Shrewd Move, Big Blue

Buying PwC Consulting gives it a full range of services

Since taking IBM's (IBM ) helm on Mar. 1, CEO Samuel J. Palmisano has spent most of his time pruning the tech giant's overgrown garden. IBM sold its money-losing hard-drive business and, in the second quarter, took a $2.1 billion charge to get rid of aging technologies and unproductive workers in slowing businesses. Now, it seems, Palmisano has stowed his clippers and begun planting seeds. In its biggest acquisition since buying Lotus Development Corp. in 1995, IBM announced a deal on July 30 to purchase PricewaterhouseCoopers' tech consulting affiliate for $3.5 billion in cash and stock.

A bold move--and one that prompted largely favorable reaction among industry watchers. It's easy to see why. The acquisition meshes nicely with Big Blue's decade-long transition from hardware maker to services giant. Already, services are Big Blue's prime source of profits, providing 47% of its $10.95 billion in pretax profits last year. By buying PwC Consulting, IBM will bring under one roof a full package of services ranging from high-end tech consulting to low-end support. That will give it extra traction and heft against rivals such as Accenture Ltd. and Hewlett-Packard Co. in a $350 billion global services market growing at 10% annually.

It's good for PwC, too. Although an initial public offering was planned, PwC Consulting CEO Greg Brenneman says it would have been unlikely to bring in more than $2.5 billion, given current market conditions. And amid the crackdown on accounting practices, the services arm was losing clients fast because half of them also used PwC auditors. That helps explain why the deal was negotiated in 10 days and why Brenneman says its partners are ecstatic about it. "They're very excited," he says. "There was not a single objection."

To be sure, there are major risks. The IT services market is scraping along the bottom right now amid weak demand, and the acquisition will almost certainly hurt in the short term. IBM Chief Financial Officer John Joyce says the buy will slash earnings in the fourth quarter by about 22% and continue to hurt profits in the first half of the year. If demand doesn't pick up as expected next year, Palmisano's big gamble might not look so boffo. It just so happens that the area in which PwC specializes--high-end consulting and software installations--is the weakest link of the tech services market because few companies can afford such luxuries these days. Says Merrill Lynch & Co. tech analyst Steven Milunovich: "There's a risk that consulting doesn't come back as quickly."

Yet it seems that Palmisano has struck at an auspicious moment. IBM is getting PwC Consulting for a song, considering that nearly two years ago HP mulled paying $18 billion before abandoning the acquisition.

Moreover, with the weak economy, IBM should have little trouble keeping its 30,000 new employees. To sweeten the pot, PwC partners will get stock options priced near IBM's 52-week low, part of a retention pool that Brenneman values at up to $700 million.

Most important, the acquisition brings IBM hundreds of big new customers and the high-margin consulting skills it had lacked. At the same time, PwC's experience in such areas as financial services, government, and consumer products will provide IBM needed expertise to help companies use technology to solve more business problems. For example, IBM now will be better equipped to help its clients roll out software that lets them manage their sales, marketing, and financial operations. For PwC customers, the IBM hookup means they will get access to IBM's famed research labs, its outsourcing unit, and giant financing arm.

Like Microsoft Corp. and Dell Computer Corp., IBM is using the downturn and its financial muscle to squeeze rivals. Its Global Services unit is already the world's largest, with about 10% of the market. The deal could help the company grab an extra 1% to 2% share. Much depends on a strong recovery in the tech services market. Otherwise, Palmisano will have to grab his clippers again.

By Spencer E. Ante, with Nanette Byrnes in New York

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