HP`s Proposed EDS Acquisition Validates IT Services

Two years ago, Hewlett-Packard CEO Mark Hurd announced at his America’s Partner Conference that he wanted to wipe away IBM’s claim as being the world’s largest technology company. HP has not only succeeded in that goal, but is on the verge of blowing it away with the acquisition of Electronic Data Systems, the world’s largest non-vendor technology integrator and service provider.

HP confirmed that it’s in “advanced” talks with Plano, Texas-based EDS, but cautioned that, “there can be no assurances that an agreement will be reached or that a transaction will be consummated.”

According to published reports, HP will pay as much as $13 billion for EDS, a premium on the company’s current stock price. If finalized, EDS will be the largest acquisition HP has made since it took on Compaq in 2003.

Is the deal worth it? While EDS stock is under pressure, it remains a $22 billion powerhouse for IT integration and outsourcing services. In the first quarter, it’s year-over-year net income fell by two-thirds to $63 million. Nevertheless, EDS signed a dozen $100-million-plus contracts, including a five-year deal to manage all of Royal Dutch Shell’s IT operations.

HP’s services division is only second to that of the Goliath that is IBM Global Services, which generates nearly $50 billion in revenue annually. If HP successfully acquires EDS, it will position the vendor as the world’s second largest IT services company and bring it nearly on par with IBM in terms of services revenue.

Additionally, an HP acquisition of EDS would propel its gross corporate revenue out of IBM’s reach. The combined HP/EDS company would have gross revenues of nearly $130 billion to IBM’s $98 billion.

The potential EDS deal is also a bit of a change of heart on the part of Hurd and HP. During that same partner conference in 2006, Hurd went out of his way to criticize HP’s reliance on its services arm for growth and that growing services was significantly more difficult than growing hardware and software sales. HP’s acquisition of Mercury Interactive was the strongest indication that HP wanted more software revenue. Going after EDS could signal a reversal of its view toward services, or it could simply be a containment measure to pressure IBM’s growth.

Interestingly, IBM is recognizing the limited growth potential and difficulties in growing, and has shifted greater attention toward revitalizing its software division.

Where Hurd hasn’t succeeded in the vision he laid out two years ago is profitability and efficiency. HP may have eclipsed IBM in top-line revenue, but IBM continues to outpace HP in other measures: profitability in regards to revenue, assets, shareholder equity and earnings per share. Whether EDS changes that paradigm will depend on post-acquisition performance. The bad news for IBM is that HP is rapidly improving its profitability efficiency, and EDS may give it an edge in these metrics.

From a channel perspective, IBM has been a partner-building machine. Partners have made fortunes not only reselling IBM product, but also fulfilling portions of the services for IBM Global Services. For the rank and file of the channel, the acquisition of EDS will make HP look more like the full breath of IBM’s products and services, give it a more large company and enterprise focus, and decrease its and its partners dependency on commodity technologies, such as printers and PCs.

More significantly, HP’s move toward services should stand as a validation of how important recurring revenue streams and non-product engagements are to growth. Services already make up the bulk of solution provider revenue. HP’s services will focus mostly on Global 2000 companies, which fall outside the purview of the average solution provider. But even small and mid-tier solution providers can emulate this business model to enhance their value proposition to customers and accelerate their growth.

The future of IT—for solution providers, vendors and end users, alike—is in services. Where HP goes, the channel should follow.

Lawrence M. Walsh is vice president and group publisher of eWeek’s Channel Insider. Share your thoughts on IT services with him at lawrence.walsh@ziffdavisenterprise.com.