HP in talks to buy EDS to compete with IBM

Enlarge Photo An employee walks past a Hewlett-Packard logo during the second day of the International Telecommunication...

Tue, May 13 04:42 AM

NEW YORK (Reuters) - Hewlett-Packard Co is in talks to buy technology outsourcing company Electronic Data Systems Corp for $12 billion to $13 billion, seeking to better compete with the top computer services company, IBM.

The acquisition would be HP's biggest since its $19 billion acquisition of Compaq in 2002. News of the talks, first reported by the Wall Street Journal, sent shares of EDS soaring nearly 28 percent, taking its market value to about $12 billion.

HP shares fell nearly 5 percent amid some skepticism that slow-growing EDS would provide more than a one-time boost, and might not be worth a premium of as much as 37 percent.

A source briefed on the matter confirmed the talks to Reuters and said the plan was to announce a deal by the close of Tuesday. HP and EDS both said they were in talks about a business combination but gave no details.

"While Hewlett-Packard has over time built up its own outsourcing practice, this clearly is a move by Mark Hurd to challenge IBM in the services area," said David Garrity, director of research at Dinosaur Securities, referring to HP's chief executive.

A bigger HP could compete better against International Business Machines Corp in going after large clients and help it keep costs in line, analysts said.

"It would put Hewlett-Packard in the sweet spot of an IT spending trend. It would definitely improve their position against IBM," said CRT Capital Group analyst Ashok Kumar.

SKEPTICISM ABOUT TARGET

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.

But there was some skepticism about HP's target, EDS.

"Unless HP has some synergies where they can dramatically impact earnings growth of EDS, I'm not sure why they'd want to buy it," said Jim Huguet, co-chief executive at Great Companies LLC. He noted that EDS's earnings growth has averaged 2.8 percent.

"EDS is trading at about half its historical PE, so they're obviously seeing it as a value, which it is if you can generate earns growth at 15-20 percent. But my question is whether it will become a drain on Hewlett-Packard?"

In April, EDS reported a 62 percent decline in first quarter profit, though the results had topped Wall Street expectations. Despite the beat, analysts said EDS faced intense competition from Indian rivals and saw little catalyst for growth.

Besides HP and IBM, EDS also competes with Accenture Ltd and Computer Sciences Corp in the United States, as well as Indian companies Infosys Technologies Ltd, Tata Consultancy Services Ltd and Cognizant Technology Solutions Corp.

"EDS has been relatively stagnant over the past few years. HP has been trying to promote themselves as a major services organization over the past few years. This will certainly help them with that," said Chad Hersh, an analyst at Novarica.

EDS has cut thousands of jobs to boost profits, and also is generating revenue from contracts including a lucrative deal last year with the U.S. Navy.

"We believe that Hewlett would be acquiring a fairly clean book of business, at least one that has been well scrubbed. So there shouldn't be any untoward surprises," Garrity said.

In 2000, HP pulled out of talks to buy the consulting business of PricewaterhouseCoopers for as much as $18 billion. IBM in October 2002 closed its $3.5 billion acquisition of PricewaterhouseCoopers' consulting division.

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