HP and EDS: High risk say analysts

Merger has potential to shake up entrenched competitive landscape for global IT services

HP's decision to buy EDS for US$13.9 billion this morning offers considerable potential benefits but the execution carries significant risks, according to analysts from IDC, a sister company of ComputerWorldUK.

The IDC European Software and Services Group said that the combined organization would be "very strong on infrastructure, but ... relatively light, compared to IBM and Accenture, (on) business-level dialogue with the customer.

"And business-level dialogue is no longer a luxury, it's an essential part of winning the higher-margin and indeed higher-growth services such as application management and business process outsourcing."

Ovum analysts Phil Codling, Tom Kucharvy, John Madden, said the merger has the potential to "shake up" the entrenched competitive landscape for global IT services.

"The top ten or so of the IT services industry have barely changed places, let alone ownership, despite interminable rumors and private equity interest. But here comes a possible very big play indeed - big not just for HP and EDS, but also in terms of its potential to shake up the entrenched competitive landscape in global IT services."

However, HP is also faced with a massive integration program. "It's difficult to comment on how an HP-EDS integration might theoretically proceed, but it would inevitably entail risks."

"Combining services portfolios and delivery platforms to maximize economies of scale would be a huge task. Of course people are the greatest asset of a services business and, despite HP's new found organizational efficiencies under Mark Hurd, HP would need to move quickly to stem any potential 'brain drain' from EDS," the analysts said.

"On paper an HP-EDS combination looks workable. But in practice it could prove anything but," they added.

Adding EDS, with revenues of US$22.1bn in 2007, would more than double the size of HP's services business, which has US$16.6bn in revenues. The resulting US$39bn services operation would still be smaller than IBM Global Services, which has revenues of US$54bn. But "the merger would bridge this gap substantially and establish the merged entity as the clear number two in IT services," said Ovum.

At a round table meeting held this morning by ICT vendor group Intellect, veteran industry watcher and analyst Richard Holway said: "I've been forecasting that a tier-one player will take over another tier-one player for 15 years and now it's finally proven that I was right. For larger companies, consolidating is clearly the right thing to do."

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Satyen Patel, executive vice chairman of Bangalore-based outsourcing firm Cambridge Solutions, told Computerworld UK that HP's capture of EDS was necessary to compete on scale with IBM, which had been "incredibly aggressive" in its pursuit of outsourcing deals recently.

Phil Morris, managing director of EquaTerra Europe, questioned whether this is the right strategic move for HP, or whether it should have chased an Indian player such as Tata (TCS), Wipro or Infosys.

"At first glance the purchase of EDS by HP adds relatively few new capabilities to the mix, although EDS is a services brand not a hardware brand, in reality there is more overlap than not -- so a market share move."

Morris also said EDS looks expensive. "The share price has been falling steadily for months and its only upward pressure is the purchase talk from HP, not its performance per se." EDS's share price rose 28 percent on the news.

Morris said he believes HP is "spending too much" for a company that "does not take them forward far enough to warrant the purchase price".

"Whilst there are clear pluses, on balance I do not believe EDS is the right target for HP, and culturally one can only stand back and watch."

Speaking at the Intellect event as the deal was being finalized, EDS UK country manager Sean Finnan said the local technology economy remains robust. "The amount of prospects is as strong as it has been for a long time," he said.

Finnan also predicted more focusing of IT services as a result of the shake-up in the IT services market.

"We'll see more specialization," he said. "For example, the need for specialist financial services skills, which is already very high, will be amplified."