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Deutsche Bank On Computer Sciences-HP Enterprise Merger: Top-Line Pressure Remains Despite 'Massive Synergies'

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Deutsche Bank On Computer Sciences-HP Enterprise Merger: Top-Line Pressure Remains Despite 'Massive Synergies'
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Hewlett Packard Enterprise Co (NYSE: HPE) said it would spin off its enterprise services business and merge it with Computer Sciences Corporation (NYSE: CSC), effectively creating a pure-play IT services company.

Deutsche Bank Analyst's Perspective

Analyst Bryan Keane noted that although the deal would deliver significant EPS upside from cost synergies, the top line for the new merged company is expected to remain under pressure.

Apart from the $1.2 billion of segment operating income from Hewlett Packard Services, the merger is expected to generate first-year synergies of about $1 billion post close with a run rate of about $1.5 billion by the end of year one. Kean expects pro-forma EPS of roughly $6.00 in year one and $7.60 in year two. The merger is expected to close by March 2017.

The combined new company is expected to generate about $26 billion in annual revenues serving more than 5,000 clients across 70 countries.

"However, it will still generate roughly high 50–60 percent of the revs from Infrastructure Outsourcing which continues to be under significant pressure from cloud migration (specifically AWS, Azure, and GCP) and could continue to weigh on revenue growth," Keane highlighted.

Related Link: Brean On HP Enterprise-CSC Deal: "Time To Give HP (& Meg Whitman) Credit For The Creativity"

Another Take

Meanwhile, Trip Chowdhry of Global Equities Research is bearish on the deal.

"Two bad assets does not make one good asset," Chowdhry wrote in a note, adding that the merger would result in 65,000 layoffs at the combined company.

Moreover, the analyst noted that cloud technology makes many of the services Computer Sciences and Hewlett Packard services provide obsolete, including hardware/software installation, software testing, system management, hardware/software configuration and application maintenance.

In addition, Keane noted that next-gen revenues are expected to represent only low-teens percentage of the combined company revenues (more than $3 billion).

"In other words, this deal is all about cost synergies, since revenue growth will likely be negative for the foreseeable future, in our view," Keane added.

Computer Sciences Q4, Guidance And Analyst's Final Take

Meanwhile, Computer Sciences reported fourth-quarter EPS of $0.73 topping the Street estimate of $0.68 on lower taxes, while revenues roughly came in line with consensus at $1.807 billion. If not for the deal, Computer Sciences shares would likely have fallen under pressure due to the weak fundamentals in the quarter.

Related Link: Hewlett Packard Enterprises CEO: A Donald Trump Presidency Won't Be Good For Business

Computer Sciences guided to low-double-digits' constant currency revenue growth in FY17 and EPS of $2.75–$3.00 including the acquisitions of UXC and Xchanging, which are expected to drive cost synergies in second half of fiscal 2017.

Keane, who has a Hold rating on Computer Sciences' stock, maintains FY17 and FY18 EPS estimates of $2.98 and $3.45. Keane also raised the price target to $48 from $34.

Stocks On The Move

Shares of Computer Sciences climbed 34.14 percent to $47.82 and touched a new 52-week high of $48.18. Hewlett Packard shares also rose 9.60 percent to $17.81 and went as high as $18.50, just below its 52-week high of $18.55.

Latest Ratings for CSC

DateFirmActionFromTo
Mar 2017Pacific CrestInitiates Coverage OnSector Weight
Oct 2016CitigroupUpgradesNeutralBuy
Oct 2016BarclaysMaintainsOverweight

View More Analyst Ratings for CSC
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