HP's plan to buy EDS to spark M&A in IT services sector

BANGALORE/NEW YORK Tue May 13, 2008 5:16pm BST

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BANGALORE/NEW YORK (Reuters) - Hewlett-Packard's move on Electronic Data Systems Corp is likely to spark a round of consolidation in the technology outsourcing sector around the globe, as suddenly much-smaller rivals scramble to stay competitive.

Analysts say Infosys Technologies Ltd, Tata Consultancy Services, Wipro and Cognizant Technology Solutions may now be forced to look for acquisitions to compete with a combined HP and EDS and boost flagging profit growth.

"Businesses of companies like Infosys and Wipro are under pressure, as their rivals like IBM and Accenture have really learnt how to be competitive even in a sluggish economy," said Avinash Vashistha, CEO of outsourcing consultancy Tholons.

"This merger, if it happens, will only make situation worse for them by potentially creating a third competitor," he said.

"Now, it has become imperative for them to make acquisitions to fill the gap in their services portfolio and get a global footprint. If they don't go for inorganic growth at this stage, they will clearly be at a competitive disadvantage."

HP is in talks to buy technology outsourcing company EDS for $12 billion to $13 billion in a deal which would vault it to a close second to IBM in technology services.

A source briefed on the matter told Reuters that a deal could be announced by the close of business on Tuesday. HP and EDS have said they were in talks about but given no details.

HP has long considered an acquisition to beef up its tech services business, a sector that offers relatively stable income and high margins even in an economic downturn.

Worldwide computer services revenue rose 10.5 percent to $748 billion in 2007, according to market research firm Gartner Inc.

IBM was the leader, with a 7.2 percent market share. EDS weighed in at No. 2, with 3.0 percent of the market, while HP was No. 5, with a 2.2 percent share.

Analysts say Indian outsourcers, already battling slowing profit growth due to a slowdown in their main U.S. market and rising cost of operations in their home country, may now seek buys in the United States and Europe to boost growth.

While all four big Indian services firms missed market estimates for net profit last quarter and issued cautious outlooks, IBM and Accenture reported better profits and raised their guidance.

India's cash-rich IT services firms have so far restricted themselves to smaller buys as their businesses were growing rapidly organically and they were wary of integration issues.

But analysts say things may change soon as they look to add new service lines, strengthen marketing muscle and add large clients in new regions.

Last year, talk circulated that Infosys, which has a market value of $24 billion, or smaller rival Wipro may bid for Europe's biggest IT firm Capgemini, but all the companies denied the rumors.

"Indian firms may not be able to digest a large firm, but they are certainly focused on small and mid-sized firms to gain access to some specific service lines, like consulting, where they have not been able to make a big mark," Vashistha said.

"They have no chance to do that and compete with players like IBM, Accenture, and possibly combined HP and EDS, organically."

The big Indian IT firms are not considered easy takeover candidates themselves. Wipro and Satyam are family controlled, while TCS is majority owned by the Tata family group and Infosys is controlled by a group of founders.

A THREAT TO IBM?

If EDS were to remain independent, it would have a tough time holding on to its No. 2 slot in the IT services market, which last year pulled in revenue of $748 million, said Allie Young, an analyst with Gartner.

"Right now IBM is double the size of its nearest competitor in the services business. What we are seeing here is that the gap has closed significantly," she said.

"IBM hasn't been threatened this much in a long time."

Together HP and EDS would have roughly $39.4 billion in services revenue, compared with IBM's $54.1 billion last year.

"Scale helps keep costs in line and they could be good for customers. With such a large services organization, the smaller customers might fall through the cracks and get lost," said Chad Hersh, analyst at technology research firm Novarica.

"But I think they are doing this to go after the truly large players. This will certainly help HP make the case that they are truly a leader in global services."

In April, EDS reported a 62 percent drop in first quarter profit, though the results topped Wall Street expectations. Analysts said EDS faced intense competition from Indian rivals and saw little catalyst for growth.

(Editing by John Mair)

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