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What Hewlett-Packard's Acquisition of EDS Means to Accenture

Companies / Mergers & Acquisitions May 30, 2008 - 01:52 AM GMT

By: Hans_Wagner

Companies Best Financial Markets Analysis ArticleInvestors who wish to beat the market often look for value in picking stocks. Hewlett-Packard's (HP) acquisition of EDS (EDS) presents an opportunity to examine the large IT Services Provides. The move by HP doubles their market share in the global Information Technology Services market. Further, IBM's recent success stems primarily from the growth in its services business. Mark Hurd, HP's CEO, is trying to follow the IBM business model where services are the driver for growth. 


I do not intend to rehash whether HP's acquisition of EDS is the good for HP. There are many articles discussing this event. Rather I am looking at what this transaction means for Accenture (ACN), who, according to a 2007 Gartner report is the third largest provider of IT services in the world. Moreover, the EDS acquisition has encouraged many speculators to buy Accenture in the hope that the shares might be bought by another large technology firm. As a result, the price of Accenture's shares have jumped up.

Quick Comparison

The 2007 Gartner report on IT Service Provides places IBM as the world leader with 7.2% market share, followed by EDS with 3%. Accenture holds down third place with 2.8% of the market followed by Fujitsu with 2.5% and HP at 2.3%. HP's acquisition will give them a solid second place with 5.3% of the market, assuming they do not lose any clients in the process.

Perhaps of even more interest, Accenture grew the fastest, up 19.7% followed by IBM at 12.2%, and HP at 8.1%. EDS grew at 3.4%. This suggests that HP is losing share to IBM and Accenture. HP has its work cut out for it to turn around their services business as well as EDS.

Accenture is also the most profitable of these large IT Services firms as shown in the table below. Part of the reason Accenture is able to achieve this higher profitability is their strategic business consulting practice that generates higher rates and margins. 

IT Services Comparisons (trailing 12 months) ($millions)

Firm Revenue EBIT Earnings Yield
Accenture $23,268 $2,843
12.2%
EDS $22,143 $1,314
5.9%
HP $17,969 $1,594
8.9%
IBM  $56,208 $5.504
9.8%

 

The market values Accenture more as their market cap was $21.910 while EDS was $12,230 as of May 23, 2008. It looks like HP is buying a firm at a low relative price and they expect to be able to turn it around, improving the profitability of EDS.

Accenture's Strengths and Weaknesses

The most significant strength Accenture possess is its extensive executive level relationships with most of the world's leading companies and governments. These relationships extend all the way up to the CEO and the Boardroom, giving Accenture a unique position as an IT Services Provider. EDS, HP and IBM tend to have their most important relationships with the IT organizations of these large companies. In 1995, EDS recognized the value of access to the Boardroom, when they acquired A.T. Kearney, a strategic consulting firm. In 2006, EDS realized they could not properly leverage this relationship, so they sold A.T. Kearney back to the partners. 

Another important strength of Accenture is they are independent of the hardware and software they use in their client's solutions. Yes, they have relationships with the various vendors, but they can recommend what is best for their clients without any bias to the parent company's products. IBM and HP claim they will suggest another company's products and software if they are better suited to the overall solution. However, the business model for HP and IBM says there should be a synergy that helps pull through sales of hardware and software. This built in conflict gives Accenture another advantage in the market place.

Finally, Accenture generated $2.3 billion in free cash flow over the last 12 months. Cash Flow numbers for the services segments of IBM and HP are not available, so a comparison cannot be made. However, since each of them generates lower Earnings Before Interest and Taxes (EBIT), I suspect their services arms are not as prolific in their generation of free cash flow. For reference, EDS produced $892 million in free cash flow in 2007. 

In the latest quarter, Accenture's net revenue rose 18.1% to $5.61 billion up from $4.75 billion. They grew their backlog, a sign the future looks good, by booking $6.44 billion in new business, helped by record bookings in the consulting segment.

As of February 28, 2008, Accenture had $3.5 billion authorized for its open market share repurchase program. In the past year, they have reduced their outstanding shares by 7.1%. This should help to offset the affects of a down market.

Like many services companies, Accenture is vulnerable to further weakness in the U.S. economy. Should the global economy experience a slow down, it is likely to affect the growth of the IT Services firms. However, as a services firm, Accenture is able to slow down its hiring to match the demand for people. While there will be some delay, it gives them a way to adjust their business model to match the demand for their services. IBM and HP can do the same with their services business, though a significant portion of their business is assigned to support installation of hardware and software sales. As a result, it will be more difficult for these firms to adjust their headcount to match the demand for services.

The Bottom Line

Accenture meets many of the criteria as a value play and a growth opportunity. When investors find such a stock, it normally represents a good longer-term opportunity. I will be looking to acquire shares on a dip in the price to the 32 – 34 area. As of the submission of this article, I do not own shares of Accenture.

If you wish to learn more about value investing, I suggest reading Value Investing: From Graham to Buffett and Beyond by Bruce C. N. Greenwald, Judd Kahn, Paul D. Sonkin, Michael van Biema Value investing in the manner initially defined by Benjamin Graham and David Dodd rests on three key characteristics of financial markets. And for more in depth research I suggest Financial Statement Analysis and Security Valuation by Stephan Penman. By focusing on the output of financial statements, Professor Penman helps readers understand how to use financial statements to value companies. While expensive, this textbook is an excellent reference for any investor who likes to do their own analysis and will pay for itself very quickly.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Hans Wagner Archive

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