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Hewlett-Packard buying EDS in $13 billion deal

Hewlett-Packard Co. is buying Electronic Data Systems Corp. for $13.2 billion in a deal that will create the second-largest technology services provider behind IBM.
/ Source: The Associated Press

Riding a hot streak that has doubled its stock price in the past three years, Hewlett-Packard Co. is rolling the dice on a $13.2 billion acquisition of technology services provider Electronic Data Systems Corp.

The all-cash deal announced Tuesday represents HP’s biggest gamble under the leadership of Mark Hurd, who was hired as chief executive in March 2005 to turn around the Palo Alto-based maker of personal computers and printers.

As Hurd relentlessly cut costs while demanding better execution from the company’s remaining workers, HP recovered from a nagging financial hangover that was exacerbated by the biggest acquisition in its 69-year history — the $19 billion purchase of Compaq Computer Corp., completed in 2002 over strident shareholder objections.

Now HP will try to show it learned from its mistakes by making the second largest deal in its history pay off faster.

Investors already are worried that HP is taking an unnecessary risk on EDS, whose disappointing profit margins had caused its stock to drop by about 30 percent over the past year. HP shares sagged $2.56, or 5.5 percent, to finish Tuesday at $44.27.

“It appears to be a very daunting deal,” American Technology Research analyst Shaw Wu.

The $25-per-share sale price represents a nice payoff for EDS stockholders, who will receive a nearly 33 percent premium compared to where the company’s shares stood before news of the HP talks leaked out Monday. EDS shares added 26 cents to close at $24.34 on Tuesday.

Including EDS’ net debt, HP values the acquisition at $13.9 billion. Based on EDS’ nearly 530 million common shares, restricted stock units and options, the sales prices works out to $13.2 billion. That represents about one-fourth of the $50 billion increase in HP’s market value since Hurd joined the company.

HP prizes EDS because it wants to become a much bigger player in technology services — a wide-ranging category that includes running computer data centers, stitching together software programs and consulting on special projects for business and government clients.

The estimated $550 billion market for technology services has long been dominated by IBM Corp., which has about a 10 percent share. HP ranks a distant fifth with a 3 percent market share, based on its $16.6 billion in technology services revenue in its last fiscal year.

By picking up EDS’ $22 billion in revenue, HP’s technology services division will more than double in size and leapfrog into second place with a 7 percent market share. Fujitsu and Accenture will fall behind the combined HP-EDS.

An IBM spokesman declined to comment on the acquisition.

HP has already surpassed IBM as the world’s largest all-purpose technology company, based on revenue.

In a sign that Wall Street doesn’t view HP’s expansion as a major threat in technology services, IBM shares gained $1.34 to close at $126.58 on Tuesday.

The EDS deal is expected to close during the second half of this year and begin boosting HP’s earnings in its fiscal year ending in October 2010.

To wring more profit from the EDS takeover, HP indicated it will make significant layoffs as it eliminates overlapping jobs and cuts other expenses. Hurd and EDS CEO Ronald Rittenmeyer declined to estimate how many workers might lose their jobs.

HP already has eliminated about 15,000 jobs since Hurd took control.

“There are obviously going to be some changes,” said Rittenmeyer, who will run the combined technology services unit and report directly to Hurd.

The combined services business would have 210,000 employees in more than 80 countries. It will retain the EDS brand and EDS’ Plano, Texas, headquarters.

While HP likely will be a more imposing force in technology services, it may still lack the heft to tackle the kinds of complex projects that IBM regularly handles, even after the deal closes, said Yankee Group analyst Zeus Kerravala.

But EDS’s emphasis on more lucrative projects, such as helping companies develop their software applications, will likely help HP, which so far has focused on hardware maintenance.

EDS traditionally has been considered “technology agnostic,” meaning it doesn’t favor particular vendors when it recommends computing gear and software to customers.

If EDS starts to favor HP computers and software under its new ownership, that could deal a blow to Sun Microsystems Inc., said Forrester Research analyst Christine Ferrusi Ross. That’s because EDS buys a lot of Sun equipment to power the data centers that it runs for its customers.

Sun shares shed 53 cents, or 3.9 percent, to close at $12.77 on Tuesday.

As in most technology acquisitions, HP’s biggest challenge as it tried to absorb EDS will likely be retaining top talent and minimizing other disruptions.

Services companies are particularly tricky to integrate because they tend to develop quirky cultures. IBM, for instance, needed several years to finish absorbing its $4 billion acquisition of PricewaterhouseCoopers’ consulting arm in 2002.

And HP’s acquisition of Houston-based Compaq was partially undermined by the cultural clashes that flared between employees in Silicon Valley and Texas. Given EDS also is based in Texas, some of the same cultural hurdles may arise, analyst Kerravala said.

Founded in 1962 by former IBM salesman — and later two-time presidential candidate — H. Ross Perot, EDS caused headaches for a previous acquirer, General Motors Corp., which paid $2.5 billion in 1984. Perot became so disillusioned with how that deal worked out that he sold his remaining EDS shares to the automaker so he could start a new rival bearing his name.

GM spun off EDS as an independent company in 1996 and remained its largest customer.

Hurd repeatedly brushed aside concerns about the acquisition in separate calls with analysts and reporters Tuesday, predicting HP and EDS will be able to create the “best services company on planet Earth, delighting customers in everything we do.”

He reiterated his confidence in a brief interview Tuesday with The Associated Press.

“It’s like anything else: you have to get the job done,” Hurd said. “Execution talks.”

If anyone can make the EDS acquisition pay off, analyst Wu believes it’s Hurd, who revived computer services company NCR Corp. before coming to HP’s rescue.

“I would argue turning around HP was tougher than fixing EDS will be,” Wu said. “I am not saying this deal is a slam dunk by any means, but people have underestimated Mark Hurd before.”

HP’s profits have consistently exceeded analyst estimates since Hurd took the reins.

The trend continued in HP’s latest quarter ended in May. In a preliminary report released Tuesday, HP said it earned 80 cents per share on revenue of $28.3 billion in the period, up from 65 cents per share on revenue of $25.5 billion at the same time last year.

If not for one-time charges for previous acquisitions, HP said it would have made 87 cents per share — 3 cents above the average estimate among analysts polled by Thomson Financial.