After capturing the top spot in personal computer sales, Hewlett-Packard Co. (HPQ) said it agreed to acquire Electronic Data Systems Corp. (EDS) for about $13.9 billion on an enterprise value basis, in a move that would strengthen HP's services business and give HP more tools to challenge IBM Corp. (IBM) in the lucrative technology services market. It is to be noted that HP already has superseded IBM as the world's largest technology company, based on revenue. In a separate press release, HP reported its preliminary second quarter results and raised its full-year targets.
The HP-EDS deal was already doing the rounds in the market since Monday and HP confirmed that is in talks with EDS regarding a "possible business combination."
As per the terms of the merger deal, announced on Tuesday, HP will pay $25.00 per EDS share, a premium of about 4% over EDS' closing stock price on Monday and a premium of approximately 33% over what EDS had been trading on Friday.
HP, the world's largest PC maker, expects the deal to be accretive to its fiscal 2009 non-GAAP earnings and accretive to 2010 GAAP earnings. In addition, significant synergies are expected as a result of the combination.
As of Monday's close, HP has a market value of over $115 billion, while EDS has a market cap of over $12 billion. According to the most recent SEC filing, HP has about $10 billion in cash.
The transaction expected to more than double HP's services revenue, which amounted to $16.6 billion in fiscal 2007. Acquiring EDS advances HP's stated objective of strengthening its services business. Further, the steady demand for data management and technology consulting services during the past two decades also gives the desired rationale to the deal. The computerization and the rise of the Internet provoked more businesses to hire contractors to help run their computer software and hardware.
Among other things, the specific service offerings delivered by the combined companies include IT outsourcing, business process outsourcing and technology services.
The companies' collective services businesses, as of the end of each company's 2007 fiscal year, had annual revenues of more than $38 billion and 210,000 employees, doing business in more than 80 countries.
In the words of HP CEO Mark Hurd, "The combination of HP and EDS will create a leading force in global IT services. Together, we will be a stronger business partner, delivering customers the broadest, most competitive portfolio of products and services in the industry."
Meanwhile, buying EDS means HP could get more government contracts. EDS, which is among the top 10 government technology contractors, had deals worth about $2.5 billion, while HP had only about $500 million in prime federal contracts in fiscal 2007. However, on a combined basis, HP and EDS still would lag significantly behind government contractors like Boeing Co. (BA) and Lockheed Martin Corp. (LMT).
Subject to customary closing conditions, the HP's acquisition of EDS is expected to close in the second half of calendar year 2008.
Once the deal closes, 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. HP plans that EDS would continue to be led by EDS Chairman, President and Chief Executive Officer Ronald Rittenmeyer, who will join HP's executive council and report to Mark Hurd, HP's chief executive officer.
Founded in 1969, EDS is considered to be initiated the concept of running data centers and providing other high-tech help for large companies and government agencies. EDS was performing well at the start of the decade, despite the dot-com bubble's bursting. However, in late 2002, earnings shortfalls led to investor lawsuits, a Securities and Exchange Commission probe, the ouster of the chief executive, and a sharp drop in the stock price.
In 2003, the company lost about $2 billion but gradually back to bright days under CEO Michael Jordan. He fixed some money-losing contracts and cut costs by outsourcing jobs to low-cost countries such as India. Last year, EDS earned in excess of $700 million on over $22 billion in revenue.
EDS, which had revenue of $22.1 billion in 2007, competes with Accenture Ltd (ACN) and Computer Sciences Corp (CSC) in the United States, but its main competitors are Indian companies such as Infosys Technologies Ltd. (INFY) and Tata Consultancy Services Ltd.
EDS has been struggling recently, faced by weak contract signings due mainly to a weakening U.S. economy. Last month, EDS reported a 62% drop in its first quarter profit. The company reported net income for the first quarter of $62 million or $0.12 per share, down from $164 million or $0.31 per share in the same quarter a year earlier. Revenue for the first quarter increased just 3% to $5.37 billion from $5.22 billion a year ago.
On the other hand, Palo Alto, California-based HP has been trying to strengthen its services division in order to better compete with IBM. HP's services division generated revenue of $4.4 billion in the most recent first quarter.
HP has long considered an acquisition to bolster its services business ever since it failed in its attempt to buy PriceWaterhouse's consulting division in 2000. That PriceWaterhouse unit was later acquired by IBM in October 2002 for $4.5 billion.
Since then, HP has tried to grow its services business through smaller acquisitions. It acquired Mercury Interactive Corp. for $4.9 billion in 2006 and acquired Opsware for $1.7 billion last year.
If the deal with EDS succeeds, it would be HP's biggest acquisition since its $20 billion acquisition of Compaq in 2002 that paved the way for HP to surpass Dell Inc. (DELL) as the world's largest PC maker. HP earned over $7 billion last year on revenue that surpassed $100 billion. In February, HP reported net income for the first quarter of $2.1 billion or $0.80 per share, compared to $1.5 billion or $0.55 per share for the year-ago quarter. HP's first quarter revenue increased 13% to $28.47 billion from $25.08 billion in the same quarter last year.
In a separate press release on Tuesday, HP announced preliminary results for the second quarter of 2008. In the second quarter, preliminary GAAP earnings per share were $0.80 and non-GAAP earnings were $0.87, compared to second quarter fiscal 2007 GAAP earnings of $0.65 per share and non-GAAP earnings of $0.70 per share. Revenue was $28.3 billion, compared to $25.5 billion one year ago. Analysts, on average, polled by First Call/Thomson Financial expected earnings of $0.84 per share on revenues of $27.94 billion. HP is expected to report its second-quarter financial results on May 20.
According to HP, the second quarter results were highlighted by solid performance across HP's business segments and strong cash flow from operations.
For the third fiscal quarter of 2008, HP estimates revenue of approximately $27.3 billion - $27.4 billion, GAAP earnings in the range of $0.76 - $0.77 per share, and non-GAAP earnings in the range of $0.82 - $0.83 per share. Street analysts expect earnings of $0.82 per share on revenue of $27.34 billion.
Also, HP raised its full-year outlook. The company now expects GAAP earnings in the range of $3.30 - $3.34, up from its previous estimate of $3.26 - $3.30. Non-GAAP earnings are currently expected to be in the range of $3.54 - $3.58, up from its previous estimate of $3.50 - $3.54. The company increased its full-year revenue outlook to a range of approximately $114.2 billion to $114.4 billion, up from its previous estimate of $113.5 billion - $114 billion. Wall Street analysts, on average, expect earnings of $3.52 per share on revenues of $113.99 billion.
On the other hand, in April, EDS revised its full-year earnings target to a range of $1.35 to $1.39 from the earlier estimate of $1.35 per share. Similarly, EDS said that it is now estimating revenues to be in the range of $22.5 billion - $23 billion versus earlier target of 2% growth. Currently, Wall Street analysts have earnings projection of $1.37 per share on revenues of $22.77 billion.
Among the rating actions after the HP-EDS deal, Fitch has placed its EDS ratings on Rating Watch Positive. Approximately $4.1 billion of debt is affected by Fitch's action, including the $1 billion revolving credit facility.
In the meantime, Credit Suisse downgraded HP shares to hold from buy just before the computer and printer maker unveiled a $13.9 billion deal to buy EDS. According to the brokerage, such a large transaction, coupled with the enhanced business risk, caused it to lower its rating until more clarity on the situation emerged.
HP shares, which are trading in the range of $39.99 - $53.48 over the past year, are down $2.81 or 6% and currently trading at $44.02.
On the merger deal, EDS shares, which are trading in the range of $15.71 - $29.13 over the last 12 months, gained 38 cents or 1.58% and currently trading at $24.46.
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