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EDS acquisition is key to HP's growth

Posted: 22 Aug 2008     Print Version  Bookmark and Share

Keywords:EDS  acquisition  revenue impact  competitive stance 

Hewlett-Packard Co. makes defying gravity look easy.

The real estate market is under water, financial companies are reeling, the equity market is swooning and jittery investors puzzle over the weak dollar. Yet HP headed by chairman and CEO Mark Hurd is breezing past financial forecasts and raking up huge profits in all corners of the globe.

Hurd doesn't want HP to rest on its laurels, however. He wants to further reduce HP's overall costs to boost margins even as it completes the integration of Electronic Data Systems Inc., which the company is buying to boosts its competitive stance against IBM Corp. in the high-tech services and consulting business.

"Make no mistake about it," Hurd said. "We are going to execute on the EDS acquisition and we are going to bring the strength of HP's operating discipline, the strength of HP's innovation, the strength of HP's position in the marketplace to make a combined business that we think will be quite competitive."

Even now, however, HP did much better than many expected. As if beating analysts' fiscal third quarter revenue estimate by more than Rs.2,000.00 crore (half a billion dollars) wasn't astonishing enough, the Palo Alto, Calif., company notes sales for the current quarter would improve approximately 7 per cent on both a sequential and year-over-year basis.

And as for that pesky dollar, which continues to gyrate wildly against other major currencies, HP sees some revenue impact but nothing that would derail its net profit expectation.

"As we've seen in the last few weeks, currency rates can be at times volatile," said Catherine Lesjak, vice president and CFO of HP during a conference call with analysts. "If the dollar remains where it is today there will be downward pressure on our revenue but we will be able to come in on our earnings per share range."

Not all smooth sailing

Notwithstanding the strength in its operations currently, HP is not immune to problems in the global economy and rivals are targeting its lucrative printer and ink cartridge business, which recorded the slowest growth of the company's business divisions in the latest quarter.

"HP continued its string of earnings per share beats on the back of lower operating expenses," said Kathryn Huberty, an analyst at Morgan Stanley & Co. Inc. "The imaging & printing group was the only segment that missed our revenue and operating income targets, a sign of lengthening lifecycles in the slower macro environment."

Additionally, HP could be headed for its biggest challenge in years as completes the Rs.59,573.26 crore ($13.9 billion) acquisition of rival EDS within the next few weeks.

The huge transaction, which HP and EDS have assigned about 500 people to work on, could by some estimates drain between Rs.6,428.77 crore ($1.5 billion) and Rs.8,571.69 crore ($2 billion) of HP's cash in integration costs over the next couple of quarters.

"We expect to close the EDS acquisition by the end of [August] and this will result in a substantial cash usage for fiscal fourth quarter," said Lesjak who declined to provide an actual estimate.

HP wants to use the EDS acquisition to bolster its high-tech consulting and services business in an effort to improve its competitive position against IBM Corp. The acquisition and successful integration is therefore critical to HP's future revenue and profit growth, according to analysts.

"We believe the acquisition and integration of EDS should help HP manage the macroeconomic storm better than others," said Shaw Wu, an analyst at American Technology Research in a report. "We see room for significant operating leverage, particularly in fiscal 2010, regardless of economic conditions."

EDS acquisition is key to future growth

To secure the expected benefits from the EDS acquisition, HP would have to continue successfully managing its current businesses, including the growth-challenged imaging and printing division, further reduce operating costs and seamlessly integrate the new unit.

Many analysts believe HP should be able to orchestrate the successful integration of EDS into its operation. The company declined to provide further details or assessment of the integration during the latest conference call, deferring all questions until its annual financial conference in September.

"The plan is going well and we are confident in the benefits this business combination will bring to customers, partners and shareholders," said chairman and CEO Hurd. "The feedback from the vast majority of the customers that I talk to continues to be extremely positive as they contemplate the power of HP's innovation coupled with EDS' scaled services business."

In the meantime, HP is focusing on continuing to squeeze costs out of its operations. With projected fiscal 2008 revenue of approximately Rs.492,872.29 crore ($115 billion), HP believes it still has ample opportunity to further slash costs and boosts margins.

In the latest quarter ended July 31, the company's net income jumped 14 per cent to Rs.8,571.69 crore ($2 billion), or Rs.34.29 (80 cents) per share, up from Rs.7,714.52 crore ($1.8 billion), or Rs.28.29 (66 cents) per share, in the comparable year-ago quarter. Revenue climbed 10 per cent during the same period to Rs.120,003.69 crore ($28 billion) from Rs.108,860.49 crore ($25.4 billion).

Gross margin in the fiscal third quarter slid slightly to 24.2 per cent from 24.5 per cent, reinforcing the company's position it must further tighten up total costs and find ways to protect itself against both currency risks and falling average selling prices.

Hurd said during the conference call that he believes HP's costs, which he defined as revenue minus profits, are more than Rs.428,584.60 crore ($100 billion).

The addition of EDS would boost that number strongly, giving the company considerable leveraging power with suppliers and outsourcing contractors in addition to cost reduction opportunities at the corporate, sales and marketing levels.

"We think about that Rs.428,584.60 crore ($100 billion) worth of costs every single day and how we can make it as efficient as we can to give us the best opportunity to go in the marketplace," Hurd said. "There will never be a day at HP at our scale when we are not trying to work hard to make our processes more efficient and get our cost structure right."

- Bolaji Ojo
EE Times

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