Hewlett-Packard (HP) and Electronic Data Systems Corporation (EDS), the Plano, TX-based service giant famous for being founded by former presidential candidate Ross Perot, and known in its early days for its military-like culture and strict dress code, announced today that HP will purchase the company for "an enterprise value of approximately $13.9 billion" (read the press release here). The deal has already been approved of by both companies' boards. Officially, the deal should be finalized some time in the second half of this year.

EDS stock has languished, and efforts to increase it value through cost cutting and revenue growth have not succeeded -- at least in terms of Wall Street. As EDS CEO Ron Rittenmeyer noted, "First and foremost, this is a great transaction for our stockholders, providing tremendous value in the form of a significant premium to our stock price."

For HP, the deal is about increasing its services business, in particular, adding more types of services and increasing its scale in order to take on the king of IT services, IBM.

Looking at what HP is buying 

In its latest filings, a February quarterly and 2007 annual report (the EDS fiscal year ends 12/31/07; read it here) and its 10-K (read it here), EDS noted that: 

• Its revenue was flat but income was up. 2007 revenue was $22.1 billion, up 4% from the $21.3 billion reported for 2006. How global is EDS? It reported that 48% of its income was from outside the US. It also said that $2.4 billion -- or about 11% of its annual revenue -- was from contracts with the US government (its biggest government deal is with the US Navy for an "end-to-end IT infrastructure on a seat management basis").
  
  As for income, the company noted that it made $716 in GAAP-adjusted profits for the year, well over the $470 million it reported in the previous year.
  
  The company noted that for the fourth quarter, it had signed $6.1 billion in contracts, down from $7.6 billion in the same quarter one year before. It did note that its "sales pipeline is up 10 percent versus the year-ago period."
  
  
• IBM is its top competitor. When discussing the competition, EDS identified IBM Global services as its top competitor in infrastructure and application services (HP was listed as 5th and 4th in those markets). Only in the business process outsourcing (BPO) market did IBM not make the No.1 spot (it was  third,; first was Accenture).
  
  
• It has lots of employees. As of 1/31/08, the company had 139,500 employees in the US and abroad.
  
  
• It offers many technical and business services. The company has three major service offering segments, with a variety of sub-groups in each. They are Infrastructure Services (server management, Web hosting, PC management, help desk, security, networking, etc.), Applications Services (development, management, modernization, integration, etc.), and Business Process Outsourcing Services (billing, HR, CRM, etc.).
  

In comparison, HP, based out of Palo Alto, CA, reported its latest annual revenue figure (from 1/31/08) of approximately $108 billion ($28.4 billion is from its printing group, or about 26% of its annual revenue). It says it has 170,00 employees across the globe. As for its major business units, the company breaks it out into seven segments. However, from a technology product and services standpoint, there are three to consider: The Personal Systems Group (PC, notebooks, etc.), the Imaging and Printing Group (printers, inks, etc.) and the Technology Services Group (TSG; hardware like servers and storage, as well as services). In reality, the TSG group is actually a combination of three business segments: Enterprise Storage and Servers, HP Services (HPS), and HP Software.

In terms of service group size, today's numbers are:

• IBM reported $98.8 billion in revenue for its last fiscal year, with 386,558 employees across the globe. Services accounts for 54% of its revenue (see this page; read the annual report PDF here). The actual total was $54.1 billion.
  
  
• HP noted that HPS generated $16.6 billion in fiscal 2007 (ending 10/31/07; 2007 10-K available here). That's about 15% of the company's revenue.
  
  
• EDS reports, as mentioned. $22.1 billion in overall revenue. 

HP's stated reasoning for scooping up EDS

Why is HP spending the cash to buy EDS? The official party line is:

Acquiring EDS advances HP's stated objective of strengthening its services business. The specific service offerings delivered by the combined companies are: IT outsourcing, including data center services, workplace services, networking services and managed security; business process outsourcing, including health claims, financial processing, CRM and HR outsourcing; applications, including development, modernization and management; consulting and integration; and technology services. The combination will provide extensive experience in offering solutions to customers in the areas of government, healthcare, manufacturing, financial services, energy, transportation, communications, and consumer industries and retail. 

What are the top benefits for HP in real world, non-PR speak terms? 

• More business strategy consulting. HP has been primarily about delivering infrastructure services, while IBM delivers those types of services as well as more strategic business and technology guidance. The EDS acquisition will enable HP to compete for more high-level engagements.
  
  
• Scale to take on IBM. Adding the huge number of EDS staff, as well as its existing contracts with private and governmental agencies, will enable HP to go after more of the services pie.
  

A typical long, bumpy road ahead 

The acquisition of EDS won't be smooth -- no acquisitions of this size are. And there is some interesting history for both companies in terms of acquisitions. For example, it's important to remember EDS was bought once before. General Motors (GM) acquired the company in 1984 and then regurgitated it in 1996. For HP, this will be its second biggest acquisition -- both were of Texas-based companies. Its largest acquisition was the 2001  purchase -- completed in 2002 -- of Houston-based, PC giant Compaq.

So what are the major challenges with regards to this deal? They are similar to most challenges faced by the merger of two multi-billion dollar companies with a somewhat overlapping product portfolio. Top issues include: 

• A huge integration effort. Merging two large companies with long histories is not easy. Issues of corporate culture, services offered, and branding will be some of the top challenges. According to the release, the EDS brand will live on: "HP intends to establish a new business group, to be branded EDS – an HP company, which will be headquartered at EDS's existing executive offices in Plano, Texas."
  
  Most likely, EDS would constitute a fourth major HP group, subsuming HPS from the existing TSG segment. In turn, that group's virtual name would most likely be re-badged as something like the Enterprise Systems and Software Group.
  
  
• Job losses. A merger of this magnitude, which also involves some overlapping capabilities, will undoubtedly result in lost jobs, relocations, and inter-company competition for those that remain in place. The most likely candidates on the chopping block: EDS human resources, marketing, and other administrative positions.
  

By: Tom Rhinelander