HP to acquire EDS for $13.9 billion

Updated at 8:30 a.m. PDT with additional analyst comment.

Hewlett-Packard said Tuesday it will acquire computer services firm EDS for $25 per share, or $13.9 billion, in a deal intended to boost HP's services revenue.

On Monday night, HP had confirmed that the two companies were in talks, following news reports earlier in the day.

The deal will create a computer services giant intended to rival IBM in the market for serving business customers.

Credit: HP

Mark Hurd,
CEO, HP

HP said the deal, which has been unanimously approved by the HP and EDS boards of directors, will close in the second half of the year. HP expects that the addition of EDS will more than double HP's services revenue of $16.6 billion in fiscal 2007. At the end of 2007, HP and EDS had a collective services revenue of more than $38 billion and 210,000 employees, doing business in more than 80 countries, HP said.

HP said it will establish a new business group, called EDS--an HP company, which will be headquartered at EDS's existing executive offices in Plano, Texas.

EDS will continue to be led by EDS Chairman, President and Chief Executive Officer Ronald A. Rittenmeyer, who will join HP's executive council and report to Mark Hurd, HP's chairman and chief executive officer, the company said. All of HP's existing technology services will remain under its TSG (Technology Services Group) wing reporting to its current director Ann Livermore, with the exception of outsourcing, which will now fall under Rittenmeyer's purview at EDS.

This isn't the first time HP has taken a crack at acquiring a major consulting firm. In 2000, HP was in talks to acquire PricewaterhouseCoopers. The controversial acquisition was the first big move by then-CEO Carly Fiorina. But a significant earnings shortfall in the fall of 2000, along with significant hand-wringing on Wall Street, prompted HP to drop the idea.

Hewlett-Packard included this graphic and the one below in a filing Tuesday with the Securities and Exchange Commission.

(Credit: HP)

IBM acquired PwC for $3.5 billion two years later, while HP took a dramatically different strategy and acquired PC maker Compaq. With EDS, HP now trails only IBM in the lucrative services sector.

"We're running the playbook we know how to run very well," Hurd told analysts during the conference call Tuesday morning. "We know how to get significant leverage out of our scale. We spent double-digit thousands of hours on the due diligence and planning. This thing (EDS) is very attractive. We didn't bake in a lot of revenue synergies, but they are there."

The two already share some of the same clients, but overlap is "few and far between," Rittenmeyer said during a call with the media. He also hinted at job cuts on the EDS side. "We are continuing to streamline our workforce, and there are going to be some changes. We've already been doing that this year, and have more planned for this year."

The EDS purchase is inconsistent with previous comments made by Hurd, who has said he planned to grow HP from within, in addition to some smaller acquisitions. HP Chief Technology Officer Shane Robison said in an interview that this doesn't represent a shift in strategy and that HP will continue to invest organically.

(Credit: HP)

The fact that HP's chief agreed to such a large acquisition means he saw significant potential in improving EDS operationally, said Lindy Hanson, senior analyst with Technology Business Research, said in a research note.

"Hurd has a reputation for focusing on the 'numbers' in excessive detail, and TBR believes that the numbers of a combined HP/EDS have been crunched and show strong upside for operational improvement," she wrote.

The consensus among industry observers is that the deal makes strategic sense for both companies, but particularly for HP.

HP "saw the light," according to Bob Djurdjevic, an analyst with Annex Research. EDS already has an established business handling outsourcing contracts in the government and manufacturing sectors, areas in which HP could use the help, he said. "The additional revenues in HP's services businesses is going to help them face serious challenges from IBM."

But the sheer size of the deal is more than a bit daunting. The deal represents the combination of the largest number of people that the IT services sector has seen, Gartner analyst Ben Pring said, and HP faces serious challenges when it comes to integrating two vastly different companies. The track record of deals like this is "pretty spotty," Pring said, and IBM's purchase of PwC demonstrated that the transition can be tough.

"There was a lot of fallout from that," he said. "People who liked the independence they had within PwC found that they didn't care for being part of a huge conglomerate like IBM. Many people won't care to be part of HP; the two cultures are very, very different."

HP's relatively relaxed, entrepreneurial Silicon Valley culture differs vastly from EDS's constrained, suit-and-tie-wearing corporate environment.

"There's bound to be a lot of tension and conflict" in attempting to mix the two, Pring said.

HP's Robison downplayed that notion and affirmed that he thought the two would be a good fit, saying, "They're both services cultures, and both understand services cultures."

He also brushed aside any concerns that a much larger services organization would be unable to meet the needs of smaller companies and added that a bigger scale operation is actually necessary to reach those small customers.

"Not every deal has to be a mega-deal," Robison said. "This is about reaching more of the market."

HP, which was originally due to report its second-quarter earnings Thursday, announced preliminary results Tuesday. Revenue earned was $28.3 billion, or GAAP diluted earnings per share of 80 cents. That compares with $25.5 billion in the same quarter a year ago, or GAAP diluted earnings per share of 65 cents.

It also slightly raised its outlook for the year, estimating total revenue of $114.2 billion to $114.4 billion, up from previous high estimates of $114 billion.

Shares of HP fell 6 percent in morning trading, while EDS's stock was up 1.5 percent.

CNET News.com's Mike Ricciuti contributed to this report.