What does the HP-EDS deal really mean?

HP Tuesday announced its plans to acquire EDS for $13.9 billion in a deal that would double HP's services business and revive EDS' position as a leader in global technology services. The acquisition will catapult HP's annual revenue for services from less than $20 billion to nearly $40 billion and position HP as the second largest services provider in the world. Here is a look at what is happening and why now.
What are the basics of the deal?
HP will purchase EDS at a price of $25 per share, or an enterprise value of approximately $13.9 billion. HP expects the deal to close in the second half of this calendar year, and the company reports the terms of the transaction have been unanimously approved by both HP and EDS' boards of directors. HP intends to establish a new business group to be branded EDS and located at EDS' Plano, Texas, headquarters. After the deal closes, EDS will continue to be led by EDS Chairman, President and CEO Ronald Rittenmeyer, who will report to HP CEO Mark Hurd. What does EDS bring to the table for HP?
"In a word -- big revenues," says Ben Pring, research vice president at Gartner.
EDS is the No. 2 vendor in IT services (behind IBM), reporting $22.7 billion in revenue for fiscal 2007, according to Pring, who says by acquiring EDS, HP will immediately more than double its revenue for services. HP reported its fiscal 2007 services revenue at $16.6 billion. While Big Blue brings in about $54 million in services revenue, the EDS acquisition will enable HP to quickly accelerate its position in the global technology services market. "IT services are a big and strategic part of the marketplace and they influence technology purchases downstream," Pring says. That means if IBM Global Technology Services is working with a client at the services level, there is more of a chance the customer will buy IBM technology. If HP can get its foot in the door with more services customers, hardware and software sales could follow.
"If HP had a bigger professional services umbrella and footprint, they would get greater access to a very strategic marketplace," Pring says.
What is the overlap between HP services and EDS offerings?
HP services today primarily focus around product support. EDS offers broader services that include data center management, network management and application outsourcing. The overlap could be minimal, Pring says, and enable HP to move beyond professional services designed to get its products up and running in customer IT shops to offering large-scale outsourcing services. "They don't have a huge overlap with the other business. There will be some stripping out of overlap and overhead to be sure, but HP will be getting a new set of services expertise to offer," Pring says.
Why do this deal now?
HP isn't shy about spending money on acquisitions; it purchased Mercury Interactive for $4.5 billion and some say the vendor overpaid for Opsware when it put down $1.6 billion for the automation software vendor. In the past decade, EDS has seen some hard times and perhaps the company didn't bounce back to its former glory quickly enough to compete with IBM.
"EDS had a rough ride earlier in the decade when everything slowed down," Pring says. The company in 2003 brought in Chairman and CEO Michael Jordan to "right the ship" and he helped the vendor mend contracts with the U.S. Navy. But Jordan in the last year has been passing duties onto Rittenmeyer, which hasn't reenergized the business as much as many had hoped. "EDS has been losing out in big deals to competitors in its peer group, IBM in particular, and the company's share price has been lagging for the past six months," Pring says. But since talk of this acquisition began to spread, industry watchers say the prospect of HP buying EDS will please many EDS stockholders.
"Stockholders are looking at this deal as a good exit strategy for EDS. There is a lot of excitement around this," Pring says.
What will this deal mean to the IT services industry?
IT services providers will compete against a stronger number two vendor in the market, and IBM, specifically, will face off against HP more directly in another market.
Pring says the deal could also drive HP to invest and develop a stronger offshore workforce to enable the combined company to service multinational clients. EDS' offshore model is not as strong as IBM's and for IBM to truly consider HP a competitor, HP will have to quickly ramp up to better serve global customers. "IBM is going to look at the scale of this deal and the potential integration headache and argue that it will be a good 18 to 24 months before HP is able to take advantage of the acquisition," Pring says.
As for the Indian offshore providers such as Tata Consultancy Services and Wipro Technologies, Pring says such vendors will continue to position themselves as an alternative to IBM Global Technology Services and now HP. "This deal will only reinforce the Indian companies' portrayal of themselves as another option," Pring says. "This deal represents consolidation at the high end of the IT services market, and the Indian providers are increasing their presence in the U.S. and Europe by positioning themselves as an alternative to these U.S. companies."
What does HP have to do now to make this deal a success?
Despite having several large acquisitions under its belt -- Compaq noted as the largest -- HP will run into issues integrating the two companies.
"HP will say it knows how to do such large integration based on its Compaq experience. And they all say they don't, but companies do tend to take their eye off the ball when they are challenged to integrate companies and cultures with a deal of this size," Pring says.
For one, this is a sizeable IT services deal. It's considerably larger than IBM's $3.5 billion acquisition of consulting firm PricewaterhouseCoopers in 2002, but of less monetary value than HP's $23 billion Compaq buy.
"We have never seen anything of this scale in IT services," Pring says. "They will have to work hard to put the two organizational charts together in a meaningful way and really prove they have learned the secret sauce of big-deal acquisitions."