”?
Jim: To my chagrin, yes.
Mike: This reminds me a bit of when I used to go to my grandmother’s house, where she used something called “toilet water” and of course to me, as a 6-year-old, “toilet water” meant only one thing, and I couldn’t understand what she was doing slathering it all over herself. I didn’t find out what that really was all about until I was 29.
Jim: Can we get back to fitness water?
Mike: Gatorade is a home run for Quaker Oats, even though it’s a product everyone agrees looks like antifreeze, and to me, tastes like antifreeze.
Jim: An amazing 40% of Quaker Oats’ sales and profit come from Gatorade. In fact, there’s talk that if Gatorade keeps growing like it has, Quaker Oats might one day be considered mainly a beverage company.
Mike: So would you buy the stock?
Jim: No.
Mike: Too bad, because I think Quaker Oats is a buy right now.
Jim: Why?
Mike: First it’s pretty cheap. There’s also a lot of growth potential in toilet water--excuse me, fitness water--and in extending what is a powerful brand in Gatorade. This company is under management that’s obviously superior to the previous management.
Jim: That’s not saying a lot, Mike.
Mike: Look, this is a stock that’s selling for something in the area of 20 times this year’s earnings, which is quite reasonable in this market.
Jim: Though that’s at the high end of the food-stock sector, and I think this stock already has had its run. For much of last year the shares went nowhere and then they plunged early this year. They’ve caught some fire ever since March, as Gatorade kept powering Quaker Oats’ earnings higher and the company started rolling out some new sports drinks and power bars.
Mike: So far I’ve heard only good things.
Jim: Didn’t you hear the part about this stock already having its ride? It was selling in the mid-$40s in early March, and now it’s in the high-$60s only a few weeks later.
Mike: But many expect this stock to climb well above $70, and I agree, meaning there’s more than a 10% gain left in Quaker Oats.
Jim: I don’t see it; this stock will be lucky to be a market performer for the next several months. Don’t forget some other things: Quaker Oats is debt-heavy. I also don’t believe that Gatorade can extend its past growth rate, even though this company spends millions every year on TV commercials and other promotions for Gatorade. Plus, don’t expect Coca-Cola and PepsiCo to just sit there and let Quaker Oats keep holding this market mostly to itself.
Mike: No, think of it this way: With global warming on the way, people are going to spend a lot more money on fitness drinks.
Jim: Which reminds me of Quaker Oats’ biggest competitive threat: It’s called tap water, and it’s free.
Mike: Except tap water is coming ever closer to tasting more like antifreeze than Gatorade.
Electronic Data Systems (EDS)
Jim: Don’t buy
Mike: Don’t buy
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Jim: Here’s another company with an interesting history.
Mike: No kidding. I mean, over the years Electronic Data Systems has been in more hands than Elian Gonzalez. And one of those owners was someone as unbalanced as some of those relatives in Miami.
Jim: You refer, of course, to H. Ross Perot, who started EDS in 1962 and built his fortune with the company.
Mike: But from there matters went from the sublime to the ridiculous. EDS ended up in the hands of General Motors, which proceeded to make a dog’s breakfast out of the company.
Jim: True. EDS was a pioneer in providing a wide range of data-processing services for companies that didn’t want to do those tasks in-house. So they’d hire EDS, and now this company does nearly $20 billion in annual revenue.
Mike: Except these days fewer and fewer of them hire EDS. But that’s not even the real problem with EDS as far as I’m concerned. The big issue is that EDS is coming so late to the Internet. How can you be a computer-services giant and not see the biggest boon to your business coming down the pike?
Jim: Like a freight train coming down the Cajon Pass.
Mike: Get this: When its new chief executive, Dick Brown, arrived a year ago he wanted to e-mail all of EDS’ employees to tell them what he wanted to do with the company. But he discovered EDS’ e-mail system didn’t allow him to reach everyone. Talk about a company that was fumbling the ball in its own territory.
Jim: Worse, it’s not entirely clear what e-commerce strategies EDS will conquer, and that’s evident in the stock price. It’s gained about 19% over the last 12 months, but for the last few years it badly lagged the general stock market.
Mike: Now, you might recall that when GM owned EDS, GM helped innovate the “tracking stock” that is becoming more commonplace today. GM kept EDS’ ownership, but issued a stock that allowed you to invest in EDS’ performance. GM did the same with its Hughes Electronics unit.
Jim: Except that for more than a decade under GM’s ownership, EDS became, well, like General Motors: flat-footed, bloated, sluggish.
Mike: GM then spun off EDS entirely in 1996, but that didn’t help the stock much. It just kept limping along with three bald tires.
Jim: Incidentally, Perot eventually went off and started another company, Perot Systems, that competes with EDS.
Mike: Right, he did so after that comical episode where GM and Perot had this public feud and GM eventually ousted him from its board.
Jim: Now, luckily for EDS, many of its contracts extend for many years, which means a constant stream of revenue. But the whole ballgame here is getting new, lucrative contracts to spike your growth.
Mike: And here again, this is an industry where there’s No. 1 and there’s everyone else, and in this case No. 1 is IBM, which roared ahead while EDS was slumbering. So now it’s up to Brown & Co. to get EDS to use the Internet to catch up, mainly by using the Web to help promulgate all of its services.
Jim: And then there are all those fledgling “dot-com” companies that could use the help from an outside computer-services firm such as EDS.
Mike: Right, but which one would hire a company that only last year figured out how to e-mail all its workers? It’s ludicrous.
Jim: Now, to Brown’s credit, he’s really tried to cut out EDS’ fat. He’s cut thousands of jobs and other costs, shed unprofitable accounts and so on.
Mike: But he claims he’s not a slash-and-burn guy only.
Jim: He can’t be, because cutting costs to boost profit only goes so far. After that you have to grow the business, and that’s where I come up short with EDS, and why I wouldn’t buy the stock.
Mike: Me neither.
Jim: Right now the stock--which took a beating Monday--is trading for about 28 times EDS’ 2000 earnings, which I think is still too rich a price given EDS’ murky outlook. I say that even though, in the past, these kinds of computer-services stocks have done pretty well in times of overall stock-market volatility.
Mike: Which brings up another problem, which is that EDS is in a ferociously competitive business, and in many ways it’s starting from back of the pack right now.
Jim: EDS is simply a work in progress, with a lot of work left. But if it makes Mr. Brown feel any better, Perot Systems’ stock has done much worse than EDS’ since Perot Systems went public a year ago.
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Write or e-mail with a stock you would like to see discussed in this column. Peltz (james.peltz@latimes.com) covers the markets and corporate financial trends. Hiltzik (michael.hiltzik@latimes.com) covers technology and entertainment and is the author of the book “Dealers of Lightning: Xerox PARC and the Dawn of the Computer Age” (HarperBusiness). Either can also be reached at Business Section, Times Mirror Square, Los Angeles, CA 90053.
You can hear a preview of Peltz and Hiltzik’s weekly column Mondays on the KFWB-Los Angeles Times Noon Business Hour on KFWB-AM (980).
