HP's 2008 EDS Acquisition Will Cost Company $8 Billion

HP will take an $8 billion impairment charge for its struggling services business, as well as another $1.5 billion charge for its planned layoffs.

Hewlett-Packard continues to pay for the $13.9 billion it spent in 2008 to buy services vendor EDS Systems, a company HP executives hoped would put them on par with their counterparts at IBM Services.

Instead, HP€™s services business has underperformed, validating those critics who said the company greatly overpaid for EDS. The harsh impact of the enterprise services business will be felt in HP€™s fiscal third quarter, when it takes an $8 billion charge due to the falling value of the unit.

That impairment charge, combined with the $1.5 billion to $1.7 billion charge HP will be hit with over its plans to cut 27,000 jobs, will drive the company€™s earnings-per-share down in a quarter that otherwise would have been solid for the massive tech vendor. HP executives announced Aug. 8 that before the charges, the company would see an earnings increase of $1 per share, up over the 94 to 97 cents previously forecasted.

However, the charges will drive down earnings by $4.31 to $4.49 a share, the company said.

HP, which has seen its stock value drop more than 30 percent over the past year, has been working under new CEO Meg Whitman to streamline the company and turn around its finances. HP three months ago announced it was cutting 8 percent of its workforce as part of a painful strategy to reduce expenses by as much as $3.5 billion over two years. HP has seen its fortunes fall over the past few years, thanks in part to high executive turnover€”including three CEOs over the span of less than a year€”sharps turns in strategy and uneven marketing, as well as slowing demand for products such as PCs and printers.

According to some reports, more than half of the job cuts€”as many as 15,000€”will come out of HP€™s Enterprise Services, which grew in size rapidly after the acquisition of EDS. Mark Hurd, who was CEO at the time of the EDS acquisition, argued that getting the company into the fold would help HP better compete with IBM. It hasn€™t yet worked out that way.

€œThe EDS acquisition was not a success for the company, because ever since it occurred we have not seen strong growth in their services business, and margins have come down,€ Shebly Seyrafi, an analyst at FBN Securities, told Bloomberg, adding that the charges HP is taking this quarter €œare a recognition that the prior management strategy did not succeed.€

Whitman, who took the top job last year after Leo Apotheker€™s turbulent 11-month tenure, has said she intends to change the focus of the Enterprise Services business away from many smaller deals to fewer large, more profitable ones.

During a conference call with analysts and journalists in May to announce fiscal second-quarter numbers, Whitman called the services business a €œturnaround€ that will take three to five years to complete.

€œWhat we're doing is having a transition,€ she said. €œWe are transitioning our services business from being heavily weighted to slower-growth, lower-margin portions or services within ITO [infrastructure outsourcing], and we want to transition this to faster-growing, higher-margin sections related to strategic enterprise services.€

Those strategic services include cloud, security, information management and analytics, and application modernization, Whitman said. Services revenue in the fiscal second quarter were down 1 percent over the same period last year.

HP is scheduled to announce fiscal third-quarter numbers Aug. 22.

HP also announced that it was making a couple of executive changes to the Enterprise Services unit, including appointing Mike Nefkens to acting head of the business. Nefkens, currently senior vice president and general manager of Enterprise Services in Europe, the Middle East and Africa, is replacing John Visentin, who was appointed to the position last year by Apotheker.

In addition, Jean-Jacques Charhon, currently senior vice president and CFO of Enterprise Services, will be COO of the unit.

The $1.5 billion to $1.7 billion in charges for the layoffs are an increase over the $1 billion that HP initially has forecast. The increase was due to more people than anticipated signing up for the company€™s early retirement program and HP cutting jobs at a faster rate than expected.

The charges come at the same time when analysts are beginning to again debate whether HP should shed its PC and printer businesses and focus on its software and services such as the cloud.