July 30, 2002 5:30 PM PDT

IBM grabs consulting giant for $3.5 billion

IBM, the biggest provider of services to help companies install and run computer systems, has agreed to buy PricewaterhouseCoopers' consulting arm for an estimated $3.5 billion, the companies said Tuesday.

The transaction is subject to regulatory approvals, but both companies' boards have approved the measure. The deal is expected to close in the third quarter.

The acquisition by IBM, which already has huge presence in the consulting market, will likely affect other companies such as Sun Microsystems, Dell Computer, Hewlett-Packard and EDS that have sought to beef up their own services, said Illuminata analyst Jonathan Eunice.

"It takes a very available bachelor out of the mating game," Eunice said. "PwC Consulting was clearly on the block and being shopped around."

HP in 2000 tried to buy PwC Consulting for about $18 billion, but later dropped the bid, saying the price was too high.

HP got a second crack two weeks ago when PwC Consulting approached HP, but this time HP wasn't interested.

"We declined the same opportunity just a couple weeks ago," said Juergen Rottler, vice president of marketing, strategy and alliances for HP's services unit.

Rottler said HP prefers partnering with many consulting firms rather than buying one. Although HP had originally talked to PwC, Rottler said the company is now in a stronger position after its Compaq acquisition. In addition, acquiring one consulting company would shut off deals with others, he said.

"As we studied our options, it was always clear to us the best option was to be acquired by IBM," PwC Consulting Chief Executive Greg Brenneman said in a conference call with financial analysts.

IBM Global Services had $35 billion in revenue in 2001, but the acquisition will bolster an area of comparative weakness, planning and installing high-end software for corporate accounting, dealing with customers, and managing corporate supplies, said Forrester Research senior analyst Christine Ferrusi Ross.

IBM will pay for the acquisition with $2.7 billion in cash from reserves and current cash flow, supplemented with a $400 million convertible note and $400 million in stock, said IBM Chief Financial Officer John Joyce in the conference call. The charge for the acquisition will lead to a decrease of 30 cents per share, or possibly somewhat less, in the fourth quarter, Joyce said.

IBM

"The timing of this acquisition is excellent," Joyce said. "The market has set a good value on this acquisition."

The acquisition will boost IBM earnings by the fourth quarter of 2003, IBM said, but that increase likely will be about offset by a decrease in the first half of 2003, Joyce said.

As a result of the deal, PwC Consulting no longer will pursue an earlier planned initial public offering, the companies said. PwC Consulting has 30,000 employees and expected revenue of $4.9 billion for its fiscal 2002, which ended June 30.

As an incentive to keep PwC Consulting employees from leaving, the deal offers them stock options greater than what they could have owned through the IPO.

Under the acquisition terms, PwC Consulting will become a part of IBM Global Service's Business Innovation Services unit. Ginni Rometty, currently general manager of IBM Global Services in the Americas, will lead the new unit.

Brenneman will work to hand off his company to IBM, he said, and "after that I'm going to go back to my private equity firm."

Stable services revenue
IBM has been hurt by the recession and reduced spending on information technology, but its Global Services unit has helped reduce the pain by providing somewhat stable revenue. Customers often sign long-term contracts under which IBM supports or even runs clients' computing operations for recurring fees.

"IBM is strong in a down economy. It can weather the storm so much better than anyone else, so it is obviously shopping for value," Eunice said.

IBM Global Services has about 150,000 employees and operations in 160 countries.

Consulting companies help companies install complex high-end servers and software and integrate new systems with existing systems. Often a company will cultivate a certain area of expertise, such as installing SAP's accounting and business software, for example.

But spending on services such as consulting has been under pressure, Forrester's Ross said. "The services market as a whole is still in difficult shape right now," she said.

Consulting engagements have dropped in scale and price, she said, to an average of $250,000 and three months, she said. As a result, there often is incentive to push toward selling outsourcing--running its clients' computing operations for them--which can provide longer-term, more stable revenue.

Ross said IBM will face this balancing act as it integrates PwC: "If you're an IBM salesperson, are you going to sell outsourcing or are you going to sell a consulting deal?"

The PwC Consulting revenue will drop because of the expected end of partnerships the company had with IBM competitors such as Sun Microsystems and HP.

"We would like to continue to do consulting and systems integration work for our competitors, though we think the likelihood of that is slim," Joyce said.

Financial auditing companies such as PwC often have had separate consulting divisions, but there is growing concern that auditors would overlook clients' problems to avoid jeopardizing lucrative consulting contracts.

IBM's purchase of PwC Consulting "will unleash the consulting unit from the regulatory restraints of our industry, and will allow the business to reach its full potential," PwC Chief Executive Samuel DiPiazza said in a statement.

"We think we will begin to see immediate improvement in our revenues with the customers who were currently audit clients of PwC," Joyce said.

IBM rivals such as Sun and HP have increasingly focused on partnerships with consulting companies.

The acquisition strengthens IBM's services while diminishing the likelihood that other consulting firms will choose to use IBM's hardware and software, said Gartner analyst Linda Cohen. That's an argument Sun CEO Scott McNealy makes frequently when defending his company's general reluctance to enter the services business but instead rely on partnerships with consulting firms.

IBM Services competitors will argue to prospective clients that PwC Consulting services will use IBM technology regardless of whether it's the best, Cohen said, but that argument likely won't carry much water these days. "Business buyers don't seem to care," she said.

IBM, not surprisingly, agrees, believing customers don't want partnerships, they want a one-stop shop.

"They've got to partner for services that we can provide end-to-end," Rometty said in an interview.

As part of its separation from the accounting firm, PwC Consulting had planned to rename itself "Monday" when it finished its split from PwC. The name drew criticism from analysts, who noted the unfavorable connection the day has with many in the working world.

Oil and water
IBM's acquisition of PwC Consulting also reflects the growing reluctance of consulting and accounting firms to keep both disciplines under the same corporate umbrella. After the acquisition, PwC will retain only its auditing, tax and legal services, in addition to some smaller "business advisory" services.

Although corporate whistleblowers have long been wary when one company provides both consulting and auditing services, the issue of auditor independence heated up in wake of the bankruptcies and scandals at Enron, Adelphia, WorldCom and Global Crossing.

At Enron, for example, consulting giant Arthur Andersen received $37 million for its auditing services and another $57 million for consulting. Critics said Andersen auditors were reluctant to cast a negative light on a company that provided so much income to Andersen's consulting side. Andersen has already been found guilty of obstructing an SEC investigation of its work at Enron.

The Securities and Exchange Commission is investigating the bundled consulting and auditing services at numerous firms, including Arthur Andersen, Deloitte & Touche, KPMG and Ernst & Young. President Bush also signed into law Tuesday a sweeping "corporate responsibility" reform package, including a provision that requires financial auditors to be independent. The law specifically restricts quantity and nature of consulting services that an accounting firm may sell to audit clients.

But Sehra Eusufzai, a spokeswoman for PwC Consulting, said that the acquisition by IBM does not reflect the company's desire to distance itself from the widening specter of corporate scandals.

"We've been trying to separate management and IT consulting from audit for two-and-a-half years now," Eusufzai said late Tuesday afternoon. "We announced our intention to file for an IPO in January and we were committed to that, but in the end we figured this deal was the best one for our clients and our employees."

In recent years, PwC, Andersen, Deloitte & Touche and KPMG have evolved into major players in the IT services business. These companies derive about 29 percent of their total revenue, or roughly $4 billion, from information-technology consulting and management, according to Prakesh Parthasarathy, an analyst at investment bank Montgomery Securities.

News.com's Ian Fried and Rachel Konrad contributed to this report.

 

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