The U.S. computer services industry is back in favor, after a decade of struggling to cut costs and compete with offshore firms from India and elsewhere. At least that would be the obvious conclusion to draw from a recent string of multibillion-dollar deals.

Xerox has agreed to buy Affiliated Computer Services for $6.4 billion while Dell is paying $3.9 billion for Perot Systems. They are picking up where Hewlett-Packard left off when it paid $13.9 billion to buy Electronic Data Systems in 2008.

But what's driving these deals is not a bet on the improving growth prospects of the services industry. Instead, the buyers value computer services companies more as sales pipelines for their own products.

Take Xerox, which has struggled for years to move beyond copiers. The idea now is to manage information in both printed and paperless form. ACS is a leader in processing health claims and student loan payments for governments. It helps commercial clients cut the costs of payroll or human resources processing.

So don't think of this deal in terms of the traditional revenue synergies used to justify technology mergers. It's about helping commercial and government clients cut costs, a tight margin business in the best of times.

For while demand for services has stabilized as the economy recovers, there's little sign of any broad-based growth surge returning. There's no end to the need for services firms to continue to restructure, replacing labor in high-cost markets with technically savvy workers in lower-cost ones.

The computer services market is defined by its two poles: At the top, IBM is the model of the globally integrated services firm that can supply hardware, software and low-cost labor as needed. Rising up are such aggressive Indian software services firms as Infosys, Tata, and Wipro and smaller players in other low-cost nations, including China and Eastern Europe.

Yet times are tough, even for the upstarts. Indian services firms that enjoyed revenue growth north of 30, 40 or 50 percent earlier this decade now face growth of 5 to 10 percent. IT budgets have dwindled and cost control is the order of the day.

Caught in the middle are the services firms that have failed to adopt new labor-saving technology and offshore service delivery. ACS, Perot and to a lesser extent EDS were all slow to embrace the offshore trend. While each has belatedly moved to expand overseas in recent years, this is not their strong suit. Instead, all three have increased their share of the market for politically sensitive federal, state and local government contracts.

Even after the recent mergers, deal-making in the sector is far from over. Big names like Accenture, Computer Sciences Corp and Cap Gemini remain in play, as do dozens of niche players in services like payroll, data center automation and healthcare information.

Who might be on the prowl? Dell, for one, has said Perot is only a start, and it will still be sitting on a cash horde of $9 billion. Xerox, on the other hand, says ACS will be its one big deal. IBM, as the market leader, can afford to be opportunistic here, but could be barred for antitrust reasons from mega-deals in the sector.

Look for other buyers to emerge from hardware and software vendors like Oracle or even deal-shy SAP.

It's hard to see intra-industry consolidation, say a merger between Accenture and CapGemini. And Indian services companies have shown themselves reluctant to overpay for services consultants they will likely replace with their own lower-cost workers.

But never underestimate the capacity of desperate companies to do desperate things.

You can find some Eric's previous columns here.

(Photo credit: Reuters/Catherine Benson)

-- Eric Auchard is a Reuters columnist. The opinions expressed are his own --
  
By Eric Auchard

LONDON, Sept 21 (Reuters) - Dell Inc has made a solid move into computer services by buying Perot Systems, even if the hefty price Dell is paying is hard to justify on Perot's standalone prospects alone. 

And the price looks very rich indeed.  Dell is spending nearly $4 billion in cash -- a premium of 68 percent to Perot stock's recent close -- to buy a slow-growing U.S. computer services firm focused on health care and government clients.
  
That's 1.4 times Perot's expected 2010 sales, or roughly two times more than rival Hewlett-Packard paid when it acquired EDS in a $13.2 billion deal last year.

But the Perot deal is best understood as arming Dell with a sales force to push its broad computer hardware lines and expanding software and services offerings out to healthcare and government customers. The acquisition lets Dell neatly expand into these markets without indulging in mega-dealmaking of the sort it has no history doing. And Dell will still be left with $9 billion in cash for any additional deals.

Electronic health records are key driver of Perot Systems growth

Acquiring Perot's Web hosting and remote services businesses fills a missing link in Dell's strategy to deliver software-based services remotely rather than more costly labor-intensive ones.
  
Dell's current services businesses generate $5.7 billion a year, two-thirds of which is technical support for Dell hardware clients. Of the remaining one-third of Dell's services business, most is made up of managed network services, and the stub is for consulting.
  
These are areas where Perot gives Dell a leg up. In return, Dell provides a pipeline of business with global customers that Perot is only starting to try to tap.
  
Perot Systems represents a big bet by Dell on the growth of the health care information technology business, which produces half of Perot revenues, and government work, roughly another 20 percent or so of sales. These are growth markets, however the debate over President Barack Obama's national health care plan ends up.
  
And for a company founded by Ross Perot Sr. -- a former U.S. presidential candidate known for his strong views on job losses to Mexico -- Perot Systems has increasingly had a global focus.
  
Perot has been investing heavily in India, its biggest employee base outside the United States, which still accounts for 87 percent of its business, and more recently in China, where it has won promising business contracts. (Perot Sr. controls a quarter of the company's shares and stands to take away more than $1 billion from Dell's offer, while his son, Ross Jr., now serves as active chairman.)
  
The short term is not as promising: Perot sales are poised to decline 9 percent in 2009 over last year, while profits remain flat. But fortunes are expected to rebound in 2010, when analysts expect 9 percent growth in sales and profit.
  
Buoyed by health care reforms, electronic health records and other moves to use technology to wring efficiencies out of government and commercial health organizations, Dell says it sees plenty of growth potential.
  
Dell should be congratulated for avoiding many of the integration headaches of buying a broader-based computer services companies, many of which remain weighed down by huge staff headcounts in the face of low-cost competition from offshore services firms. I wrote in July of Dell's wider services strategy in a column entitled "A brutal logic to Dell's reinvention."
  
Shortly after acquiring EDS, HP set in motion plans to cut 24,600 employees, or more staff than Perot Systems employs across its whole company. Acquiring EDS has diminished HP's ability to do new deals for the time being.
  
Dell can also find ways of wringing further costs from Perot, but the deal is more about expansion than simple merger synergies.
  
Most important, buying Perot keeps Dell's powder dry for further acquisitions to fulfil its stated strategy of expanding into services and software makers from its base in computer hardware. It can pursue other mid-sized and smaller deals and have cash left in the bank.

-- At the time of publication Eric Auchard did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. –

For previous columns, go to http://blogs.reuters.com/eric-auchard/

(Photo credit: REUTERS/Hyungwon Kang)

(Update: Dell PR misspoke about Johnson’s responsibilities, and we’ve made changes below as indicated.)

Dell, which announced plans to buy Perot Systems for $3.9 billion on Monday, completed the deal without help from an executive in charge of mergers and acquisitions.

It’s a touchy subject for Dell, which earlier this year named David Johnson to its executive team, poaching him from IBM where he served as head of M&A. IBM filed a lawsuit, saying that Johnson violated a non-compete agreement by taking the job with Dell. But IBM failed to persuade a judge to bar Johnson from working at Dell while the litigation is pending.

CEO Michael Dell told reporters on a conference call that Johnson was not involved in the Perot transaction “in any way,” noting that the two companies had held discussions back in 2007, while Johnson was still at IBM. “It was not a new idea,” Dell said.  But the discussions heated up again over the summer, after Johnson joined Dell.

Reuters asked Dell spokesman David Frink how Dell could negotiate a $3.9 billion deal, its biggest ever, without involvement from Johnson, its head of M&A. He said that Michael Dell and Chief Financial Officer Brian Gladden had led a group of other executives who worked on the deal.

He added: “We don’t have a head of M&A.”

When asked what Johnson does for Dell, Frink said: “We don’t spending a lot of time talking about what he is focused on”

What is his title? “Head of corporate planning and development,” Frink said.

Does that area include M&A? “Yes.”

Frink initially said Johnson’s job included M&A, but he called back later to say Johnson had no such responsibility. The M&A group reports to Chief Financial Officer Gladden, he added. There still is no head of M&A.

It beggars belief that humbled telecom equipment supplier Alcatel-Lucent could be scooped up by a Chinese rival with nothing better to do. Huawei or ZTE seem credible candidates. The question is, why would they ever bother?

That didn't stop shares of Alcatel-Lucent from rocketing up as much as 21 percent on Wednesday on rumors of an unnamed suitor. Momentum was helped by a rating upgrade on the depressed stock by French broker Natixis. The shares later settled back somewhat to trade at 2.75 euros, up 12 percent on the day in Paris.

Why would a Franco-American company that is widely considered a failed example of industry consolidation be doing the same thing over again, but with the added complexity of China in the mix?

The typical explanation for cross-border mergers involving Chinese buyers is to acquire Western branding for goods produced at lower cost in China. But didn't BenQ's 2006 acquisition of Siemens mobile handset business spell the end of that kind of easy cross-border logic?

To begin with Chinese companies seem to be having little problem making inroads with Western phone carriers on their own. Low-cost trumps national identity in purchasing decisions these days, even with former national heroes like Alcatel or Lucent.

Furthermore, cross-border mergers in the telecoms industry have a way of tripping all sorts of national security alarms. It was only 18 months ago that a far smaller deal was blocked by U.S. political opposition when Huawei tried to buy a stake in struggling network gear maker 3Com.

Only with a struggle did IBM manage to push through the sale of the IBM PC division to Lenovo three years ago. No doubt Alcatel-Lucent's government contracts dwarf those of those earlier deals. Of course, playing the security card is usually just an excuse for national chauvinists to derail a deal they don't like for local reasons.

And just to further complicate the issue, Alcatel-Lucent itself has one of the longest operating histories of any Western company in China, through a joint venture called Shanghai Bell formed in 1984, one of the earliest foreign investment ventures of the modern era. That's the context to Alcatel-Lucent saying it had signed a big contract with China Telecom to supply backbone networks across ten provinces, which no doubt contributed to the stock's rise.

More than likely, someone looking for a quick exit from the stock is spreading a useful rumor. The trick involves finding a player with deep pockets but who is unlikely to immediately deny the speculation. It works best in the thin trading of late summer markets. A few years ago, Google was somehow always the likely suitor. Chinese network equipment suppliers have to fit the bill these days, now that Google is seen as less omnivorous.

This merger speculation is more than a bit silly, given the dearth of actual deals getting done these days. The rare exceptions are Oracle-Sun, which is closing in on final regulatory approvals. And Bharti Airtel-MTN Group are looking more likely to reach a deal in coming weeks .

One London investment banker said this speculation highlights the optimism carrying stock markets along these days. I'd say the opposite. It's just another measure of the market's desperation as it runs out of ideas to rally around.

(Photo: Reuters/Kevin Zhao)

-- Eric Auchard is a Reuters columnist. The opinions expressed are his own --

By Eric Auchard

LONDON, July 22 (Reuters) - Dell Inc needs to reinvent itself to cope with falling margins for key products and a spate of mergers which are rapidly reshaping the competitive scene.

So the computer maker's moves into business services that help customers slash costs rather than add new programs look promising, given that every company under the sun is chasing this goal.

The other shift in Dell's favour is that corporate buyers look ready to start spending again on technology to generate new business, albeit at lower levels than before.

There is a brutal logic to Dell's reinvention. Personal computers are becoming low-cost commodities, yet still produce 60 percent of the company's revenue.

Dell is showing a willingness to cannibalize its existing hardware business in favour of higher-margin software and services businesses.

More than other large computer vendors, it has embraced "virtualization" technology that lets many big tasks run on the same machine rather than separate ones.

This will cost Dell no small amount of future hardware sales. But it frees it to make money from more profitable services which can lower customers' software and labour costs.

Dell's current reliance on PCs also has an upside as it leaves it best-positioned among major computer makers for a long overdue upgrade of ageing corporate PCs set to start later this year with the introduction of Microsoft's new operating system, Windows 7.

What could be the last great Windows replacement cycle will kick in during 2010 and 2011, buying Dell time to develop businesses beyond the PC.

The company says it is looking at outside acquisitions to fuel its internal growth in business services and software. Yet unlike rivals who have made big acquisition moves in the past year, Dell is steering clear of mega deal-making. Meanwhile, Oracle is buying Sun for $7 billion, while H-P paid $13 billion to acquire EDS.

Instead, Dell says it is looking at small- or medium-sized deals that allow it to attack what's broken in corporate technology. The strategy is to provide managed services from remote locations at far lower to its customers cost than traditional hardware-software systems. It has signed up 5,000 corporate clients so far, mostly in the United States and is only now expanding into other regions of the globe. It manages 2.5 million PCs via such services.

The real magic lies in what Dell doesn't do.

For Dell, consulting should be more like a training session -- brainstorming ideas and then proposing a plan of action. Strategy engagements are counted in days and weeks, not months and years. This threatens the old model of big-budget computer services contracts that were denominated in the hundreds of million of dollars per year and billions over the life of such deals.

Rather than technology differentiation, Dell believes most customers need a lot of the same things -- affordable desktops and notebooks, and mounds of raw computer capacity and data storage. Above all, customers want technology that just works.

Dell reckons it can eliminate the need for complex and expensive systems and network management software by providing it online and only when required whereas rival vendors typically use such software to lock customers into buying other products and services.

This strategy is not without risks. But by shifting its business model to one that drives down fixed corporate spending, Dell has timed its revamp to fit the new realities in which we work.

-- At the time of publication Eric Auchard did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can read some of Eric's recent columns here. --

(Editing by David Evans; Photos: Reuters/B Mathur, New Delhi, and Brendan McDermid, New York)

A good day for Apple — or a bad one? Judging from the early reaction in the stock market, investors seem to have already gotten used to the idea that Steve Jobs underwent a liver transplant two months ago,  as reported by the Wall Street Journal on Saturday. Shares of the company opened a touch higher.

One reason might be that — for most investors — certainty is also preferable to uncertainty. Know the risks and you can deal with it. And until this weekend, there was very little information on the nature of Jobs’ health problems, which began in 2004. (Apple, by the way, is not commenting on the WSJ report, other than to say that the company’s leader will return by the end of the month, as planned).

Another reason for the stock strength may be more basic: business looks pretty good. Apple said this morning that it had sold more than 1 million units of its newest iPhone in the first three days of its launch, a big number in the context of the current economy.  The device, which offers faster speeds, longer battery life and the ability to take videos, hit stores on Friday.

So it appears it could be a good day for Apple. Or another good day, we ought to say. The stock is, after all, up 63 percent so far this year.

Keep an eye on:

• Hey Wimbledon fans, IBM has a new application for you (Reuters)
• The Cannes advertising festival isn’t quite so hot this year, given the industry’s troubles (Reuters)
• You may want to sit down… media stocks are outperforming the broader stock market (NY Post)

Photo: Reuters

What do you do if your company is reported to be involved in an $8 billion acquisition and you’re already scheduled to give a big speech?

If you’re Sun CEO Jonathan Schwartz, you honor the commitment and then make a swift exit.

The pony-tailed CEO took the lectern on Wednesday at the Open Source Business Conference at San Francisco’s Palace Hotel, his first public appearance since reports surfaced last week that IBM and Sun were in acquisition talks (reports that neither company has so far commented on).

While the putative deal has produced endless column inches of analysis and speculation in the business media, it had no place in Schwartz’s remarks. Instead, Schwartz spoke about Sun’s recently-released cloud computing service, largely rehashing talking points he made in an earlier series of blog posts.

The most intriguing nugget, for those running Schwartz’s comments through the filter of an IBM deal, was his characterization of Sun’s open source operating system as the “single most valuable” part of the company, as it represents the key building block for Sun to play in high-margin, adjacent markets like networking.

When his 30 minutes were up, Schwartz slipped behind a curtain and retreated backstage, conveniently avoiding any reporters in the audience eager for ask him about the IBM deal.

And when a couple of reporters greeted him at the hotel’s exit, Schwartz proved equally aloof - the surprised CEO was good-mannered enough to shake hands, but didn’t break his stride, or his silence, to answer a question about the progress of the IBM deal. Maybe next time…

This is turning out to be an earnings season when all bets are off on how technology giants will perform. With tech earnings taking the market on a roller-coaster ride, it wouldn’t be surprising if investors are a little sick in the stomach already. 

The hits and misses so far among the biggest and brightest:

Intel: Missed expectations, profit fell 90 percent and they said they wouldn’t give a detailed quarterly forecast due to the economic uncertainty.

IBM: Beat expectations and gave an outlook above Wall Street estimates. Not only did IBM shares surge on the news, it even lifted major U.S. indexes.

Apple: Record quarterly earnings made Wall Street delirious. Can’t blame investors for feeling relief after all the worry about CEO Steve Jobs.

Microsoft: Didn’t want to hold on to the bad news until the appointed time, so the it reported earlier than expected on Thursday. Said revenue and profit would almost certainly drop over the next quarter or two. 

Google: Saved the day, kind of, by balancing Microsoft’s disappointing results with news of a quarterly profit that topped Wall Street expectations.

Google gave Jefferies & Co analyst Youssef Squali some hope that the tech sector continues to be more resilient than other sectors. “Although it depends on the severity of the recession,” Squali wrote in an e-mail yesterday. “Nobody is immune forever.”

Squali carried this ominous tone into his Friday morning research note as well, calling this earnings season a “mixed bag” and the 2009 outlook “unanimously poor.”

With Yahoo and Amazon set to report earnings next week and no guarantee what surprises might be in store there, we wonder if investors will just call in sick until next year’s earnings.

(Photo: Reuters)

Apple’s market cap edged over Google’s to hit $159 billion today (kudos to AllThingsDigital’s John Paczkowski for spotting this).

Is the maker of the iPhone, iPod and Mac worth more than the top Internet company’s $157 billion? How soon might either beat tech stalwart IBM, which is now worth $170 billion?

Mull over these stats to help you decide, courtesy of Reuters Estimates:

Forecast fiscal 2008 revenue
IBM: $109 billion, Google: $22 billion, Apple: $33 billion

Forecast FY2008 profit (excluding special items)
IBM: $12.2 billion, Google: $6.3 billion, Apple: $4.7 billion

Share price rise/fall in the year to date
IBM: +16 percent, Google: -28 percent, Apple: -9 percent

Forward price/earnings multiple
IBM: 14 times, Google: 25 times, Apple: 34 times

In case you’re wondering when any of them might catch up with the world’s largest tech company, they’ve got a ways to go yet. While Microsoft may lag Google on the Web market, the software maker’s shares are worth $255 billion.

(Photo: Eamon Sullivan of Australia (C) swims to a world record next to Pieter van den Hoogenband (R) of the Netherlands and Brent Hayden (L) of Canada in their men’s 100 meters freestyle semi-final at the National Aquatics Center during the Beijing 2008 Olympics August 13, 2008. REUTERS/Wolfgang Rattay)

Microsoft may be the behemoth monster 800-pound gorilla of software, whose Windows and Office products are nothing short of Golden Gooses. Or Geese. Or whatever.

But it’s interesting to hear how its leaders view themselves. To hear Chief Executive Steve Ballmer talk about Microsoft, you might think it is still the underdog startup it was 33 years ago when Bill Gates and Paul Allen started the company . Or the sapling it was when Ballmer joined in 1980.

People are underestimating Microsoft. Yes, we make mistakes, but we come back and learn from those things.

His comments were made during an event today to mark Gates’ stepping down from day-to-day operations.

Can you blame them? Someone once said that as we grow old, we never lose the sensibilities of our youth: the awkward nerd may always be raring to fight the big bully. Maybe that’s why Ballmer, after some 28 years at Microsoft, said this about IBM:

We went toe-to-toe with the biggest, most powerful computer company in the world and we beat them. Windows vs. OS2.

Sure enough, the David vs. Goliath story came out with the right ending. 

And they showed (again) a funny “farewell” video about Gates, the world’s third-richest man, warming up for a “fight”, with the help of buff actor Matthew McConaughey, who while steadying a heavy boxing bag for a sparring Gates, said:

“Steve Jobs! (Jab); Larry Ellison! (punch); Nice, a head shot.”

Maybe someday that little Microsoft will be a contender…

(Here is an earlier version of the video, first shown at the Consumer Electronics Show in January, without the boxing reference, from MSN)