HP, Compaq Form Pact

Hewlett-Packard says it will merge with Compaq Computer in a stock swap deal worth about $25 billion. The boards of both companies approved the union Monday night.

by Michael Singer and Thor Olavsrud of internetnews.com [September 5, 2001]

The combined company will have the top worldwide revenue positions in servers, access devices like portable computers and hand-helds, and imaging and printing, as well as huge revenue positions in IT services, storage, and management software. Only IBM is reported to have a slightly larger share of the market.

The merged company will be headquartered in Palo Alto but retain a significant presence in Houston.

Carly Fiorina, HP chairman and chief executive officer, will act as Chairman and CEO of the combined companies. Michael Capellas, Compaq chairman and chief executive officer , will act as President. Capellas and four other members of Compaq's current Board of Directors will join HP's Board as soon as stockholders approve of the financial terms and the Securities and Exchange Commission approves the deal.

"At a particularly challenging time for the IT industry, this combination vaults us into a leadership role with customers and partners—together we will shape the industry for years to come," says Fiorina.

The new HP will be structured around four operating units that build on the companies' similar market and product development structures:

• A $20 billion Imaging & Printing franchise to be led by Vyomesh Joshi, currently President, Imaging and Printing Systems, of HP.
• A $29 billion Access Devices business to be led by Duane Zitzner, currently President, Computing Systems, of HP.
• A $23 billion IT Infrastructure business, encompassing servers, storage and software, to be led by Peter Blackmore, currently Executive Vice President, Sales and Services, of Compaq.
• A $15 billion Services business with approximately 65,000 employees in consulting, support and outsourcing to be led by Ann Livermore, currently President, HP Services

The deal is expected to heat up the competition in the sagging computer hardware sector especially for the likes Dell and Sun Microsystems, which have also suffered from recent sluggish sales.

Detailing the deal
According to the terms of the deal, one Compaq share will be substituted for about 0.63 Hewlett-Packard shares, providing a premium of around 18 percent.

HP says the merger is expected to generate cost synergies reaching approximately $2.5 billion annually. Based on both companies' last four reported fiscal quarters, the new HP would have approximate pro forma assets of $56.4 billion, annual revenues of $87.4 billion and annual operating earnings of $3.9 billion. It would also have operations in more than 160 countries and more than 145,000 employees.

At the close of trading on Friday, shares of Palo Alto, California-based HP were lower by 19 cents, to $23.21 per share. Houston-based Compaq's stock closed on the downside as well at $12.35, 34 cents less than on Thursday.

Mixed reaction
Both HP and Compaq stock prices slid slightly in mid-day trading Tuesday as the market took stock of the companies' plans to merge. But while HP found its stock down 12.5 percent at noon and Compaq stock was down 2.4 percent, while Dell surged ahead 6.8 percent.

Analysts appear to be cautious about the $25 billion merger, which will create the world's largest PC manufacturer with revenues of $87.4 billion. According to Gartner Dataquest, Compaq is currently the second largest PC manufacturer while HP is fourth. In worldwide server sales, Compaq takes the top slot and HP is fourth.

But the companies contend that the merger will give them an edge in competing with rivals like IBM and Sun Microsystems for business computers, analysts are questioning whether a combined company under the Hewlett-Packard moniker will be able to overcome differing business models, brand confusion and a sluggish market for PCs.

Dell bears out
While those questions linger, analysts also appear to feel that Dell, which would be unseated as top dog in the worldwide PC market by the combined company, would benefit from industry consolidation.

"Given the uncertainties and integration issues surrounding the merger of Compaq and HWP, we think that Dell benefits from this consolidation," said Andrew Neff, an analyst with Bear Stearns, in a research note. Bear Stearns upgraded Dell from "attractive" to "buy" on news of the planned HP-Compaq merger. "We see it in a superior position to emerge a winner from the ongoing price war and consolidation with its cost leadership and a direct model."

He added that Dell is "positioned to benefit from industry consolidation and could see its market share gains accelerate as Hewlett and Compaq work to integrate operations and brands."

Meanwhile, HP and Compaq Tuesday projected cost savings of $2.5 billion by mid-fiscal 2004, resulting from the elimination of overlaps and redundancies. Part of that savings will be in the form of 15,000 jobs, which the two companies expect to shed within a year or two of the merger's completion. HP also said it expects the merger to give earnings a 20 percent boost by 2003.

Euro regulators
However, before that can happen, regulators are likely to put their fingers in the pie. The European Union's competition watchdog, the European Commission—which already shot down a proposed merger between American industrial giants GE and Honeywell earlier this year—said Tuesday that it plans to investigate the merger.

London-based consulting company Frost & Sullivan argues that the merger should be seen as necessary, but dangerous.

The necessity for this deal lies in the analysis of the dynamics of the PC market. In 2001, the total PC market has contracted for the first time. Dell took advantage of these deteriorating market conditions to launch a price war based on their manufacturing efficiency. Compaq and HP's inability to compete on price with Dell, has left them both suffering significant falls in their market share.

Andrew Ball, Frost & Sullivan research analyst at, says big has always been perceived as beautiful in the PC market.

"The dominant manufacturer is in the position to drive downwards the costs of their suppliers," Ball notes "Thus, HP and Compaq found themselves facing a vicious circle. Market share loss contributes to difficulty obtaining the best deal with suppliers. The resulting pressure on prices, in turn, leads to further market share loss. The merger between the two companies is the only way to escape this quagmire."

Ball says the danger in this deal is the result of two faultlines.

"First of all, the difficulty of achieving the integration between the two companies needs to be hurdled," Ball added."The second faultline is that it leaves the new HP still dependent on a PC market whose current key trends are pricing pressure and a decline in unit sales."

Best case: The merger is tough, but economies of scale and synergies in R&D, procurement, marketing and administrative spending pay off and lead to better margins within two years. Dell cannot sustain their price war against the new HP, and is marginalised in niche US markets. The new HP emerges as the leader in hardware and uses the margin of safety that it enjoys in hardware to manage its shift into higher value services.

Worst Case: The merger is never finalised as a result of a clash of cultures between the two companies and differing production models. The new company has to cut more staff than expected to stay afloat, sending staff morale plummeting. The share price tumbles and investors demand radical action lowering staff morale still further. Dell, disciplined and solitary, cleans up in the PC space and IBM continues to lead in high-value IT. The new HP ends up in the purgatory of a half-finished merger when confidence and funding finally run out. Their hardware business collapses and competitors buy up the chunks that remain.

Should the deal overcome antitrust hurdles, the two companies expect to close the merger in the first half of 2002.

—End