HP acquires EDS to create a "super plumber" for data centers

The services sector has proven to be one of the hottest in information technology. You need trained people to manage the ebb and flow of computing in a massive, air-conditioned data center that handles the life blood of a corporation such as its e-commerce transactions or internal business operations.

IBM has been the primary beneficiary of the services boom, but now it will face more determined competition with Hewlett-Packard’s $13.9 billion acquisition of Electronic Data Systems. Together, they can create what one analyst (at IDC) called a “super plumber” for corporate data centers.

The deal is the biggest for HP since it bought Compaq six years ago for $20 billion and it will put HP at a strong No. 2 behind IBM in IT services.

HP will buy Plano, Texas-based EDS for $25 a share, about 32.5 percent higher than the data center outsourcing company’s closing price on Friday. Both boards have approved the deal and the transaction is expected to close in the second half.

HP’s CEO Mark Hurd said that EDS would remain a separate business group in Texas with current CEO Ronald Rittenmeyer as its chief. Rittenmeyer will also join HP’s executive council. The deal is likely to be far less controversial than the Compaq merger, which led to negative employee perceptions of then-CEO Carly Fiorina. The poor execution following the merger led to Fiorina’s ouster and Hurd’s hiring in 2005.

Hurd has been executing well, but you could argue that he is just continuing the strategy that Fiorina spelled out: that size and scale matter in the information technology industry. If the deal goes through, you can expect to see a lot of layoffs.

“It’s another step in the consolidation of the traditional IT infrastructure players and gets HP deeper into the enterprise segment,” said Jason Green, a partner at Emergence Capital. “Good for start-ups as the larger and less nimble the big guys are, the better.”

Jeff Nolan, author of the Venture Chronicles blog, said the deal makes sense because EDS has been under pressure to perform and an acquisition could spur it forward. EDS, meanwhile, could help HP with not only its services revenue but hardware sales as well. Lastly, he said that the deal could give HP the resources to initiate a cloud-computing operation, similar to what IBM is starting to do.

Dave Roux, meanwhile, a partner at Silver Lake Partners, said, “It signals that services matter and large-scale technology solutions remain complex to design, architect, install, configure, tune, manage, modify, debug, upgrade, extend, integrate, secure and operate efficiently.”

HP has been making smaller acquisitions of software and services companies as it battles to take on rivals such as IBM and Sun Microsystems. EDS has expertise in managing huge data centers for other companies. EDS had $22 billion in services revenue last year, while HP had $16.6 billion. IBM has $54 billion. HP, however, has eclipsed IBM as the largest tech company, with HP at $104 billion in revenue last year compared to IBM’s $98.8 billion.

EDS’ operating margins are thin at 6 percent, a sign of the tough competition as outsourcing operations grow in countries such as India. You can bet that the combination will result in a lot of layoffs on both sides. HP has 172,000 employees while EDS has 140,000. Hurd is known as a cost cutter, but given the possibility of a huge amount of duplication in the U.S., integrating so many people won’t be easy.

“We can see some real synergies in this deal, mostly cost synergies rather than revenue,” said Mette Ahorlu, an analyst at International Data Corp.

In fact, in a conference call this morning, Hurd said there wasn’t a lot of overlap between the companies, but he also said that the deal was “very attractive” because of the potential cost synergies, particularly in overhead.

The Wall Street Journal first disclosed the talks yesterday and HP confirmed it was in discussions. HP’s stock price yesterday closed at $46.83, down nearly 5 percent. EDS closed at $24.13, up 28 percent from Friday.

EDS was founded in 1962 by H. Ross Perot, a maverick who sold the company to General Motors in 1984 but became a thorn in the side of his parent company. GM spun off EDS in 1996. While Hurd has focused on internal growth, he likely made the move on EDS because its stock was out of favor.

IDC said that the market for hardware, software and services is blending into a single entity, sold to enterprise customers as an HP-branded platform. IDC said that EDS has a niche in vertical offerings such as outsourcing IT services for federal and local governments in the U.S.