Electronic Data Systems

• The Bottom Line: Electronic Data Systems (EDS) is a masterclass for the value investor, showcasing the entire lifecycle of a great business: the creation of a powerful economic moat, the hidden value unlocked by corporate spin-offs, and the catastrophic risk of a company overpaying for a decaying asset.
• Key Takeaways:
• What it was: Founded by Ross Perot, EDS was a pioneer of the Information Technology (IT) outsourcing industry, building a business on long-term, high-margin service contracts.
• Why it matters: Its history provides timeless lessons on identifying a durable economic_moat, spotting value in spin_offs, and understanding the danger of poor capital_allocation when a great company like Hewlett-Packard (HP) acquired it.
• How to use it: By studying the rise and fall of EDS, investors learn to analyze the durability of competitive advantages and critically assess the price and strategic fit of major corporate acquisitions.

Imagine you run a fantastic artisanal bakery. You make the best sourdough in town, and customers are lining up. But you spend half your day wrestling with your clunky inventory software, managing employee payroll, and trying to fix the Wi-Fi. You're a baker, not an IT expert. Now, what if a company came to you and said, “You focus on the bread. For a fixed fee every month for the next ten years, we will handle everything else—your computers, your software, your network, your payroll systems. We'll run it better, cheaper, and more reliably than you ever could. Your problem is now our problem.” That, in a nutshell, was the revolutionary business model of Electronic Data Systems. Founded in 1962 by the legendary and larger-than-life figure Ross Perot with just $1,000, EDS didn't sell software or computers. It sold outcomes. It pioneered the concept of IT outsourcing, taking over the complex and messy “digital plumbing” of large corporations and government agencies. Its clients, like General Motors or the U.S. military, could then focus on what they did best—building cars or national defense. EDS's secret sauce was its contracts. They were long-term (often 5-10 years), deeply integrated into the client's operations, and incredibly sticky. Once EDS was running a company's entire data processing system, ripping them out and replacing them was as complex and risky as performing a heart transplant on a marathon runner mid-race. This created a predictable, recurring revenue stream that was the envy of the business world. The company was also known for its distinctive, quasi-military culture. Perot recruited heavily from the military, instilling a “get the job done, no excuses” ethos. His teams were known for their clean-cut look (dark suits, white shirts, no beards) and relentless focus on execution.

“Inventories can be managed, but people must be led.” - Ross Perot

EDS grew into a titan of industry before being acquired by General Motors in 1984, spun off as an independent company again in 1996, and finally acquired by Hewlett-Packard in 2008 in a deal that would become a textbook example of value destruction. Its story is not just a piece of business history; it's a goldmine of lessons for the discerning value investor.

For a value investor, the story of EDS is like a great novel with three powerful acts, each teaching a critical lesson. It's far more than a defunct company; it's a permanent case study in what creates and destroys long-term value. Act 1: The Economic Moat in Action (1962-1990s) Benjamin Graham taught us to seek businesses with a durable competitive advantage. EDS, in its prime, had a formidable economic_moat built on two pillars:

• High Switching Costs: As mentioned, once a client's entire IT nervous system was run by EDS, the cost, risk, and disruption of switching to a competitor were immense. This gave EDS pricing power and locked in revenue for years.
• Intangible Assets: EDS built a reputation for world-class execution. Perot's famous line, “The business of business is to get the job done,” became the company's DNA. This reputation for reliability was a powerful brand asset that competitors found hard to replicate.

For a value investor, a business with this kind of moat is a dream. It produces predictable and growing free_cash_flow, making the task of estimating its intrinsic_value far easier and more reliable than, say, a cyclical commodity producer. Act 2: The Classic Spin-Off Opportunity (1996) In 1984, General Motors acquired EDS. For years, EDS operated as a division within the sprawling automotive giant. This is a classic setup that should make any value investor's ears perk up. Often, the market struggles to properly value a great business hidden inside a mediocre, larger one. The sum of the parts is often worth more than the whole. When GM spun off EDS as an independent company in 1996, it was a quintessential special situation. Investors finally had the chance to invest in a pure-play IT services leader, free from the bureaucratic and capital-intensive baggage of its parent company. The new, independent management could focus 100% on the EDS business. These situations, as identified by investors like Joel Greenblatt, are often fertile ground for finding mispriced securities because the market is flooded with shares from parent-company investors who don't want the new stock. Act 3: The Ultimate Cautionary Tale (The HP Acquisition of 2008) This is perhaps the most important lesson. By the mid-2000s, EDS's moat was eroding. Competition from lower-cost offshore rivals (like Infosys and Tata Consultancy Services) was intensifying, and the rise of more flexible, decentralized computing was making EDS's mainframe-centric model look dated. The business was still big, but it was no longer great. In 2008, Hewlett-Packard, in a desperate attempt to build a services business to compete with IBM, acquired EDS for a staggering $13.9 billion. The value investing alarms should have been screaming:

• Paying for the Past: HP paid a massive premium for EDS's past reputation, not its future prospects. They were buying a castle just as the walls were beginning to crumble.
• Ignoring the Changing Landscape: The competitive dynamics had fundamentally changed. What was once a high-margin business was on its way to becoming a commoditized one.
• Terrible capital_allocation: HP's board destroyed tens of billions of dollars in shareholder value. Just a few years later, in 2012, HP had to write down the value of the acquisition by $8 billion, explicitly admitting they had massively overpaid.

This disastrous acquisition serves as a stark reminder of Charlie Munger's wisdom: turnarounds seldom turn. It teaches investors to be deeply skeptical of large, “transformative” acquisitions, especially when the target's best days are clearly behind it. It reinforces the absolute necessity of a margin_of_safety. HP had none.

You can't buy shares in EDS today, but you can use its ghost to guide your modern investment analysis. The lessons are timeless. Here is a practical method for applying them.

When analyzing a potential investment, particularly in the technology or services sector, ask yourself these four questions inspired by the EDS saga.

1. 1. How Durable is the Moat?
   • The EDS Question: Is this company's competitive advantage based on yesterday's technology (like EDS's mainframes) or tomorrow's? Are high switching costs real and sustainable, or are new technologies making it easier for customers to leave?
   • Application: Look beyond the current financials. Talk to customers in the industry. Read trade journals. Is the moat widening or shrinking? A shrinking moat is a giant red flag, even if the stock looks cheap.
2. 2. Is There Hidden Value in the Corporate Structure?
   • The EDS Question: Is this a great business trapped inside a larger, unfocused conglomerate (like EDS inside GM)?
   • Application: Screen for companies with multiple, unrelated business segments. Research the individual segments. If you find a “crown jewel” division whose value is being obscured, you may have found a future spin-off candidate. Put it on your watchlist.
3. 3. Who is Buying What, and For How Much?
   • The EDS Question: Is a company making a huge acquisition to patch a hole in its own failing strategy (like HP)? Are they paying a nosebleed price for a business with a deteriorating competitive position (like EDS in 2008)?
   • Application: When a company you own (or are watching) announces a major acquisition, become a skeptic. Don't just read the glossy press release. Analyze the target company as if you were buying it yourself. Calculate the valuation multiples. Is the price rational? History shows that most large mergers destroy value. This is a moment of high risk.
4. 4. Is the Industry Commoditizing?
   • The EDS Question: Are new, lower-cost competitors entering the market and turning a high-margin service into a low-margin commodity (as offshore firms did to EDS)?
   • Application: Study the pricing power of the company. Are they consistently able to raise prices, or are they constantly in price wars? The erosion of pricing power is the first sign of commoditization and the death knell for a wide-moat business.

Let's apply these lessons to two hypothetical IT service companies today.

The EDS case study immediately helps us see that Legacy Data Corp., despite its apparent cheapness, is a dangerous investment. It is the EDS of 2008. AgileCloud Inc., while not without its own risks, displays the characteristics of the young, dynamic EDS of the 1970s—a growing moat built on a modern, sticky platform.

• Full-Lifecycle Perspective: EDS provides a rare look at the entire arc of a business, from a disruptive startup to a mature blue-chip to a declining asset. This is invaluable for understanding business dynamics.
• Timeless Principles: The lessons about moats, spin-offs, and capital allocation are as relevant today as they were decades ago. They transcend industry and technology.
• Clear Cause and Effect: The consequences of strategic decisions (the GM spin-off, the HP acquisition) are unambiguous and provide clear, memorable lessons for investors.

• Hindsight Bias: It is easy to look back now and say HP's acquisition was a mistake. At the time, many analysts praised the “bold” move. The true skill is learning to identify the red flags before the disaster, not just analyzing it afterward.
• Technological Context: The specifics of EDS's mainframe-centric business are outdated. An investor must be able to abstract the principles (e.g., switching costs) and apply them to today's technologies, such as cloud computing, AI, or cybersecurity. Don't look for a literal “next EDS”; look for a business with analogous characteristics.
• The Founder Effect: It can be tempting to attribute all of EDS's early success to the genius of Ross Perot. While he was critical, the underlying business model was incredibly powerful on its own. It's important to separate the strength of the founder from the strength of the business itself.

• economic_moat
• capital_allocation
• spin_offs
• margin_of_safety
• value_trap
• special_situations
• free_cash_flow