The Wall Street Journal reports that Hewlett Packard (NASDAQ: HPQ) will spend $12.8 billion to buy Electronic Data Systems (NYSE: EDS). While this combination would make HP the second largest, behind International Business Machines (NYSE: IBM) in computer services, this may not be a good way to spend $12.8 billion.
That's because EDS and HP would under perform in services when it comes to profitability. EDS's bigger business earned a 1% net profit margin in the first quarter. But HP's services business generated a far higher 9% estimated net margin. Unfortunately -- for reasons described below -- the combined company will probably have lower margins.
Meanwhile, IBM's profit lagged HP's slightly -- it made an estimated 7% net margin in the first quarter in its services business. But IBM is and will remain a much bigger player. Combined, EDS and HP's services business will control 5.3% -- lagging IBM. That's because IBM controlled 7.2% of the tech-services market in 2007 while EDS was a distant second at 3% and HP was fifth, with a 2.3% share.
I think HP's most profitable business, printers, might be able to make better use of the $12.8 billion in capital. This Imaging and Printing Group earned a 13% estimated net margin. It grew a mere 4% to $7.3 billion in revenue and given that this unit is by far the most profitable in HP's stable of businesses, this would appear to be the best place to invest for future growth.
Now may be a good time to sell HP stock. Mark Hurd came into HP as a nuts-and-bolts operator. This deal suggests that Hurd has run out of growth options and that HP can't grow earnings through more cost cuts. I have no doubt that Hurd could cut costs once EDS has been integrated.
However, government work -- which accounts for the biggest part of EDS's revenue -- is inherently less profitable than the commercial work which HP performs in its services business. So, I would guess that the EDS merger will lower HP's services margins.
What HP really needs -- and lacks due to Hurd's particular skills -- is the ability to innovate as it did successfully in printers back in the 1980s and 1990s when it invented the highly profitable printer and ink business.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.
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Reader Comments (Page 1 of 1)
5-13-2008 @ 11:43AM
BigJohn547 said...
Not with Customer Service coming from India!!!
5-13-2008 @ 12:46PM
gumbo koontz said...
no dopehead! Microsoft will buy HP . Microsoft can not live on software alone anymore... Everybody else has a hardware division of its own. IBM, Sun, Apple but not MIcrosoft... Microsoft need the feelings of hardware in order to design better Windows computers.
5-13-2008 @ 12:49PM
gumbo koontz said...
Microsoft tried to buy EDS long ago. I figure that Microsft is giving HP instructions to buy EDS before MSFT will buy HP. How else can Microsoft compete with IBM other than software?? MSFT can beat IBM up anyday.. What kept MSFT from doing it is its addiction to ultra profts on software alone. MSFT has to own up to the day that it got to start bending metals and stuff ... The days of visiting manicurists are over!!!!
5-13-2008 @ 12:51PM
gumbo koontz said...
Google will realize the same thing someday.. You can not run business on search and advertisment alone much longer. It is machines machines machines !!!!
5-13-2008 @ 1:00PM
gumbo koontz said...
We will see so much more variities in embedded machines running on whateverOS that comes along. You will see them in your cars, stores, motels, transporations, planes, entertainments, factories, offices, everywhere . Everythign will be so hardwired that no friggin hacker can get in at all. Software will be hardened. We are having our own fills with hackers doing nothing useful but making great livings under the tables... MSFT will write codes in wires not magnetic ink so to speak. We will probably put a lot more diodes in chips along with transistors so that software will go in one way not the other so hackers cant go back in and out and they will have to go around in same directions we use and get nabbed in no time flat.
5-13-2008 @ 1:02PM
gumbo koontz said...
Microsoft are depending too much on the hardware boys so MSFT got to learn how to make chips and stuff and write better codes to go with them. I predict a lot more diodes will be built in chips in the future.
5-13-2008 @ 1:03PM
gumbo koontz said...
End of my tech ramblings! So long, folks!