Why HP is smart to gamble on EDS

May 12, 2008: 7:49 PM ET
HP CEO Mark Hurd is taking a risk by bidding for troubled services player EDS. Image: HP

Hewlett-Packard CEO Mark Hurd has built a world-class reputation as a cost-cutting turnaround artist, and he's risking it all with a smart bid for technology services giant Electronic Data Systems.

HP (HPQ) announced Tuesday that it would pay $13.9 billion in cash for Texas-based EDS (EDS), which manages technology projects for a range of large clients. If HP does it right, buying EDS is the business equivalent of a triple-play. In one fell swoop HP is more than doubling the revenue of its services arm, mounting a more serious threat to IBM (IBM), and shutting down a distribution channel for other competitors.

Strategically, the deal makes sense. Hurd is in the midst of expanding HP beyond its base providing lower-margin hardware like PCs and printers. Instead, he wants HP to grow more profitable businesses such as "services," – industry parlance for helping customers to buy and manage technology gear. (In a Super Bowl commercial eight years ago, EDS memorably compared this tech management challenge to herding cats.)

Still, Hurd's play for EDS is a gamble. It will raise questions on Wall Street about the efficiency expert's ability to close a mega-deal. Hurd and his team will also face the daunting task of deciding whom to keep among EDS's 140,000 employees, how to get the troubled company into shape (it's trading far below its $22 billion annual revenues), and how to manage the acquisition without losing ground to rivals. So far, investors are taking a wait-and-see approach. After news of the deal talks broke Monday, HP's stock dropped just 5 percent to close at $46.83, a relatively small hit given the size of the deal. EDS stock rose 28 percent to $24.13 per share on Monday.

In a humorous Super Bowl commercial years ago, EDS compared the technology services business to herding cats. If an acquisition goes through, HP could have a similarly tough task integrating EDS.

Hurd has plenty of reason to believe HP can do the deal smoothly. Under the leadership of Chief Strategy Officer Shane Robison, HP has recently snatched up prizes like Mercury Interactive and Opsware. And even though those two companies were bigger than HP's existing software business, it managed to successfully integrate them. HP has also worked on getting into tip-top shape operationally, tightening up its IT systems and its performance management policies. That should make a large acquisition easier to digest.

Perhaps more important, the EDS acquisition would mark a homecoming of sorts for HP Services head John W. McCain, who would likely lead the combined EDS/HP Services. [UPDATE: HP has said EDS will remain a standalone organization, based in Plano and led by Ronald Rittenmeyer.] Earlier in his career, McCain spent 16 years at EDS and rose to the ranks of president of e.Solutions. As a veteran of EDS culture and practices, he's sure to have opinions about how HP could get the most value from the company. McCain might also know how to position EDS's workforce to sell more HP equipment and less from competitors such as Dell (DELL), Xerox (XRX) and Sun Microsystems (JAVA), without alienating the customer base.

The EDS buyout is expected to close later this year and is subject to EDS shareholder and regulatory approval.

HP has now postponed its official earnings announcement until next Tuesday, May 20, after the close of trading. The company released a preliminary earnings statement today for its second fiscal quarter saying that sales came in at $28.3 billion and non-GAAP profits at 87 cents per share,  both beating Wall Street's average estimates. The company also raised its revenue and profit guidance higher for the year. HP now says revenue will be between $114.2 billion and $114.4 billion, at least $200 million higher than the previous range. Non-GAAP diluted earnings per share will be $3.54 to $3.58, just above the previous range.

Join the Conversation
Current Issue
  • Give the gift of Fortune
  • Get the Fortune app
  • Subscribe
Powered by WordPress.com VIP.