Compaq Proposal: Pros and Cons

(1) Do you support Fiorina’s proposal to acquire Compaq? What are the pros and cons? Will you the merger with Compaq bring HP closer to Dell, or IBM?

Assuming that the merged new HP can overcome some issues, we would support Fiorina’s proposal to acquire Compaq because the following benefits would outweigh the negatives.

Pros

• The merger would create a full-service technology company capable of doing everything from selling PCs and printer to setting up complex networks in entire categories.
• PCs: The merger would improve the economics and innovation of their PC business to compete with industry leader Dell.
• Server and Storage: As a result of the acquisition, their combined server and storage product lines would give new HP a significant boost due to fully covered product categories and technologies to compete with IBM.
• IT service: The combined firm would have 65,000 IT architects operating in 160 countries. The new HP would be leading position in both mission-critical service and multivendor support.
• Financial Benefit: The merged firm could eliminate redundant product groups and cost in marketing, advertising, and shipping. According to the plan, the merger would generate $2.5bn in annual cost savings by mid-2004.

Cons

• HP’s business portfolio will be worse due to increasing exposure to an unprofitable PC business.
• here are many overlapping units that have no complementary benefit.
• HP’s management has no experience with huge merger.
• The merged balance sheet would be worse than that of a stand-alone HP.

The acquisition would make a firm with total revenue only slightly less than that of IBM. The merged firm would become a stronger competitor for IBM in the server market, and Dell in the PCs business. In conclusion, the new HP would be in a position to compete with IBM and Dell across its entire product line.

(2) Why was the board so divided on this issue? What grade would you give HP’s board in the way they handle this complicated strategic issue?

The main reason that the board was so divided on this issue is the conflicts in the interests between the management and shareholders of HP.

For the management team, as mentioned in question 1, CEO Fiorina was hired to execute an “e- service” strategy which could help HP to meld the independent businesses into a powerful and profitable whole. But the performance of the business turned out to be frustrating. The sales growth kept declining and the share price trailed substantially especially in year 2001 when the states met with big recession and 911 attack. The management team must take some actions to turn the situation around. In this case, merger with Compaq became crucial for HP to reverse the tide.

But on the other hand, the shareholders of HP led by Walter Hewlett, the director, oppose to this acquisition. They considered the merger would destroy shareholders benefits. “From the date the proposed merger was announced, Hewlett-Packard stockholders have lost $7.0 billion relative to an index of comparable companies.[1]” Also, the dramatic reduction in the earnings forecast for Compaq since the announcement means that HP stockholders are getting too little of the merged company relative to HP’s contribution to earnings. Furthermore, when compared to a stand-alone HP, the combined firm represents a lower credit rating with greater equity risk and a higher cost of capital.

In this case, considering the big conflicts between the board members on this merger, we would grade C to HP’s board in the way they handled this complicated strategic issue.

(3) Why did Walter Hewlett vote for the deal in the board room, and vote against it as an inventor?

Walter Hewlett had not choice and had to do like this.

As an investor, he believed that the merger would destroy the share holder value. He believed that 1) the merger would dilute HP shareholders’ interest in the profitable printing and imaging business and increase their exposure to an unprofitable PC business and therefore the HP business portfolio would be worse; 2) the integration risk was rather substantial; 3) There would be negative and 4) There won’t be a significant improve of the company position. He personally opposes this transaction and had voiced his opinion for many times.

Despite Walter’s opposition, the CEO insisted to pursue the deal. Actually, if Walter vote against in the board room, the agreement could not be signed without renegotiation, which might result in HP’s having to pay a higher price. Since the merger would be approved even without his vote and he felt that it was his duty to negotiate the lowest possible price. He was forced to vote for the deal in the board room.

That is why Walter Hewlett voted for the deal in the board room, and voted against it as an investor

(4) What is your assessment of the role played by third parties – consultants, investment bankers, analysts, and institutional investors – in this deal?

The third parties played significant roles in this deal by either advising for or against it. There are the following third parties:

• Consultants (McKinsey and Accenture) who evaluated strategy and operations due diligence of H-P and Compaq, respectively. Without positive findings from these consultants, the merger process might not have happened.
• Investment banks (Goldman Sachs and Salomon) who advised merger for H-P and Compaq, respectively. The investment banks provided financial aspects such as exchange ratios. With the financial analyses, both boards were able to approve the merger.

Other investment advisors were hired (Laurence Hoagland, FFL, Booz-Allen) to independently evaluated merger for Hewlett Foundations, the Trust, Packard Foundation. The findings from these advisors were used to fight against the mergers.

• Institution investors in the end played critical roles in determination of the merger. Strongly opposed the merger, Hewlett lined up several important institution investors (the Trust, Foundations, Packard families etc) to fight the merger. By going public to announce his opposition and the analyses from investment banks, he had significantly impacted the investors. Although the merger was approved by 51.4% of votes, the marginal approval votes showed the deeply divided institution investors on the merger.
• A key third party was ISS – without favorable evaluation from ISS, the merger would be highly likely to fail.
• Analysts’ opinions also affected investors. Again, analysts were divided on the merger, with some analysts were in favor of the deal, others were not.

(5) In Exhibit 6, Goldman Sachs performed a contribution analysis and listed some implied exchange ratios. What are the pros and cons of this approach in determining the exchange ratio in a stock-for-stock deal? What about the historical exchange ratio analysis in Exhibit 7?

The approach followed is a standard industry practice where the following are excluded:

1. gains/losses from synergies
2. acquisition accounting such as reconciling GAAP, IFRS standards
3. financing adjustments such as tax or debt servicing benefits

Hence, the contribution analysis provides a useful side-by-side comparison of each company’s contribution to various line items on the combined business’ income statement. Also, it helps in obtaining a range of exchange ratios that ultimately help in finalising the appropriate exchange ratio during the actual merger deal offered to the stockholders.

However, since the approach doesn’t factor the premium paid to the stockholders of the acquired company and misses the expenses accrued due to merger process, there is a danger of mis-valuation. Appropriate adjustments need to be done in the final value to reflect the same. Moreover, forecasted revenues post-merger are subject to the realisation of the assumptions in the valuation model used.

Exhibit 7 shows that the historical implied exchange ratio is closest to 0.6325 when 3-month high data is considered. The table also shows that a premium is being paid in the range of 10-18% over and above the fair price as indicated by the implied exchange ratios.

(6) Large technology mergers had a history of failure. What are the common risks in large technology deal?

Common risks:

• Frequent changes of the industry

  The technology industry is highly competitive and marked by frequent product introductions, continuous improvement in product performance characteristics, and fierce competition. The companies should quickly tailor their product and service offerings to satisfy the new taste of customers, so that to operate profitably. However, merger deals often take a very long time to prepare until being finally completed. It would result in inappropriate strategy to beat the target when deals are done.

• Changes in business portfolio

  According to the article, “most botched tech mergers involved companies trying to buy their way into new business they knew little about.” Marketplace is changing, with the increasingly changes in divergent products demand. The large tech mergers would possibly fail to maintain the profitable strength and establish as good brand image as before in new acquired areas. Also, too much time and cost are spent on acquisition would inevitably delay the research for new emerged product, which leaves chances for rivals to compete for customers.

• Cultural conflicts

  Differences in culture between two large tech mergers are also responsible for the failure. After the acquisition, each of the two firms may prefer the “old way” of working style and operating strategies. This would lead to the conflicts and negative effect in implementing plans and actions.

• Intellectual loss

  Intellectuals are the biggest assets in technology companies. Product research and innovations are heavily relied on the personnel. High turnover rate of employee, which is resulted from the unsatisfied working environment and unfair payroll, would also be the risk for merger failure.

Bibliography

• Professor Cong Wang (2010), “FIN6170A Mergers & Acquisitions”, The Chinese University of Hong Kong, MBA course material
• The New York Times, “Hewlett-Packard in Deal to Buy Compaq for $25 Billion in Stock (http://www.nytimes.com/2001/09/04/business/hewlett-packard-in-deal-to-buy-compaq-for-25-billion-in-stock.html?pagewanted=1)”, September 2001
• CNET news, “HP to buy Compaq for $25 billion (http://news.cnet.com/2100-1001-272519.html)”, September 2001
• E-Commerce Times, “Analysts Applaud HP-Compaq Merger (http://www.ecommercetimes.com/story/18917.html)”, August 2002
• Channel Web, “Walter Hewlett: The Consequences of the HP-Compaq Merger (http://www.crn.com/it-channel/18827986;jsessionid=0JJA0XBMKGC13QE1GHRSKH4ATMY32JVN)”, March 2002