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CSC

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By SARA FISHER

Staff Reporter

In every company’s history, there are deals and then there are deals.

By capturing the much-coveted Internal Revenue Service computer modernization contract, with a value of between $3 billion to $7 billion, El Segundo-based Computer Sciences Corp did the corporate equivalent of hitting a ball clear out of the park.

Called the biggest contract in the history of the computer services industry, the IRS deal also may be the biggest non-defense contract ever awarded by the federal government. The troubled tax agency, buffeted by congressional hearings earlier this year, has finally turned to the private sector to overhaul its antiquated computer system. The IRS previously had spent hundreds of millions of dollars in several bungled attempts to fix the highly criticized system itself.

CSC now faces the daunting task of giving one of the world’s most technologically challenged institutions a head-to-toe makeover.

The biggest undertaking, according to Michael Laphen, president of CSC’s civil group and the head of the IRS team, will be to introduce customer-service features into the organization by the end of 2000. For taxpayers, the new system should finally make gaining access to personal tax records and reaching agency officials as easy as dealing with a bank.

Other tasks include expanding an electronic tax payment system, further developing an Internet-based tax filing system, and designing secure IRS computer terminals that will protect taxpayers’ privacy. CSC will also ensure that the Year 2000 bug has been fixed in the system.

Over the longer run, CSC will completely modernize the IRS’s database, presumably reducing errors and allowing the agency to collect more taxes. “We’re talking about a computer system that is quite old, going back into the ’60s and ’70s,” Laphen said. “The technology needs to be replaced.”

The IRS contract is flexible in both duration and budget, with the higher-end estimates hovering around 15 years and $7 billion respectively, so that the CSC team can determine the exact scope of work needed as it progresses. Leading a team of seven companies, including IBM, KPMG Peat Marwick, Lucent Technologies and Northrop Grumman Corp., CSC is expected to capture as much as 35 percent of the contract.

“We’re currently in the six-month start-up period to finalize the program management,” Laphen said. “We’ll then begin picking the most appropriate pieces of the system to first modernize, and determine a head count for the team working on it. Later on, we’ll bring on other partners to help with specific parts of the project.”

With this deal of deals in its pocket, Computer Sciences has restored Wall Street’s flagging faith and secured a strong revenue stream for the coming year in one fell swoop.

“There had been concern that CSC had not signed a mega-contract in 1998 and that its market share was slipping,” said David Gremmels, a research associate for Volpe Brown Whelan and Co. “The IRS contract goes a long way to address those investor concerns. It’s fair to say that CSC is ending the year with much stronger footing than where it started.”

Upon news of the contract, a slew of analysts promptly upgraded their recommendation from “hold” to “buy,” and CSC stock jumped to $68, compared with the $50 range where it was trading for most of the fall.

More important to Wall Street, CSC beat out a prominent competitor and large government contractor, Lockheed Martin Corp., for the contract. Although CSC is one of the major players in the $950 billion global information technology services industry, it had been losing contracts out to rivals such as IBM and EDS over the last two years.

“CSC’s ability to win business was in serious question on the Street,” said Moshe Kotri, a director at Warburg Dillon Read LLC who upgraded his rating upon hearing of the deal. “This contract shows a trend reversal, making it a major coup for the company. We now expect to see it fuel future revenue growth.”

Analysts are now predicting that CSC revenues $6.6 billion for fiscal 1998, which ended April 3 will surge 20 percent in 1999. Company officials share the enthusiasm about what this contract means for their bottom line, but they also emphasize that revenue patterns in the computer services industry tend to be cyclical.

“This contract clearly increases our revenue visibility going forward, but if you had asked me before Thanksgiving, I still would have been positive about our revenue performance for 1999,” said CSC Vice President Bruce Plowman. “It is hard to tell the exact flow of funds from this deal, but of course we are pleased. We’re talking about an ongoing stream of money that is scheduled to go on indefinitely.”

The IRS contract also gives CSC more leverage in bidding for future contracts. Wall Street pundits tout this asset heavily, particularly with CSC competing for two more large projects that are expected to be awarded by the end of 1998. The larger of the two, with the state of Connecticut, is worth nearly $1 billion.

Overall, the company has $11 billion worth of potential contracts in its pipeline for the next 28 months. Yet Plowman and Laphen said the IRS contract does not necessarily give them an advantage over rivals.

“Each bid stands alone on its own merit,” said Plowman. “Of course, the visibility is a nice thing to have, but we already have a strong presence in the government sector.”

When CSC was founded in 1959, there were fewer than 3,000 computers in the world. Two enterprising Southern Californian aircraft-industry programmers, Fletcher Jones and Roy Nutt, saw an opportunity in servicing the less-than-user-friendly computers of the time, pooled $100 in savings and founded CSC.

They started off writing system software for computer manufacturers, and within five years grew to become the largest independent computer services firm in the United States. As the industry started to grow at the end of the ’60s, CSC aggressively targeted the government sector, scoring major contracts for such agencies as NASA and the U.S Atomic Energy Commission.

Before the IRS deal, CSC last made headlines 10 months ago when Long Island, N.Y.-based Computer Associates International Inc. launched a hostile bid for the company. CSC successfully rebuffed it.

In some sense, the company has become a more desirable takeover target now than it was a year ago. It has a stronger revenue stream, and both the software and telecommunication industries are showing greater interest in beefing up their service business.

But according to Gremmels, CSC has clearly established itself as the acquirer rather than the acquired. Since launching an aggressive expansion plan in 1986, CSC has purchased 60 companies; over the last five years, one-third of CSC’s 47,000 employees were amassed through acquisitions.

“We are going to continue to acquire companies and remain independent,” Plowman said. “We’ve already shown what happens in an unfriendly takeover situation. The (Computer Associates) issue was a difficult period, but we emerged stronger than ever.”

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