December 11, 2001 03:12
All-or-Nothing Effort Needed to Save Compaq-HP Merger, Analysts Say
By Tom Fowler, Houston Chronicle
Dec. 11--Will Compaq Computer Corp. and Hewlett-Packard Co. ditch their consumer PC businesses in an effort to appease investors?
Or will the tech giants stick to Plan A and push toward what many say is a doubtful shareholder vote in February?
Whatever the tactic, it will take an all-or-nothing effort for the companies to sell their merger plans to Wall Street, analysts say, or executives will be looking for new jobs and Compaq will be back in the same leaky boat it started the year in.
The news Friday that one of the biggest HP shareholders, the David and Lucile Packard Foundation, plans to vote against the merger was seen by many as a deathblow to the deal.
The influential foundation's 10 percent stake in the company, combined with the 6 percent stake represented by other dissenting family investors, means at least 60 percent of all remaining voters need to be swayed to back a deal that has had few supporters.
While the $25 billion merger can still be salvaged, the margin of error has narrowed.
"They've just lost the first three games of the World Series," said George Elling, an analyst at Deutsche Banc Alex. Brown and one of Wall Street's few supporters of the deal. "They can still win, but they've got to play incredible ball."
Even the home crowd appears to be turning against the deal, with HP employees said to be buying full-page ads in national papers to encourage directors to cancel the deal.
The performance of the two companies' stock Monday seemed to indicate investors agreed with the pending ads, with shares of Compaq closing down $1.62 to $9.70, and shares of HP down 52 cents to $23.
"If they want it to happen, they have to go on a full-court press with a large-scale political campaign," said Rob Enderle, an analyst with Giga Information Group. "Unless HP executives want new careers, and I don't think they do, they need to change their tactics."
Many expected the companies to defuse one of the biggest criticisms of the merger -- that it would make the company too reliant on the money-losing consumer PC business -- by selling off those operations or at least spinning them off.
But the plan presented to the Packard Foundation last week apparently didn't include such steps, and a Compaq spokesman said Monday the companies are sticking by the current merger plan.
"The agreement is definitive and there are not plans to change any part of the structure," spokesman Arch Currid said.
Analysts say its probably too late for a consumer PC divestiture to make a difference in the deal anyhow, but many think it's a move that will be inevitable for both companies.
Compaq and HP have a strong foothold in retail stores, with a combined 70 percent of the market in the United States. But neither has had much success making money selling PCs to consumers, particularly when pitted against the low-cost business model of Dell Computer Corp., which shuns the retail space in favor of an online sales approach.
"The sooner they wash their hands of this consumer PC business, the better," said Terry Shannon, publisher of a newsletter for Compaq users.
How the companies get out of the business isn't clear, but Charles Szalkowski, an attorney with law firm Baker Botts, said companies have a couple of options when spinning out a business unit.
For example, the unwanted assets and business can be packaged and shopped around to potential buyers looking to expand in that one area.
Or the company can create a subsidiary that takes over responsibility for those assets and businesses and issue shares in the company to its existing shareholders.
The subsidiary would have an independent management team even though the parent company would still have a large stake in it.
"The problem is, if you're going to try and sell stock in the subsidiary and convince investment bankers and analysts to follow it, you need to have a good story to tell," Szalkowski said. "If you're spinning off that business because it's not viable and you're losing money, it's not likely you'll find many interested."
Over the past two years Compaq has tried to squeeze the costs out of its consumer PC business by contracting with other manufacturers to build its computers overseas and cutting its inventory.
But with a business model that relies heavily on a network of independent resellers, cutting costs for such low-margin machines is difficult, Shannon says.
"They can make money with their Alphas, with their Himalayas and their storage equipment," Shannon said, referring to Compaq's most powerful and profitable systems. "But they can't beat Mikey Dell at his own game in the low-cost consumer space. They should just get out."
Even if the companies do decide to step away from the low-cost PC business in an effort to make the merger plan more appealing, they still have a difficult sales job ahead of them.
The next target for persuasion: Institutional Shareholder Services, the Maryland-based firm that advises hundreds of large stockholders on how to vote their shares in company issues. ISS advises a number of large HP shareholders, including Barclays Global Investors, which is the third-largest HP shareholder.
ISS is not expected to make its recommendations until at least 20 days before the vote, which is now slated for the end of February.
The companies have already been in communication with ISS informally, however, and are supplying the firm with data supporting the merger, sources said.
Andrew Whitaker, an analyst with Lehman Bros., says the deal has a 25 to 35 percent chance of passing.
"It's too early to say the deal is completely dead, because there's still a mathematical possibility," he said. "But if they can convince ISS to go their way, it could change things yet again." |
