HPQ and EDS Deal

Toni Sacconaghi, an analyst at Bernstein Research, notes that since 2002, EDS has generated annual revenue growth of just 0.4% versus 8% for HP. And he notes that gross margins at EDS are around 15%, versus 24% for HP. “Given that we do not believe HP will be able to materially improve either revenue growth or gross margins,” he writes, “the acquisition is likely to result in some multiple compression over time even though the deal is accretive and HP has the opportunity to boost EDS’ operating margins from current levels.” Sacconaghi also notes that EDS is heavily weighted to the U.S., with only a third of the company’s workers outside the country. He says that appears inconsistent with HP’s stated goal of building global capacity in its services business. Sacconaghi suggests that for $13 billion, the company could have instead bought Satyam (SAY) or Cognizant (CTSH), which have higher growth and fatter margins. He keeps his Market Weight rating on the stock.

Louis Miscioscia, Cowen: “Now is a good time to buy given the recent hit due to the announced deal with EDS,” he writes. “We would not have recommended that HP acquire EDS, and are concerned about opportunity costs, but we do believe that HP can make it work, that is with a lot of heavy lifting. Financially the deal is about a push, strategically this should actually help HP’s positioning in services and finally operationally one has to decide if Mark Hurd can run EDS better than EDS running itself. We think he can.” He keeps his Outperform rating.
Richard Gardner, Citigroup: “We would be aggressive buyers of HPQ shares on today’s pullback,” he writes. Gardner says the sell-off is “a clear overreaction.” Gardner says that HP faces slower industry growth, more stable component pricing and a more stable dollar going forward, but that “these factors are more than fairly reflect in consensus estimates” and the stock price.

Doug Reid, Thomas Weisel Partners: Reid writes that he is “incrementally more negative on HPQ” for three reasons: EDS’s “comparatively weak” margins and revenue profile and “significant integration risk.” He maintains a Market Weight rating.
Richard Krugele, Needham: He contends that “investor sentiments appear to be overdone.”
Scott Craig, Bank of America: Likewise, he says that “the stock price decline over the past 2 days…is an overreaction and a good buying opportunity for the stock.” He says that the deal “makes strategic long-term sense, even if the price paid is a little aggressive.” He says the reasons investors are nervous about the deal include lack of detail on potential cost and revenue synergies and “EDS’s challenging history.”