HP Looks to Power Up

Eyes purchase of Computer Sciences Corp. to bolster services arm.

Buying Computer Sciences Corp. could bring needed brawn to Hewlett-Packard Co.s outsourcing business, but such a deal wouldnt come without risks and may not, in the end, be enough to vault HP into the upper echelon of outsourcing providers.

The Palo Alto, Calif., computer maker reportedly is part of a group—which includes The Blackstone Group, a private equity company—interested in buying CSC, which has been the subject of acquisition talk for months.

For HP, such a deal would deliver an influx of revenue, expertise and business reach that would enable it to better compete with IBM Global Services and Electronic Data Systems Corp. for major outsourcing deals. It also would be the largest pairing to date in an industry expected to see its share of consolidation over the next year or two as players look for ways to deal with a market hampered by rising competition and slow growth, according to industry analysts.

"[The deal] does have some risks, but in the absence of growth in outsourcing at the moment, companies will begin to pair off," said Crawford Del Prete, an analyst with IDC, in Framingham, Mass.

According to reports last week, Blackstone, of New York, and HP were in talks to buy CSC, a major outsourcing company in El Segundo, Calif., that has had its share of large projects but also has been looking for a buyer. Blackstone was part of another group that included Lockheed Martin Corp. that had tentatively offered $12 billion for CSC in the fall before negotiations fell apart.

The reports, quoting anonymous sources, said the deal would have HP initially buying a minority stake in CSC and later buying out Blackstones share. Robert Sherbin, an HP spokesperson, declined comment.

Analysts said the deal would make sense for HP, which is being squeezed on prices from below by vendors such as Dell Inc. and overseas competitors but cannot yet consistently compete with IGS or EDS. Ann Livermore, executive vice president of HPs Technology Solutions Group, which includes services, has said several times in the past 18 months that HP was looking to grow its outsourcing capabilities beyond its own hardware line, to the point where it effectively runs the largest data centers of the top corporations.

HP has had a number of major wins—including a 10-year, $3 billion deal with The Procter & Gamble Co. in 2004—but to continue that momentum, HP needs to grow the size and depth of its services business, given the amount of human and capital expenditures such large deals entail.

"Thats why very large deals are a blessing and a curse," said Julie Giera, an analyst with Forrester Research Inc., in Cambridge, Mass. "It gives HP credibility, but it also strains resources in terms of other big deals."

Bringing CSC into the fold would allow HP to fill some of the holes it now has in its outsourcing capabilities, Giera said. It would mean trained personnel with expertise in managing hardware from other vendors and complex data centers and application architectures.

It also would grow HPs reach into regions where its services business isnt strong, such as Asia and Australia, as well as into new business sectors, such as government, where CSC is dominant.

CSCs business with the federal government grew last year, according to the companys most recent quarterly Securities and Exchange Commission filing in November. Revenue from CSCs federal sector rose 7.5 percent in the second fiscal quarter, and total federal contract awards of $2 billion were announced in the quarter. Major contracts include a $307 million deal with the U.S. Air Force Air Education Training Command and a $284 million deal with the Naval Surface Warfare Center. In the third fiscal quarter, CSC signed an additional 97 federal contracts.

Forresters Del Prete said it is surprising in one sense that HP would consider moving on CSC. 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, analysts said.

With the influx of vendors getting into services—not only traditional players but also newer companies from India—now is the time for a company such as HP to make a move, Giera said. "Theres a window of opportunity for any of these service providers to make their mark, and that window will shut in the next 18 to 24 months," she said.

As expected, HPs possible purchase of CSC didnt concern IBM officials. Comparing IBMs resources with the potential gains offered by an HP-CSC tandem, Ginni Rometty, head of business consulting services at IGS, in Armonk, N.Y., said, "What weve built is end-to-end. It has taken 15 years. You gain experience by building assets. My view is, we probably have a 15-year head start on that."

Robert Moffatt, senior vice president of integrated operations at IBM, whose responsibilities include data center outsourcing, offered this comment on the possibility of an HP-CSC combination: "One could argue how effectively they will be able to integrate and whether they will be able to bring value to the customer. ... They will have challenges in doing it, but the challenge is in how effectively they will be able to serve customers. I dont find a merger of those two companies anything that makes me nervous, sitting here."

A P&G spokesperson said HPs buying CSC would neither hurt nor help the Cincinnati companys outsourcing deal with HP. "We dont think it will have an impact on our relationship one way or the other," the spokesperson said.

However, the deal would come with risks for HP, analysts said. The equity strategy of buying a customers IT equipment and hiring some of its employees forces outsourcers to assume a lot of debt and risk, Giera said.

Executive Editor Stan Gibson and Senior Editor Caron Carlson contributed to this report.