The transaction, which values EDS at $25 per share, is expected to close in the second half of 2008.
HP said it would create a new business unit that will house EDS' operations and be led by current EDS CEO Ron Rittenmeyer, who will report directly to HP CEO Mark Hurd. The new unit will go to market under the name "EDS " an HP company."
In one stroke, the merger would create the world's second largest IT and business services company, next to IBM. The combined services revenue for EDS and HP last year was $38 billion, compared to $54 billion for Big Blue.
HP's EDS unit will also house 210,000 employees.
The deal "gives us scale," said Shane Robison, HP's chief strategy and technology officer, in an interview. "One of the things you need in the services business is people with a lot of vertical expertise and operational expertise," Robison added.
HP has struggled to grow its services business internally. Despite publicly stating its intention to become a leader in the outsourcing market and investing accordingly, the company often found itself in the position of also ran against competitors like IBM, Accenture and EDS when big deals were handed out.
With EDS in-house, HP would double its outsourcing business overnight while adding blue chip customers like American Airlines, Bank of America, and Royal Dutch Shell. "This fulfills our strategic objective of expanding in the services area," said Hurd, during a conference call Tuesday.
HP shares were off 6.85% to $43.62 in mid-day trading Tuesday despite reporting better than expected preliminary second quarter results. Investors were cautious over whether the company can successfully integrate EDS' operations without disrupting customer service and sales.
IBM in recent years has slimmed down to focus solely on enterprise hardware, software, and services. To emphasize its enterprise focus, the company went so far as to jettison its PC business in 2005.
HP, on the other hand, continues to operate a consumer-oriented personal computer and printing business that accounts for about half of its revenues. It could be difficult for HP to convince blue chip EDS customers that their service would not suffer in the hands of a company with such a significant stake in the consumer market.
Robison insisted such worries are unfounded. "Mark [Hurd] is very active with our customers. I don't think there's going to be any concern about their not having the CEO's ear," said Robison.
Uncertainty over the merger could provide a boost for IBM and also help India-based outsourcers, including Wipro, TCS, and Infosys, that are expanding their presence in the U.S. market.
"Integration is going to be a challenge," said analysts at Technology Business Research, in a note on the deal. Still, the analysts said they believe Hurd is up to the integration task, having "proven his strength in operations."
Part of Hurd's mandate will be to improve profits at EDS. In its most recent fourth quarter, EDS posted an operating margin of 7.3%, compared to 11% reported by rival Accenture in its most recent quarter. Part of the fix will likely include job cuts. "There's always job adjustments" during a merger, Rittenmeyer said in the conference call.
Still, HP, with the addition of EDS, could rightfully claim that it's the sole vendor capable of furnishing customers with the entire spectrum of IT products and services -- from PCs and servers to middleware and global outsourcing services. Hurd called the mix "one of the broadest, most competitive portfolios of products and services in the industry."
The deal remains subject to regulatory approval and approval by EDS shareholders, HP said.