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HP's bid for EDS: Opportunity costs loom

The debate around Hewlett-Packard's purchase of Electronic Data Systems follows three primary questions. Is the EDS acquisition another Compaq--a deal that will take years to pay off?
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Written by Larry Dignan on

The debate around Hewlett-Packard's purchase of Electronic Data Systems follows three primary questions. Is the EDS acquisition another Compaq--a deal that will take years to pay off? Is EDS the right acquisition for HP? Are there other places where HP should spend its money?

HP on Tuesday officially acquired EDS  for $25 a share, or roughly $12.8 billion. EDS will become HP's services unit.

Also see: Can Hurd run EDS better?

On Monday HP confirmed that it is in talks with EDS and the general consensus is that the deal makes strategic sense, but enthusiasm is muted (Techmeme). Dennis Howlett outlines the various reactions to the EDS deal. Dennis' take: HP CEO Mark Hurd will make EDS more efficient and jettison management. Tom Foremski says that HP will still need a high-end consultant business and should make more software deals to address middleware. Om Malik says maybe EDS is part of HP's grand plan to be a cloud computing giant. And Vinnie Mirchandani notes that EDS is focused on infrastructure outsourcing like HP so it's a scale play. However, business process outsourcing is still a missing element for HP.

That latter point is important. Is HP fighting an old fight with EDS, a company that is running to keep flattish growth since 2000?

Here's a look at the burning questions around this deal:

Is EDS another Compaq? Carly 2.0 references are being tossed around this morning since HP is making a big deal. The problem with that analogy: The Compaq deal actually worked out nicely. HP got scale, market share and squashed Dell's direct model with a hybrid approach that Michael Dell is now trying to emulate. Sure the execution left a little to be desired and the court battle was ugly--although quite entertaining for me--but in retrospect buying Compaq was a good move. Cowen & Co. analyst Louis Miscioscia said in a research note that HP's personal systems group is growing at an annual clip of 25 percent so the Compaq purchase "did turn out well," but it was "many years in the making." Another thread: Former CEO Carly Fiorina was ousted because she overpromised and underdelivered. Hurd is the master of managing expectations and is all about the execution.

Is EDS the right deal? Miscioscia raises an interesting point: EDS, like HP, is a specialist in IT infrastructure outsourcing (ITO). HP with EDS will have a lot of scale. However, IT infrastructure is yesterday's news. "Our concern is that ITO is a mature, competitive, capital intensive business," said Miscioscia. Simply put, HP's purchase of EDS is a wash financially, but does have opportunity costs. HP should be buying Indian outsourcing companies like Cognizant, Satyam or a business process outsourcing giant like Accenture.

Deutsche Bank analyst Chris Whitmore has similar worries:

"Our preliminary analysis of the transaction suggests modest dilution, low returns and significant opportunity cost. This deal appears to be a cost-cutting / restructuring play (benefits from existing program largely realized) that will dilute HP's overall growth rate and margin/return profile."

Simply put, IBM could be the biggest winner from this deal over the next few years.

What else could HP do with its money? HP clearly needs to beef up its services business, but to compete with IBM it will also have to address software. More than 20 percent of Big Blue's annual revenue comes from software. HP's software business is about 3 percent of total revenue despite the acquisitions of Mercury Interactive, Opsware, SPI Dynamics, Bristol Technology and Peregrine. Those software purchases will come in handy when HP tries to automate the EDS data centers, but the gaping hole in Hurd's portfolio is middleware. IBM has remade itself into a software and services company with high profit margins. If HP is going to do the same at some point in the future, it will need to beef up its software lineup.

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