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Hewlett-Packard Co.s reported interest in buying Computer Sciences Corp. brings its share of benefits and risks, according to industry observers.
The move could rapidly grow HPs services and outsourcing business, giving the Palo Alto, Calif., company the size and breadth to compete with the likes of IBM Global Services, they said. However, if not done right, such a move could prove to be a major burden on a company that is trying to improve its financial situation.
The possible deal was first reported in the Wall Street Journal Thursday, which said that HP would team with the Blackstone Group, a financial equity firm that had been part of another group that had looked into buying CSC before negotiations ended. That group—which included Lockheed Martin Corp. and Texas Pacific Group—reportedly had offered $12 billion this fall for the El Segundo, Calif., company. It was unknown what price HP and Blackstone may be offering for CSC.
Robert Sherbin, a spokesman with HP, declined to comment.
Acquiring CSC would bring in an influx of revenue for HPs services business as it looks to take on the larger players. Credit Suisse First Boston estimates that IGS will finish out its 2005 fiscal year with $48 billion in revenue. HP, whose fiscal year ended Oct. 31, reported FY 2005 services revenues at $15.5 billion, while CSC reported $14 billion in revenue. Its fiscal year ended in April.
Such a deal also would fuel HPs drive to grow its outsourcing business beyond its own hardware products, said Julie Giera, an analyst with Forrester Research Inc., in Cambridge, Mass. Ann Livermore, executive vice president of HPs Technology Solutions Group, which includes its services business, said about 18 months ago that HP wanted to expand the business.
CSC would bring with it a range of expertise and trained resources currently lacking at HP, enabling it to compete for more large outsourcing deals that may include running data centers that are outfitted with hardware from other vendors, such as IBM, Giera said.
It also would rapidly grow HPs outsourcing personnel, which would help the company vie for more large contracts. HP already has won a number of major outsourcing deals—such as the 10-year, $3 billion deal with The Procter & Gamble Co., in Cincinnati—but they also mean a large expenditure of capital and people.
“Thats why very large deals are a blessing and a curse,” Giera said. “It gives HP credibility, but it also strains resources in terms of other big deals.”
Purchasing CSC also would give HP a larger presence in particular regions and verticals, she said. Right now, HPs services business is well-known in places such as Europe, but not as much in regions such as Asia and Australia. In addition, CSC has a strong federal government business and also is a player in the insurance sector.
HP needs to make a deal like this if it plans to continue to compete in an increasingly competitive sector of the IT industry. As with HPs hardware business, it is being squeezed from the bottom by the likes of Dell Inc. and its cutthroat pricing model, and behemoths like IGS and Electronic Data Systems Inc. In addition, the rising number of outsourcers from India also is putting a new spin on the business, Giera said.
Typically, when an outsourcing deal is made, the outsourcers buys some of the customers assets—such as purchasing the computer hardware and hiring some employees—which can lead to greater debt and higher costs. However, Indian outsourcers tend not to buy such assets, which means they are not as burdened by high upfront costs or the need to maintain and depreciate the hardware, and can price their services accordingly. This is putting even greater pressure on the major traditional outsourcers.
That said, the way HP is reportedly going about the deal—initially it would take a minority stake in CSC, then buy out Blackstone at a later date—makes sense, said Crawford del Prete, an analyst with IDC, in Framingham, Mass.
It would enable HP to do a lot of the work of integrating CSC into its services business, but “at the same time view it at arms length a little,” with Blackstone making the initial heavy investment, del Prete said.
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Such a deal would be surprising to a degree, he said. HP is first and foremost an IT innovation company, and there tends to be little innovation in the outsourcing business. Still, outsourcing offers benefits such as long-term customer relationships and recurring revenue, and the time is right for HP to make a move to bolster that business. The outsourcing business is a tough one, with a lot of players, slow growth and some low valuations, which will lead to consolidation in the industry, del Prete said.
“[The deal] does have some risks, but in the absence of growth in outsourcing at the moment, companies will begin to pair off,” he said. If thats HPs intentions, its smart that the company is doing it now.
In a report issued Thursday, Bryan Keane, an analyst with Prudential Equity Group LLC, said HPs emergence as a possible buyer of CSC was surprising. When Mark Hurd took over as CEO last year, he indicated that HP—which still was dealing with the $19 billion purchase of Compaq Computer Corp. in 2002—would not pursue another major acquisition in the near term. The company had made some smaller deals to bulk up its management software capabilities, including buy Peregrine Systems Inc. and RLX Technologies Inc. However, he appeared to soften that stance during a meeting with analysts in December, Keane wrote.
He also wrote that HP needs to grow its services business if it intends to compete with the larger vendors. HPs services unit accounts for about 20 percent of the companys overall business, he said, but “is currently perceived as a weak player in the services market relative to IT services giants like IBM, EDS and Accenture [LLP].”
Keane also outlined several challenges for CSC and the services business in general, including possible reductions in IT spending by government agencies and large enterprises, weak demand for such businesses as systems integration and consulting—about 20 percent of its overall revenues—and its businesses in what Prudential calls weak international markets.
During the analyst meeting in December, Hurd continued to lay out his plans for HP. He repeated his earlier statements that the company had no intention of spinning off any of its other businesses—such as PCs or printing—and that he would continue focusing on ways of making HP more streamlined, financially sound and a better company to do business with.
Last summer, Hurd made several moves designed to create a “simpler and nimbler HP,” including eliminating the Customer Solutions Group, redistributing the sales force and cutting about 14,500 jobs—about 10 percent of HPs global work force.