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Mark Hurd’s Teflon Coating Chips

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HP CEO Mark Hurd has finally done something that Wall Street doesn’t like – he’s buying EDS, the IT infrastructure outsourcing outfit founded in 1962 by one-time presidential hopeful and outsourcing pioneer Ross Perot, for around $13.9 billion cash – a venture that some people think is poor use of money better spent elsewhere. 

It’s Hurd’s first really big deal and they don’t like it that EDS has been in turnaround mode for years. They don’t like its laggard un-IBM margins, or its puny operating profits, or that it has had and looks to have practically zip organic growth, or that HP is paying a roughly 25% premium. 

And they definitely don’t like the fact that it’s not an offshore service operation or that it could be a huge integration distraction even given HP’s practice with Compaq in 2002. 

They didn’t like it to the tune of sheering something like 12% off HP’s market cap between the time the deal leaked in the Wall Street Journal late Monday and the close of business Tuesday, a few hours after it was announced. 

One analyst said during the conference call Tuesday that it could slow down HP’s revenue growth. And Credit Suisse turned around and downgraded HP. 

Countering the trend HP rushed out its preliminary fiscal Q2 earnings, which were due to be released Thursday, and said it would clear 80 cents (GAAP) or 87 cents (non-GAAP) on $28.3 billion, up from $25.5 billion a year ago. Three cents better than expected. 

It also upped its full-year earnings to between $3.30 and $3.34 a share, from $3.26-$3.30, on revenues of $114.2 billion-$114.4 billion, not $113.5 billion-$114 billion. 

It won’t post all the Q2 numbers now until May 20. 

Contrary to Wall Street, HP likes the EDS acquisition idea just fine, thinking that EDS will let HP slop up more of the services gravy that sustains IBM, a business it says is “counter-cyclical” and can do better in bad times than in good. 

With EDS, HP goes from being an also-ran number five in services to number two, doubling service revenues from $16.6 billion to $38 billion behind IBM and its $54 billion, and ahead of Accenture and Computer Sciences. 

It also suddenly gets to be number one in applications outsourcing at $5.5 billion in revenues. 

Hurd, who defended the deal as “compelling commercially, strategically and financially,” pointed to the ~8% growth the $750 billion-a-year services market is seeing in general and plans to wrest his share. 

He figures EDS has made a good start in taking out costs and Hurd – you could hear it in his voice – is actively looking forward to practicing his chief skill – which is cost-cutting – on the new acquisition. But HP put no number on the potential savings or the charges it’ll take. 

EDS is expected to be accretive to HP’s non-GAAP earnings in fiscal ’09 and accretive to its GAAP earning in 2010. 

HP intends to run EDS as a fourth business unit – retaining its headquarters in Plano, Texas and under its current CEO Ron Rittenmeyer, reporting directly to Hurd – and “reverse merge” its own services operations into EDS, starting with IT services. It’s holding back on consulting and integration initially but insiders say they’ll be going over too. 

Services at HP currently report to Ann Livermore. 

According to both Hurd and Rittenmeyer there’s little overlap in service customers between HP and EDS. 

“EDS – an HP company” will have 210,000 people, 140,000 from EDS, 70,000 from HP. Hurd wouldn’t speculate on how many would be cut. 

Automating services is apparently expected to play a big part in making the acquisition pay off and HP expects to move more of its own hardware and software through the operation, which may create a problem for CA among others like EDS partner Dell and Sun. 

EDS also owns ~60% of mPhasis in India, which has 27,000 people going on 33,000, which may make IBM uncomfortable. It is now up to IBM to make a counter-move. And Reuters speculates that Indian companies like Wipro, Tata, Infosys and Cognizant may have to protect their flanks and consolidate. 

Rittenmeyer explained that EDS had – and had to have – a third of its people in-country or in-state because of its business with the US government. 

HP is going to pay EDS shareholder $25 a share by using $9 billion of the $10 billion it’s got in the bank and borrowing the rest. It expects to replenish its coffers in “four or six quarters post-close,” it said. 

The deal should close in the second half of this calendar year. The $13.9 billion figure HP says it’s paying includes almost a billion in assumed debt.

An HP insider who ought to know told us the talks between EDS and HP date to January when EDS approached HP with a joint venture proposition. 

EDS had revenues of $22.1 billion last year. When we put out that flash the other day saying this was happening we stupidly misread EDS’ income statement and reported its last quarter as its year. Dumb. Sorry about that.

 

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