HPE unloads services biz as outsourcing consolidation gains momentum

Contact: Scott Denne Katy Ring

Hewlett Packard Enterprise (HPE) is looking to get out in front of a wave of consolidation in the IT outsourcing and services sectors by selling its services business to CSC for $6bn in stock and cash. The deal marks the latest and largest of HPE’s divestitures as the company shifts its focus toward building its software-defined infrastructure capabilities on the back of its legacy enterprise software and hardware group. In divesting its services division, the company risks losing one of its largest sales channels, although not selling the unit presents the same risk as HPE was unlikely to invest heavily in a line of business that’s outside its primary focus just to keep up with market consolidation.

CSC will hand over half of its equity (valued at $4.6bn before the announcement, although CSC stock jumped by one-third afterward) to HPE’s shareholders to acquire the services business. In addition, it will pay $1.5bn in cash to HPE and assume $2.5bn in liabilities, including pension payments and $300m in an outstanding bond taken out by EDS. The deal is structured as a Reverse Morris Trust, where HPE will spin off the target to its shareholders and sell it to CSC in a 50:50 merger, making it a tax-free sale. It values the unit at $8.5bn, or 0.4x trailing revenue – below the 0.6x that HP paid to buy EDS back in 2008.

Along with the cash and stock, CSC has agreed to maintain the level of purchases of HPE gear to service the target’s legacy customers for the next three years. This give HPE a window to maintain a major sales channel while bolstering its appeal to CSC and other major IT services providers, now that it will no longer be a competitor. HPE CEO Meg Whitman will have a seat on CSC’s board and HPE will name half of CSC’s directors.

Although the services unit has shrunk under HPE’s ownership, it had become more profitable in recent quarters. Its top line declined 2% year over year in Q1, but the total value of its contracts and the value of new accounts were both up, suggesting that declines were leveling off. In the overall IT services space, a wave of consolidation will make that increasingly tough to maintain. According to 451 Research’s M&A KnowledgeBase, $27.8bn worth of IT services and outsourcing businesses have been sold this year, already topping last year’s tally and on pace to be the highest total value of such deals since 2007. All of that despite this year being among the lowest in IT services transaction volume.

HPE may have been slow to invest in its services business as the market for traditional IT outsourcing declines and the demand for newer, business application-focused services increases – however, CSC has shown no such hesitation. CSC has inked seven acquisitions in the past 12 months, including consolidation plays such as today’s move and the $720m pickup of Xchanging, as well as deals for new talent and tech, such as its recent acquisitions of SaaS specialists Fruition Partners and Aspediens.

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