EDS Deal Suggests that HP's Out of Growth Options

5/14 - "Clearly, the intent of the deal is to challenge IBM’s supremacy in IT services. IBM claims the largest share of the international IT services market with 7.2%, according to Gartner Inc. EDS is second with a 3% share, and HP is fifth with 2.3%. As with any large scale merger there will be organizational difficulties and differences of corporate culture, but this merger should provide much upside for HP."

"The IT service group is obviously a focal point for HP CEO Mark Hurd’s growth strategy and many analysts foresee the industry as a whole growing at a steady 8% clip of the next 5 years. Mr. Hurd wants to claim more of that growth for HP as opposed to industry leader and rival IBM. The other reason HP is eager to grow its IT services group is because—unlike their Personal Computer business segment—the IT service group is very resistant to business cycle fluctuations. The deal will greatly enhance HP’s presence and versatility in the industry; up until now HP’s IT services have mostly been limited to support for its own products."

5/13 - "HP will be able to compete head-to-head with IBM Global Services, particularly in the outsourcing market...HP will be in IBM’s face in many of IBM’s mainframe site, whose data centers EDS runs. This is going to help HP sell some of its enterprise software...Dell has a strong partnership with EDS and it will surely suffer because of this merger. HP will simply get all the associated server business. I’ve no idea how to estimate the size of this, but it’s not peanuts...Industry trends are running in favor of outsourcing and managed service provision in many areas. HP can ride this trend."

"In summary, the synergies abound for increased sales of HP hardware and software and HP has proved it can strip cost out of its own operation, so it ought to be able to do the same for EDS. And let’s not forget the fact that it’s primary goal will be to grow the combined consultancy operation."

"The obvious question to ask here is: “Has Mark Hurd bitten off more than HP can chew?” My guess is that he probably hasn’t. If nothing else Mark Hurd is a gifted and focused manager. He doesn’t acquire companies as though he were collecting old masters for a fine art collection - there’s always a commercial plan...The bottom line is that you will see a double impact on HP from the merger; operational costs in outsourcing should diminish over time and sales should receive a boost."

5/13 - "Clearly, the Street is not crazy about Hewlett-Packard’s (HPQ) plan to acquired Electronic Data Systems (EDS). In two days, the Street has knocked about 10% off HP’s stock price, chopping its market cap by about $12.5 billion, almost equal to the $13.9 billion deal price. The obvious question is, why?...And the answer is, there are several reasons."

"Toni Sacconaghi, an analyst at Bernstein Research, notes that since 2002, EDS has generated annual revenue growth of just 0.4% versus 8% for HP. And he notes that gross margins at EDS are around 15%, versus 24% for HP. “Given that we do not believe HP will be able to materially improve either revenue growth or gross margins,” he writes, “the acquisition is likely to result in some multiple compression over time even though the deal is accretive and HP has the opportunity to boost EDS’ operating margins from current levels...He keeps his Market Weight rating on the stock."

"Louis Miscioscia, Cowen: “Now is a good time to buy given the recent hit due to the announced deal with EDS,” he writes. “We would not have recommended that HP acquire EDS, and are concerned about opportunity costs, but we do believe that HP can make it work, that is with a lot of heavy lifting."

"Richard Gardner, Citigroup: “We would be aggressive buyers of HPQ shares on today’s pullback,” he writes. Gardner says the sell-off is “a clear overreaction.” Gardner says that HP faces slower industry growth, more stable component pricing and a more stable dollar going forward, but that “these factors are more than fairly reflect in consensus estimates” and the stock price."