Hewlett-Packard has struck a deal to buy Electronic Data Systemsfor $12.6 billion, seeking to boost its technology services business to better compete against market leader IBM.
Some Wall Street analysts were critical of the deal, which would be HP's biggest since its $19 billion purchase of Compaq in 2002. They said HP was paying a rich premium for a slow-growing business, even if EDS would vault it to second place behind International Business Machinesin services.
The deal values EDS at $25.00 per share, a 33 percent premium to its Friday closing price, before reports of talks sent the stock soaring on Monday. Including debt, the deal's enterprise value was $13.9 billion, the companies said.
"I would say the deal, in my view, is a little pricey but we'd have to look at the details," said Jeff Embersits, chief investment officer of Shareholder Value Management, which owns HP shares.
He said the key was how EDS would be integrated to make it a more profitable business.
"Mark's working with a five-year plan. So this will probably look a lot smarter in two or three years, but it could be a tough year," he said about HP Chief Executive Mark Hurd.
HP said it expects the deal to close in the second half of 2008, and boost its adjusted fiscal 2009 earnings and fiscal 2010 net earnings.
HP also reported better-than-expected preliminary quarterly results on Tuesday and raised its fiscal 2008 outlook, which it said did not include any potential impact from the EDS deal.
The acquisition will more than double HP's services revenue, which amounted to $16.6 billion in fiscal 2007. The combined services businesses will have annual revenue of more than $38 billion and 210,000 employees, the companies said.
That compared to IBM's $54.1 billion in services revenue last year.
HP shares fell more than 5 percent to $44.30 in early New York Stock Exchange trading after losing nearly 5 percent on Monday. EDS shares rose 1.5 percent to $24.45 after gaining nearly 28 percent on Monday.
Lucrative Services Business
HP has long considered an acquisition to beef up its tech services business, a sector that offers relatively stable income and high margins even in an economic downturn.
Worldwide computer services revenue rose 10.5 percent to $748 billion in 2007, according to data released on Monday by market research firm Gartner.
But analysts on a conference call with Hurd questioned the choice of EDS, which brings a strong base in infrastructure outsourcing but — like HP — is not strong in the high-end consulting business that is a strong suit for IBM.
EDS is also a company that is still seen to be in a turnaround mode, facing intense competition from Indian rivals like Infosys Technologies and Tata Consultancy Services , as well as U.S. competitors Accenture and Computer Sciences Corp.
"I guess what is troubling, Mark, is it is a high opportunity cost in terms of spending $13 billion, $14 billion, and what other assets you could have bought because capital is not limitless, particularly going in different areas such as software," Bank of Montreal analyst Keith Bachman said.
Hurd responded: "Obviously people are free to look at it as they choose and I respect opinion.We expect this deal to be more accretive risk-adjusted than a large stock buyback."
Analysts said the deal is likely to spark a round of consolidation as suddenly much-smaller rivals like Infosys, Tata Consultancy, Wipro and Cognizant Technology Solutions , scramble to stay competitive.
"We're going to start seeing more, I believe, of these strategic deals where it's not private equity coming, but it's big companies -- such as Microsoft trying to go after Yahoo -- who have cash on their books and see beaten-down stock prices," said Matt McCall, president of Penn Financial Group. "And just like investors, (they) should be taking advantage of that."
HP intends to establish a new business group called EDS that will be headquartered at EDS's existing executive offices in Plano, Texas, and led by EDS Chairman, President and CEO Ronald Rittenmeyer who report to Hurd.