Hurd Plans to Herd EDS into HP

Early year in the year, I observed that Hewlett-Packard looks recession proof. Its recent Electronic Data Systems (EDS) acquisition and earnings announcements go on to say just that. On Tuesday, HP (NYSE:HPQ) reported a strong second quarter driven by strong international sales that accounted for 70% of its revenue and offset weakness in the U.S. market. Earlier coverage is available here and here.

Revenue was up 11% y-o-y to $28.3 billion. Sequentially, revenue was down marginally by 0.7% from $28.5 billion last quarter. GAAP operating profit was up 22% to $2.6 billion ($0.80 EPS). Non-GAAP operating profit was up 22% to $2.8 billion ($0.87 EPS). During the quarter, it bought back shares worth $2.8 billion and paid dividends for $197 million.

Region-wise, revenue from the Americas grew 4% y-o-y to $11.1 billion, EMEA grew 16% to $11.9 billion, and Asia Pacific grew 16% to $5.2 billion. Revenue from Brazil, Russia, India and China [BRIC] grew 26% y-o-y and accounts for 10% of total revenue.

Segment-wise, Personal Systems Group [PSG] revenue grew 16% y-o-y to $10.1 billion, driven by 31% growth in notebooks. Imaging and Printing Group [IPG] revenue grew 6% year over year to $7.6 billion led by supplies growth of 8%.

Enterprise Storage and Servers [ESS] revenue was $4.8 billion, up 4% driven by 68% growth in ESS blades and 14% growth in storage. However, Industry standard server revenue was flat compared to particularly strong sales last year, and a tough 17% compare.

HP Services [HPS] revenue grew 12% to $4.6 billion with Technology Services growing 10%, Outsourcing Services 14% and Consulting and Integration 15%.

HP Software revenue grew 28% driven by 36% growth in the Business Technology Optimization portfolio. HP Financial Services [HPFS] revenue was $685 million, up 25% y-o-y.

For Q3, HP estimates revenue to be in the range of $27.3 billion to $27.4 billion. GAAP diluted EPS is expected between $0.76 and $0.77. FY '08 revenue is expected between $114.2 billion and $114.4 billion, up from previous guidance of $113.5 billion to $114.0 billion. FY '08 GAAP diluted EPS is expected between $3.30 and $3.34.

HP plans to acquire technology outsourcing company EDS for $13.9 billion to accelerate its reach in key enterprise accounts. This acquisition would also place it in a challenger position behind IBM (IBM) in the $748 billion computer services market where it currently is at No.5 with 2.2%. EDS is currently at No.2 with 3% and IBM leads with 7.2% market share.

HP, with its $115.5 billion market cap and cash hoard of $11.6 billion and market cap of around $114 billion, can manage a $13.9 billion deal. Can it integrate this huge acquisition? Time will tell. The Compaq integration went just fine, although Fiorina lost her job, and Mark Hurd had to come in and clean up. With Hurd in charge, I have fewer concerns on operations and integration.

The Indian outsourcers will now need to compete with behemoths IBM and HP, as well as Accenture (ACN) and one another. There are some 3500 of them, so roll-ups are definitely recommended, as HP digests EDS.

The market didn’t react too well to news of the deal, and HP’s shares fell from a high of about $50 to trade around $46.

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Disclosure: None

Comments

[Feelin Groovy:]

With the right leadership in place, there is tremendous potential to lean down EDS and make it more profitable through speed to market and increased innovation.

Michael Jordan performed financial miracles cleaning up the Dick Brown era mess. Unfortunately he didn't bring in solid IT operational experience and the result is that EDS is still stuck in the old GM-EDS go slow mode with tremendous no value add overhead.

Several of us that haven't been at EDS long enough to have Blue Blood running through our veins have fantasized about being made CEO: we would come in and whack 20% headcount overnight. This headcount reduction would come straight out of the non-technical expert groups. Many of us who came to EDS from other IT organizations find it to be a slowly plodding dinosaur with an overabundance of people that seem to have made up their job and who are looking to latch onto projects/programs that have a lot of potential and suck the life giving blood out of them.

Program mgrs, project mgrs, anything with coordinator in the title, and in fact anyone with a strange title that doesn't have technical expertise should be shown the door.

My current role has between 6-10 people all supposedly performing functions that I have done in the past on top of my technical role. Confusion about who does what reigns at present day EDS.

Mark Hurd, forget talking to anyone with VP, Director or even Manager in their title. Come in and talk directly to the technical experts, especially those that haven't spent 10 years or more at this dinosaur.

Change the EDS theme song from "Feelin Groovy":
Slow down, you move too fast.
You got to make the morning last.
Just kicking down the cobble stones.
Looking for fun and feelin' groovy.
Hello lamppost,
What cha knowing?
I've come to watch your flowers growing.
Ain't cha got no rhymes for me?
Doot-in' doo-doo,
Feelin' groovy.

Got no deeds to do,
No promises to keep.
I'm dappled and drowsy and ready to sleep.
Let the morning time drop all its petals on me.
Life, I love you,
All is groovy.

to "Born to be Wild"
Get your motor runnin'
Head out on the highway
Lookin' for adventure
And whatever comes our way
Yeah Darlin' go make it happen
Take the world in a love embrace
Fire all of your guns at once
And explode into space

I like smoke and lightning
Heavy metal thunder
Racin' with the wind
And the feelin' that I'm under
Yeah Darlin' go make it happen
Take the world in a love embrace
Fire all of your guns at once
And explode into space

Like a true nature's child
We were born, born to be wild
We can climb so high
I never wanna die

Born to be wild
Born to be wild

2008 May 22 08:18 AM

[User 49180:]

HPQ 's Gross Margin was in the 24.5% range last year. The 1/3 of revenues from PC & related returned commodity level margins. EDS had a Gross Margin of about 13.7% last year. Even with substantial EDS/HPQ cost savings, HPQ's combined margin including EDS appears headed down from the 25% level. Given the slowdown in US consumer spending expected by the Fed it seems logical to assume that the PC segment gross margins will be headed down as well as all the PC makers compete for fewer buyers.

HPQ may be moving in the right direction - but margin compression may lead to HPQ stock p/e compression. And it would seem achieving the 42%+ Gross Margin that IBM achieved last year is not on the horizon.

2008 May 22 07:06 PM

[Kunst:]

Don't underestimate Mark Hurd. He is going to be one of the greats.

-- Former HP employee

2008 May 24 10:57 PM

[CycleGirl:]

I retired from HP only 1 year ago after a 24 year career there. As a shareholder, I have great faith in Mark Hurd. Trust me on this. Mark Hurd is planning major cost cutting at EDS and HP services. He would not have purchased EDS without this in mind.

2008 Jun 05 11:54 PM