Is HP interested in buying CSC?

The New Year has kicked off with a bang in mergers and acquisitions activity in the software management sector. Actually, the activity level picked up in the fourth quarter and has just kept going, with the most significant buys being:

* HP’s acquisition of asset management provider Peregrine and Linux management vendor RLX.

* IBM’s purchase of network management provider Micromuse.

* CA’s acquisition of applications management software vendor Wily and support automation provider Control-F1.

* Mercury Interactive’s purchase of service-oriented architecture software and services developer Systinet.

* Fluke’s acquisition of network manager Visual Networks.

It appears the outsourcing sector may see some acquisition activity as well. Pending transactions include HP and Blackstone Group, which are reported to be in discussions to buy CSC. Also, a group of investors including Blackstone and others are said to be looking to buy ACS. Are these a couple of isolated transactions or is this the beginnings of a trend?

HP is said to be looking at a minority position in CSC, with Blackstone Group taking the majority position. This would allow HP to begin to establish partnerships with CSC and work out a larger position or full acquisition later. You might wonder why it doesn’t buy the whole thing straight up.

CSC’s revenue is about $14 billion while HP’s services revenue is around $15.5 billion. The combined services revenue would put them in the big leagues, not too far behind leader IBM Global Services at $48 billion in services revenue and in the range of other big players like EDS and Accenture. HP has been working hard for many years to build its current services portfolio, but in a slow growth space, as IT services has been in recent years, organic growth is not going to grow HP into the size it needs to compete. A major acquisition like CSC certainly would help.

So why doesn’t HP buy the whole thing? Well, according to reports, Blackstone previously worked with Lockheed Martin to acquire CSC, but that deal fell through. However, I think there is more to it than that. Here are some other reasons why HP may be walking slowly toward a deal with CSC:

* According to reports, Lockheed Martin and Blackstone offered $12 billion and didn’t get the deal done. An HP/Blackstone deal would cost closer to $15 billion. HP is still digesting the $19 billion acquisition of Compaq … maybe HP is slow walking this one to ensure it gets its directors and shareholders on board with the idea.

* Maybe HP doesn’t want all of CSC and it can work with Blackstone to break out the parts it’s not interested in. This could include businesses, such as CSC’s legal business process outsourcing team, that are not in line with HP’s strategic direction.

* CSC has significant federal contracts. HP could be working to isolate certain contracts or certain consulting teams that could be in conflict with other HP contracts.

* Acquiring CSC could seriously complicate HP’s relationship with its channel partners. IBM struggled with this after acquiring PWC. Slow walking the acquisition would give it time to sort out these issues.

Whatever the reasons, HP appears to be moving cautiously toward a significant and strategically important acquisition. If it can bring this one home, HP will be adding significant revenue, federal contracts, global contracts, services business supporting non-HP hardware, and legions of experienced staff. The move may also be the tip of the iceberg of a consolidation and restructuring of the outsourcing industry.