Investors and pundits alike were ecstatic following news last month that Computer Sciences Corporation (NYSE: CSC) was merging with recent spinoff Hewlett-Packard Enterprise (NYSE:HPE). As of the close of trading on June 7, Computer Sciences stock was up 45% since the news broke on May 24, and HP Enterprise shares had jumped 18%.
Those are impressive stock price pops, but that's not even the best part for shareholders. An initial spike in share price is to be expected given the merger news; momentum investors love stories like the Computer Sciences-HP Enterprise combination. But rather than pull back after the initial euphoria, both stocks have not only retained their respective gains, but they continue to add value with each passing day.
Which raises the questions: Are Computer Sciences' and HP Enterprise's stock jumps sustainable? If so, is it too late to enjoy the ride? Thankfully for investors, the answers are yes and no, respectively.
Just the facts
According to the news release from Computer Sciences on May 24, the combined companies will generate approximately $26 billion in revenue following the merger, which is expected to close in March of next year. That total revenue estimate may prove overly conservative given that Computer Sciences generated $7.1 billion in its last fiscal year, and HP Enterprise sales climbed 1% last quarter to a whopping $12.7 billion.
The current shareholders of each IT services provider will end up owning approximately 50% of the combined company (50% for each). Interestingly, given the differences in size as measured by market capitalization -- Computer Sciences is valued at $7.2 billion following its meteoric stock price jump, and HP Enterprise weighs in at $33.8 billion -- the new company will be led by Mike Lawrie, who is Computer Sciences' current CEO. HP Enterprise CEO Meg Whitman will join the new company's board of directors.
The synergies of the combined IT services behemoths are expected to save an estimated $1 billion post-closing in the first year and climb to a $1.5 billion run rate after the first year. It's too early to make a formal announcement, of course, but don't be surprised to hear of some significant layoffs following completion of the deal. One bearish analyst suggested the paring of jobs could be as high as 65,000.
One of the keys to the success of the combined companies is that it will instantly become one of the world's leading IT services firms in the exploding cloud, big data, and security markets. By virtually every estimate, software-as-a-service, platform-as-a-service, and infrastructure-as-a-service solutions will each become $100 billion markets in the coming years.
Cloud service revenue alone is expected to generate $127 billion in two years, and managed services will reach $256 billion. Leapfrogging to the top of the pack in markets with nearly unlimited potential warrants investors' enthusiasm for the Computer Sciences-HP Enterprise deal.
If the merger appears especially kind to Computer Sciences, it's because it is, certainly if last quarter is any indication. While HP Enterprise announced its solid fiscal 2016 Q2 in which revenue edged up, earnings per share came in on the high side of expectations, and the company authorized another $3 billion for its stock repurchase plan, Computer Sciences reported another rather dismal quarter.
Computer Sciences' two primary divisions, global business services and global infrastructure services, declined 4% and 6.9%, respectively, last quarter. Computer Sciences surely needed a shot in the arm, and the pending merger with HP Enterprise has done the trick.
Recognizing the combined entity will become an IT services leader in some of the fastest-growing markets on the planet nearly overnight, investors shouldn't be concerned that Wall Street's bullishness means the ride is over. That said, it will be March of next year before the deal is done, and several months after that -- at the minimum -- before the synergies are recognized and the assimilation complete, so a good deal of patience is a necessity.