Update: HP to buy EDS for $13.9B

The move could make HP more competitive against IBM

Hewlett-Packard Co. said this morning that it has signed a deal to acquire IT outsourcer Electronic Data Systems Corp. for $13.9 billion, or $25 per share.

The deal has been approved by both companies' boards of directors and is expected to close in the second half of this year. HP said that acquiring EDS will more than double its services revenue to an annual total of $38 billion.

HP plans to fold its outsourcing business into a new unit to be called "EDS -- an HP company," which will be based in Plano, Texas, where EDS has its headquarters.

"This is about us putting our outsourcing business into EDS," said HP Chairman and CEO Mark Hurd, in a conference call with analysts.

The EDS division will be led by EDS Chairman, President and CEO Ronald A. Rittenmeyer, who will report directly to Hurd.

That will take away control of some of HP's services operations from Ann Livermore, executive vice president of HP's Technology Solutions Group (TSG). Services, including outsourcing, contribute almost half of that group's revenue: the other half comes from storage, servers and software. Livermore "has got a big job," said Hurd, adding that much of HP's services activity will remain with TSG.

Rittenmeyer's appointment raised at least one analyst's eyebrows.

"It's interesting that he has been put into this spot, as there were questions about how he was doing since taking over as CEO at EDS," said Gartner Inc. analyst Ben Pring.

The deal will greatly expand HP's IT services business and catapult it to the No. 2 spot, close behind IBM, whose Global Technology Services division has long been a strong profit generator for the company.

"I see [the acquisition] as an attempt by HP to really go head to head with IBM in a much more meaningful way, especially in technology services and IT outsourcing," AMR Research Inc. analyst Dana Stifler said yesterday while the two companies were still in talks.

The worldwide market for IT services was worth $748 billion in 2007, an increase of 10.5% from the year before, according to recent figures from Gartner Inc. IBM led the market with about $54 billion in revenue, followed by EDS with $22 billion. HP was in fifth place with revenue of $17 billion, behind Accenture Ltd. and Fujitsu Ltd.

Buying a services business in a faltering economy is a good investment, because that's when customers are keenest to cut their costs by outsourcing, Hurd said.

"Services is countercyclical, the tougher things get, the better services does," he said.

Rittenmeyer said EDS has a "strong pipeline" of contracts ahead of it.

There is little overlap in the channels by which the two companies reach customers, said Hurd, since HP's services business primarily targets small and midsize businesses. Nevertheless, Hurd sees other areas where the companies can realize "significant synergies" and reduce operational costs.

Hurd vowed that EDS will remain hardware-agnostic following the acquisition, despite the presence of HP's hardware business. "While this is a popular question because of our product portfolio, in the services industry you have to work with all kinds of [products]," he said.

At the same time, the acquisition will enable EDS to begin offering lower-priced services to customers, according to Hurd. "There's a tremendous leverage you get from scale," he noted. "We're spreading our cost structure across a much larger revenue base. We expect to bring that capability to EDS."

Buying EDS will increase HP's services business and allow it to offer a wider range of services to attract large business customers. EDS is strong in infrastructure management services and custom application services, in which it helps companies to design, integrate and manage applications.

EDS is less strong in providing services for packaged applications, however, and the acquisition will not give HP a big lift in the type of business consulting services delivered to line managers and business executives either, Stiffler said.

HP has been keen to expand its services business for years, and EDS is not its first attempt to do so. In 2000, HP dropped plans to acquire PricewaterhouseCoopers Consulting, which was ultimately scooped up by IBM two years later for $3.5 billion.

HP's services business generated only 16% of its total 2007 revenue of $104.3 billion, while IBM makes more than half of its annual revenue from services. The company increased its revenue estimate for fiscal year 2008 this morning, saying it now expects revenue of between $114.2 billion and $114.4 billion, up from a previous estimate of $113.5 billion to $114 billion.

The company also reported preliminary results for its second fiscal quarter, ended April 30. It made revenue of $28.3 billion for the quarter, compared with $25.5 billion a year earlier. The figure beat estimates of analysts polled by Thomson Financial, who had expected $27.98 billion. HP also said estimated earnings per share for the quarter were 80 cents, up from 65 cents a share one year earlier. Excluding acquisition related costs, EPS was 87 cents, beating the analyst estimate of 84 cents.

It expects to announce final results on May 20.

Buying EDS will give HP the muscle it needs to become a serious threat to IBM's services business, said Kathryn Hale, an analyst at Gartner who also spoke before the companies confirmed the deal. HP has the resources and the wherewithal to acquire EDS and improve its business results, she added.

EDS reported revenue of $22.1 billion for its fiscal year 2007, which was up only a fraction from 2006. Net income was $716 million, up from $470 million.

EDS and its subsidiaries employ about 137,000 people worldwide, with 90,000 of them located overseas — including 45,000 workers in relatively low-cost countries such as India and China. Rittenmeyer said today that EDS is aiming to boost the latter number to about 55,000 going forward. HP, meanwhile, ended its 2007 fiscal year last October with about 172,000 workers.

(Editor's note: This story initially was posted with incorrect information about the current workforce at EDS. The last paragraph of the story was corrected at about 2 p.m. EDT on May 13.)

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