(MONEY Magazine) – Shares in Electronic Data Systems got clobbered in June after the company warned that its second-quarter sales wouldn't meet analysts' expectations. The stock shed a quarter of its value in a matter of hours, skidding to $43 a share. Four analysts, in chorus, downgraded EDS, which MONEY had recommended in March. And PaineWebber strategist Edward Kerschner kicked it off his widely followed list of highlighted stocks. All told, the stock is down nearly 40% from its February high.

CEO Richard Brown insists that investors have overreacted. He concedes that business has been sluggish but says, "We expect revenue growth to accelerate" in the September quarter, thanks partly to some $6 billion worth of recently signed contracts with customers like Rolls-Royce and the Commonwealth Bank of Australia. Brown adds that EDS is also thriving overseas, racking up record sales in both Latin America and Asia.

So far, Wall Street isn't buying his story. One reason for this skepticism: EDS derives 75% of its $18.5 billion in annual revenues from a relatively lackluster business--its information solutions unit, which helps companies manage their information technology (IT) departments, data centers and Web hosting efforts.

Trouble is, the IT services industry has been struggling for the past year, since many companies were so focused on making their systems Y2K compliant that they froze spending on other large-scale tech projects. Once all that Y2K-related work was wrapped up, a lot of firms shifted their attention to developing Web strategies--an area where EDS has been weak. To make matters worse, says Legg Mason analyst William Loomis, EDS' information solutions division has fairly meager gross margins of less than 20%. And the company faces fierce competition in this area from Computer Sciences, IBM and others.

Still, the worst may be over for EDS. For a start, the computer services business finally seems poised to revive. Dataquest, a market research firm, forecasts that revenues for the sector will grow from $527 billion this year to $745 billion in 2002--a 41% jump. One reason: Many companies are now looking to create online storefronts and automate their supply chains to remain competitive and keep costs down. Such efforts, plus new technologies like wireless networking, may force them to upgrade their tech systems, often under the aegis of consulting firms like EDS. The company is "well positioned to benefit from increased spending," says Loomis, who has a $65 price target for EDS, though he warns that it may be a while before this windfall materializes: "It's more of a 2001 story."

In the meantime, EDS is expanding aggressively into businesses with faster growth, especially e-commerce consulting. It is beefing up its e-solutions unit, which offers services such as building corporate websites. In the past two quarters alone, this unit saw sales jump by 35%, compared with the prior year. CEO Brown hails this as "the fastest-growing part of our business," and Loomis notes that the e-solutions unit has juicy gross margins of 40% to 50%. This business currently produces only 5% of EDS' total revenues, though, so its impact on the overall company is still small.

Nonetheless, the unit's torrid growth is one indication that the company is starting to come alive under Brown, who joined as CEO in late 1998 after a successful reign at Cable & Wireless. EDS, which was wholly owned by General Motors from 1984 to 1996, has long had a reputation for being lumbering and bureaucratic. Brown has already done much to streamline it. Last year he slashed 15,000 jobs, and he canned many of the company's less productive salespeople. He anointed a crop of new managers, scrapped many unprofitable business accounts and collapsed 48 overlapping units into four. The company says these efforts have led to $1 billion in annual savings. In addition, his beleaguered sales force finally seems to be getting its act together. Brown boasts that the average salesperson was almost twice as productive in the first half of this year as in the same period in 1999.

Brown is clearly on the right track. But as the firm's recent sales disappointment shows, it isn't easy to turn around an old behemoth like EDS. So it's not surprising that Wall Street remains skeptical. As Nevin Chitkara, an analyst at MFS Investment Management, puts it, the company "is still proving itself."

Yet at a recent price of $45 a share, the stock looks strikingly cheap. It currently trades at only 17 times next year's earnings--well below the IT services sector's average of 23 times earnings. EDS is also inexpensive by historic standards: Over the past five years, it's typically traded at about 26 times earnings.

Bill Schaff, a value investor who manages the Info Tech 100 fund, argues that disappointed investors have now discounted the stock too much, forgetting that they thought "Brown walked on water" just a few months ago. Schaff, who expects the company to generate 25% revenue growth in the second half of 2000, says he's impressed with Brown's cost cutting. "I'm very optimistic about 2001," he adds. "That's only six months away. I can afford to wait."

Of course, it's hard not to lose faith in a company that's so recently let down its shareholders. But Schaff sees ample reason to give EDS another chance: "Do I love the company? No. Do I think it's worth more than $45? Yes. Into the mid-$50s is a fair value."

--CAROLYN WHELAN [BOX]

ELECTRONIC DATA SYSTEMS

Ticker: EDS Price: $44.50 52-week range: $38.50 to $76.75 1999 earnings: $958 million Market cap: $20.5 billion