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A Bad Deal All Around
By Monica Rivituso
INVESTORS HOPING that juicy merger talk between two computer-hardware titans might inject some life into the moribund PC sector will have to wait a little longer. Seems Hewlett-Packard's (NYSE:HWP - news) proposed $25 billion takeover of Compaq Computer (NYSE:CPQ - news) just isn't tantalizing enough — to put it mildly.
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Computer-hardware makers, which have been suffering amid slower corporate and consumer sales for the last year, have been trying to remake themselves into providers of ``total solutions'' of hardware, software and services, much in the way that IBM (NYSE:IBM - news) revamped its business into the juggernaut it is today. A merger between H-P and Compaq would create a massive company that would be the world's No. 1 seller of PCs, and the second largest in terms of overall information technology behind IBM.
But while a combined H-P and Compaq would create an $87 billion PC, server and printing behemoth, plenty of concerns surrounding this megamerger resonated throughout the market Tuesday. Hewlett and Compaq shares plummeted 18.7% and 10.3%, respectively.
The agreement, which was approved unanimously by both companies' boards, calls for Compaq shareholders to receive 0.6325 of a newly issued H-P share for each Compaq share. As of Friday, the deal was valued at $25 billion — a mere 19% premium to Compaq shareholders and a far cry below the average 41.7% premium for U.S. deals seen this year, according to Thomson Financial Securities Data. But by the end of trading on Tuesday, the deal was valued at just $21 billion after the pounding of H-P's shares, wiping out almost all of the premium.
Why the thrashing? While the merger would surely create a giant computer-hardware outfit, says Roger Kay, director of client computing at market research firm IDC, H-P and Compaq's product portfolios are too similar. Both have big presences in the consumer market — especially in the U.S. — and a similar amount of international presence, he explains. Gartner Dataquest analyst Todd Kort agrees, noting that because there's so much overlap, the main benefit to the merger would be the elimination of overhead and personnel.
As for more substantial strategic benefits from the merger, they're harder to see. Neither company is particularly strong in services or software, the higher-margin businesses that were integral in transforming Big Blue into the profitable, revenue-growing monster it's been of late. ``To me, it seems like a merger where one plus one equals about 1.5,'' says Kort. ``This doesn't really help either company all that much because they're still way behind IBM as a combined entity in terms of software and services.''
They've been roughed up in the hardware business as well, amid an industrywide slump. Both have watched revenues and profits slip. Compaq lost its title as No. 1 seller of PCs to direct-seller Dell Computer (NASDAQ:DELL - news) in the first quarter, after it posted flat growth next to Dell's 34% jump in unit shipments. H-P Chief Executive Carly Fiorina, meanwhile, has come under fire for the company's poor performance; a merger now would only create another challenge. ``You've got two companies that have not been managing their businesses very well, [that have been] losing share and [are] fighting for direction,'' says analyst Brett Miller, who covers Compaq for A.G. Edwards. ``And now you're going to put them together?''
Adding to the uncertainty: major integration risk. H-P has done little in the way of large-scale acquisitions, while Compaq's last biggie, Digital Equipment, has been deemed a disaster by industry watchers. The aim of that $9.6 billion 1998 deal in was to provide Compaq with a much-needed services strategy. But it took three long years for Compaq to announce formally that it would shift from being a hardware maker to a company that provides hardware, software and service packages to customers. That's a lot of plotting — or plodding.
Now, industry watchers expect a fair amount of indigestion to result from the H-P/Compaq deal. Consider that IBM needed five years to make the internal changes necessary to become a services-oriented organization, notes Miller. Fully integrating H-P and Compaq and realizing the expected $2.5 billion in annual cost savings will require plenty of cuts in product lines, personnel and overlapping departments like finance and marketing. IDC's Kay says he wouldn't be surprised if the headcount, which now totals more than 145,000 world-wide, were trimmed by 40,000, or 27.6%.
``Those companies will be tangled up in their underwear for something like two years, trying to straighten out what product lines and what research-and-development functions they're going to keep and merge and how they're going to do that,'' says Kay. ``Not to mention the executive shakeout as various large egos contend for a smaller number of spots.''
The two or three transitional years that H-P and Compaq are facing as they try to merge their operations will likely be tough going. And they could create a tremendous window of opportunity for Dell to gain market share, analysts say. Moreover, even after the new tech giant compresses its businesses into one, it will still be, predominantly, a hardware company. That means it remains ``dead in the sights of Dell,'' according to Gartner's Kort. Perhaps investors agree with that assertion; Dell shares were one of the bright spots in tech on Tuesday, rising 4%.
But aside from Dell, a merger of this size doesn't bode well for the overall industry, says Stephen Baker, an analyst at market research firm NPD Intelect. Eliminating redundancies in marketing and promotion will only mean less money overall will be thrown at coaxing consumers to buy new PCs. And the fact is, PCs still drive overall information-technology spending, Baker says. Any easing up on the PC promotion and marketing front could further slow computer sales, which in turn will ripple through the IT food chain to retailers, distributors, semiconductor makers and semiconductor-equipment companies.
In the end, H-P and Compaq raised more questions than spirits with this proposed merger. ``I don't have extremely high hopes for this merger,'' says Gartner's Kort. ``I think it's going to be painful. And five years from now, I think people will be questioning what it got everybody.''
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