From G-S's morning update:
Hewlett-Packard will host its semi-annual analyst meeting on Wednesday, February 27 in New York.
With HP having just reported its January quarter, we expect the bulk of investor questions to center on the pending merger and its impact on the combined company. Our thoughts are as follows:
1) WE THINK THE COMPAQ MERGER HELPS HP'S ENTERPRISE COMPUTING BUSINESS. HP's computer business continues to underperform as a result of slow IT spending and HP's unfavorable standing relative to market leaders. In the January quarter, HP's enterprise computer business lost $160M, representing operating margin of -8%. Until volumes improve and HP can fix its NT server business, we do not see a return to profitability here. Compaq gives HP a better chance at fixing its ailing computer business by reducing its losses in this area while beginning to rebuild a more competitive position. Areas that will improve with the Compaq acquisition include storage and NT servers, where Compaq is a market leader, and services, where the addition of Compaq's sizable maintenance business should at least add a large profitable annuity stream and expand HP's access to a wide variety of customers.
2) MANY EYES ARE FOCUSED ON A KEY INSTITUTIONAL OPINION OF THE MERGER. Institutional Shareholder Services (ISS) will issue its opinion on HP's pending merger with Compaq some time within the next week or so. ISS normally issues its opinions two to three weeks before the shareholder vote, with the HP vote scheduled for March 19. Under normal circumstances, this would suggest that we could get a decision as soon as today or within the next couple of days. Some, however, seem to believe that the importance of this decision may lead ISS to prolong the process. We understand that ISS has influence over roughly 20% of the outstanding shares, but we think its decision will probably serve less as a given and more as a guideline.
3) THE CONSUMER MARKET APPEARS TO BE SLOWING. HP's revenues in the last two quarters benefited from a strong consumer-selling season and channel restocking of printer supplies. Our view is that this is unlikely to continue in the April quarter given consumer-spending seasonality. Already, Circuit City has indicated that it has seen slowing in its business in January and February, with part of the reason attributed to slower consumer PC sales. We have already assumed some level of slowing in HP's consumer business with our model showing a 3% sequential decline in April quarter revenues.
4) VALUATION IS ATTRACTIVE AT CURRENT LEVELS. HP's stock is currently trading at 17.4X our calendar 2002 EPS of $1.15, less than the S&P 500's 26.4X and at close to the midpoint of its pre-bubble trading range. The deal is expected to close around the middle of CY 2002 and if the company's assumption of substantial accretion in the first full year after the merger is correct, the current First Call mean of $1.35 for HP could move up by 13% to $1.53 for the combined company, yielding a P/E of 13X. Our own EPS estimate for FY 2003 is $1.40. |
