Demise of H-P-Compaq Deal May Have Been Exaggerated
By SCOTT THURM and PUI-WING TAM
Staff Reporters of THE WALL STREET JOURNAL
WSJ - HEARD ON THE STREET
A month ago, Hewlett-Packard's proposed acquisition of Compaq Computer was widely considered dead. Shares of both companies dropped sharply after the deal was announced in September. Then board member Walter Hewlett, son of the company's co-founder, started a proxy fight to kill the $25 billion deal. By early December, members of the Hewlett and Packard families controlling 18% of H-P shares had pledged their opposition.
But rumors of the deal's demise may turn out to be greatly exaggerated. H-P still faces an uphill fight in its bid to swallow Compaq, but its chances have improved significantly. A few big shareholders have endorsed the deal. The merger is expected to get approval from the European Commission Thursday, clearing an important regulatory hurdle, according to people familiar with the situation. Compaq's financial situation appears to be improving. H-P shareholders who don't like the deal are selling shares, reducing their clout. And those who continue to hold H-P shares increasingly are focusing on how the company's outlook would be muddled if the deal is defeated.
"While I don't really like this deal, I dislike it less than I did," says Steve Salopek, a fund manager at Banc One Investment Advisors, Columbus, Ohio, which owns shares of both H-P and Compaq.
GOOD DEAL? Join the discussion: Was Carly Fiorina's decision to acquire Compaq a smart move? How should shareholders vote?
Mr. Salopek met separately in recent weeks with H-P Chief Executive Carly Fiorina and Mr. Hewlett. He won't say which way he'll vote the firm's H-P shares, which totaled 5.6 million as of Sept. 30 -- 0.3% of H- P's shares outstanding. But Mr. Salopek says he is troubled that Mr. Hewlett "doesn't really say what the alternatives are. At least with a merger, there is the benefit of some synergies and cost-cutting."
The deal's improved prospects can best be measured in the narrowing spread between the value of Compaq shares and their implied value if the deal is completed. After Mr. Hewlett announced his opposition to the deal in November, Compaq shares traded at as much as a 37% discount to their implied value. Today, the spread is 14%.
As the spread narrows, arbitragers, who had largely shied away from the deal, are testing the waters, which could further narrow the spread. Most arbs buy the stock of a proposed target and sell short the stock of an acquirer. Arbs making this bet hope the two prices will converge, netting them big profits. "The perception has changed quite a bit that this may not be a lost cause," says a representative of a prominent arbitrage firm, who asks not to be named.
H-P, for one, is feeling encouraged. "I think we're making great progress," says Bob Wayman, H-P's chief financial officer, who has recently visited institutional shareholders on the East Coast and in the Midwest to garner support. "We continue to leave meetings feeling very good." On Tuesday, for example, Mr. Wayman said he had seven shareholder meetings and about half of those "indicated support" for the deal.
The deal is still far from a sure thing. To overcome the families' opposition, H-P needs the backing of 61% of other shareholders. Mr. Hewlett continues to hammer at the deal's shortcomings. In a Securities and Exchange Commission filing Thursday, Mr. Hewlett sharpened his criticism of past technology mergers, including Compaq's difficult 1998 acquisition of Digital Equipment.
"Walter Hewlett continues to meet with stockholders and feels his arguments are resonating with them," a spokesman for Mr. Hewlett said Thursday. "He believes he is gaining support in his efforts to stop the transaction."
Merrill Lynch analyst Steve Milunovich, who endorsed the deal on Monday, still thinks it has only a 30% chance of being completed. But Mr. Milunovich thinks those odds have improved in recent weeks. "There is a perception that time is on H-P's side," he says.
For one, the deal has begun to attract support from big H-P shareholders, such as Alliance Capital Management Holding. Compaq Chief Executive Michael Capellas last week said he believes Putnam Investment Management will back the deal. Putnam is Compaq's biggest shareholder, and H-P's sixth biggest, excluding the family foundations. Putnam declined to comment.
Shareholders, money managers and analysts cite five other reasons for the deal's improved outlook:
• Regulatory approval. European antitrust regulators are expected to approve the deal today, and U.S. officials at the Federal Trade Commission are also expected to approve the transaction shortly. The deal wasn't viewed as facing big antitrust problems, but merely crossing the hurdle removes one element of doubt.
• Deal opponents selling shares. Many H-P shareholders who don't like the deal are selling, rather than holding shares to vote against the deal. Three shareholders that are skeptical of the deal, including Safeco Asset Management and Victory Capital Management, say they have sold shares in recent months. "Institutional investors have a habit of voting with their feet," says Bob Rezzaee, a portfolio manager for Montgomery Asset Management, which holds Compaq shares but not H- P shares.
All told, more than one billion shares of H-P stock have changed hands since the deal was announced Sept. 4, roughly half the two billion H-P shares outstanding. While many of those shares have circulated more than once, sales by opponents could tip the balance in a close vote. "It's pointless for a shareholder to buy the stock and vote against the deal," says one fund manager who has been actively selling H-P shares.
• Concern about H-P's fate if the deal fails. The shortcomings of the deal, from the perspective of H-P shareholders, were apparent immediately, namely more reliance on the ruthless PC business, and diluting its strong printer business. But as the debate drags on, big shareholders are focusing on what it would mean for the deal to fail. Ms. Fiorina probably would depart, as might several board members. In the ensuing uncertainty, it could be six months or a year before a new management team crafts its own strategy. In recent weeks, H-P has been hammering at Mr. Hewlett for not offering an alternative, and that attack appears to be resonating with investors.
Lawrence Babin, a portfolio manager at Victory Capital in Cleveland, sees "many, many months of uncertainty" if the deal fails. So Mr. Babin, who is skeptical of the deal's promised benefits, has been selling some of Victory's 6.6 million H-P shares. "It seemed like a lose-lose situation," he says. An analyst at another big H-P shareholder, who has misgivings about the deal, says his firm and others may end up voting for it, "because if we vote against it ... we're going to have a year a half of upheaval at H-P," he says.
• Compaq's improved outlook. Compaq last week told analysts to increase the PC maker's financial targets for the year, based on an expected rebound in computer sales in the fall, and continuing cost-cutting at the Houston-based company. The rosier forecast includes some caveats, but many analysts and fund managers think Compaq is narrowing the gap in operating performance with industry leader Dell Computer.
"There's now a lot more confidence in Compaq," says Vinnie Muscolino, a fund manager at David L. Babson Funds, which owned 578,000 shares of H-P and 326,000 of Compaq as of Sept. 30. A onetime skeptic, Mr. Muscolino says Compaq's improved outlook makes him more supportive of the deal. "It's very encouraging."
• H-P shareholders voting with an eye on their Compaq investment. Almost 80% of H-P's institutional shareholders also own shares of Compaq, according to Sanford C. Bernstein & Co. Some analysts think these holders may be more willing to vote for the deal at H-P because they fear a drop in the value of Compaq shares if the deal fails.
Bernstein analyst Toni Sacconaghi plays down that factor, saying that only about 10% of these institutions own a bigger stake in Compaq than they do in H-P. But Mr. Muscolino, for one, acknowledges that his Compaq holdings could have a bearing on his H-P vote.
Write to Scott Thurm at scott.thurm@wsj.com and Pui-Wing Tam at pui-wing.tam@wsj.com
Updated January 31, 2002 12:01 a.m. EST |
