Services Anyone?

By Eric Fox | September 30, 2009 AAA

The great rush by hardware firms to diversify out of their narrow base of slower growth businesses is underway. Which information technology services firm will be next?

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The technology sector has seen two large deals in September 2009. Last week, Dell Computer (Nasdaq:DELL) announced that it would buy Perot Systems (NYSE:PER) for $30 a share, a 68% premium.

Next came Xerox Corp (NYSE:XRX) buying Affiliated Computer Services (NYSE:ACS) at a 34% premium.

The rationale for the deals is an attempt by the hardware companies to expand into higher growth and higher margin businesses. Also, the hardware companies can now sell the service businesses it has acquired into its corporate customer base.

So who could be next? Let's take a look at the top four information technology companies by market capitalization.

Large And In Charge?
Computer Sciences Corporation (NYSE:CSC) is one of the largest services company with a market capitalization of $8 billion. The problem with Computer Sciences Corporation as it pertains to its attractiveness to hardware companies is that 41% of its sales are in the public sector, primarily the Federal Government.

The company is also a serial acquirer, has purchased dozens of other businesses and may not be for sale.

Scandalous Satyam

Satyam Computer Services Ltd. (NYSE:SAY) is involved in an accounting scandal with a former Chairman admitting to falsifying earnings. The company is currently restating past years financials making this company toxic to a buyer for the time being. (Read about other scandals in our article The Biggest Stock Scams Of All Time)

Stretching Beyond The Borders
NCR Corp. (NYSE:NCR) offers a widely diversified base of services to its customers, serving the financial, healthcare and retail industries. The company is also diversified geographically, with 66% of its revenues outside the United States. This may increase its appeal to a buyer. However, NCR Corp is not exclusively a services provider; about 50% of its revenues came from products rather than services in its most recently reported quarter.

Mini But Mighty
Syntel Inc. (Nasdaq:SYNT) has a $2 billion market capitalization, and is easily digestible by a larger company. The company is fast growing and is positioned well in the services business, but it had only $410 million in sales in its last fiscal year, which may not be enough to interest a large hardware company.

The stock is fairly expensive, trading at 20 times earnings excluding any premium that an acquirer would have to pay. Also, the stock is trading at a lifetime high price of just under $50 a share.

Asking The Wrong Question?
Perhaps a more important issue is who would the buyer be? Dell Computer and Xerox are no longer in the market. Hewlett Packard (NYSE:HPQ) bought EDS last year, and doesn't really need anything else. IBM (NYSE:IBM) is already the ultimate software/services/hardware company, and wouldn't benefit except perhaps with a small bolt on acquisition to fill a hole in its lineup.

It would seem that investors are not the only ones that engage in herd-like behavior as traditional hardware-oriented technology companies queue up and pay up for companies stacked with technology services businesses. It's not all that clear that such a strategy will work for these eager buyers. (To learn about how to value mergers and acquisitions, see Accretion/Dilution Analysis: A Merger Mystery)

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