HP Faces EDS Integration Challenge

HP faces major challenges swallowing its $13.9 billion EDS acquisition, warn analysts, highlighting the services giants recent struggles in a tough economic climate.

Goldman Sachs analyst David Bailey, for example, voiced his concern over HP’s decision to buy a “slow/no growth services company” at a time when users are tightening their purse-strings.

”Even with HP’s track record of improving profitability in struggling businesses, it will undoubtedly take time for HP to improve EDS’s margins, given the ongoing cost cuts over the last few years at the company," he wrote in a note released this morning.

EDS’s recent first-quarter profits were down year-over-year, and the services giant has been shedding staff for some time in an attempt to streamline its business and get its costs under control, particularly after the recent loss of a Verizon contract worth up to $9 billion.

Baird analyst Jayson Noland also voiced concern about the deal.“HP's acquisition of a low-margin, low-growth services organization may raise questions as to strategic direction,” he wrote, adding that this could limit HP’s "organic" cost cutting opportunities. “Although we view the deal as potentially positive to EPS, we believe uncertainty regarding rationale may pressure valuation.”

In addition to a tough spending climate, EDS has also been bitten by a major change in how companies approach outsourcing, according to Lindy Hanson, senior analyst at Technology Business Research (TBR). “EDS has struggled; there have been a lot of trends that have impacted the company,” she told Byte and Switch. “They have traditionally focused on large deals, but customers are now focused on smaller, broken-up deals.”

A good example of this is automotive giant and EDS customer GM, which split its outsourcing efforts into 40 separate projects and six vendors.

Speaking on a conference call this morning, EDS CEO Ronald Rittenmeyer and his HP counterpart, Mark Hurd, nonetheless played up the benefits of merging the two companies.

“In calendar 2007, our companies’ collective services revenues were more than $38 billion,” said Hurd, explaining that the deal will boost HP’s presence in the government, financial, healthcare, and energy sectors.The exec also predicted that the deal will double HP’s services revenues, which were $16.6 billion in fiscal 2007, clearly underlining his desire to take on IBM’s lucrative Global Services division.

Both EDS and HP were unwilling to divulge too many specifics about their integration plans, although Rittenmeyer confirmed that there will be an unspecified number of job cuts post-acquisition.

“I would say that the overlap [between HP and EDS] is actually not very extensive,” he said. “It’s too early to give specifics, but we’re clearly going to look at synergies.”

EDS is said to have around 140,000 employees in its workforce, around two-thirds of whom are in the U.S. HP has attempted to streamline its own business in the last few years, and the vendor’s workforce is now said to number 172,000.

When the acquisition closes in the second half of this year, Rittenmeyer will head up a new EDS division within HP, based in the EDS offices in Plano, Texas.The EDS supremo will report to Hurd, who was grilled about the deal’s impact on HP’s storage services during this morning’s call.

The CEO confirmed that storage services will remain part of HP’s Technology Solutions Group (TSG), which is led by Ann Livermore. “[Ann] has got a big job -- TSG will be a very critical, important group,” said Hurd, explaining that the EDS division’s role will be focused on outsourcing.

HP expects that the EDS deal will be accretive to its 2009 non-GAAP earnings and to 2010 GAAP earnings.

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