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HP, Compaq face challenges
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September 4, 2001: 3:02 p.m. ET
Computer makers to join in stock swap, Fiorina to be company's CEO
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NEW YORK (CNNfn) - Hewlett-Packard Co.'s proposed plan to buy rival Compaq Computer Corp. would create a much more formidable competitor in the struggling information technology industry, but the deal still faces regulatory hurdles as well as the daunting prospect of integrating the tech titans' vast operations.
Aiming to bolster their competitive positions in a sagging market, the two companies agreed Monday to join forces in a $25 billion merger.
"It makes us a more effective competitor, and an even more effective partner," Carly Fiorina, HP's CEO, told a news conference in New York Tuesday. "If you don't believe it, watch."
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 HP's Carly Fiorina and Compaq's Michael Capellas speak with CNNfn's Lou Dobbs on the $25B merger. |
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Under the terms of a deal, HP (HWP: down $4.33 to $18.88, Research, Estimates) has agreed to acquire all of Compaq's (CPQ: down $1.30 to $11.05, Research, Estimates) outstanding shares through a stock swap, creating a new company that would have sales of $87.4 billion and earnings of about $3.9 billion.
The deal, which the companies expect to be completed in the first half of 2002, will put the new company second behind IBM (IBM: up $1.50 to $101.45, Research, Estimates) in the computer hardware business worldwide. It also would move the combined company, which would retain the HP name, ahead of Dell Computer (DELL: up $0.82 to $22.20, Research, Estimates) as the leading supplier of personal computers -- a position Dell took from Compaq earlier this year.
Fiorina -- who has faced a lot of criticism recently amid plummeting sales and profits -- will be CEO of the newly formed company. Michael Capellas, Compaq's CEO, will be president and chief operating officer.
Executives from both companies -- which compete in areas such as PCs, servers and storage systems as well as handheld computers -- said that by joining forces they will be able to better compete against rivals. Those rivals include Dell in the PC market as well as IBM and Sun Microsystems (SUNW: down $0.35 to $11.10, Research, Estimates) in the server and storage products market.
Many computer hardware makers have been sharpening their focus on servers and storage systems, which are more profitable business lines with more potential for growth.
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Carly Fiorina will lead the combined company. | |
The combined company also will have a stronger technology consulting and services business, another more-profitable business line on which high-tech companies have concentrated recently. IBM has made exceptional strides in this area. During the second quarter, Big Blue reported that its services business had overtaken its hardware business in terms of total revenue.
Merrill Lynch analyst Tom Kraemer said Tuesday that the merger could do a lot to improve both companies' ability to compete. But he noted that it will face some challenges, both in getting approval from regulators as well as in integrating their operations should it receive such approval.
"This move makes HP look much more like IBM and, in our opinion, makes strategic sense," Kraemer told clients in a research note Tuesday.
"Both HP and Compaq have been pursuing several common strategies: Becoming more services-centric, Wintel in the enterprise, storage as a technology growth engine, and moving to an overall solution sell," Kraemer said. "There will obviously be regulatory and enormous execution hurdles, but, with the addition of Compaq, HP should be better positioned to move forward on every one of these fronts."
Kraemer said IBM has proven that the "services/solution" approach to the high-tech market can build shareholder value. Now HP has to prove that it can integrate a huge company quickly enough so as to not lose significant share or focus, he said.
GE-Honeywell snag sparks regulatory concerns
As for the regulatory approval, some market observers said Tuesday their main concerns were in Europe. Earlier this year, the European Commission squashed another high-profile merger of U.S.-based companies when it rejected the combination of General Electric (GE: up $0.12 to $41.10, Research, Estimates) and Honeywell (HON: down $0.26 to $37.00, Research, Estimates), citing antitrust concerns.
Fiorina on Tuesday said there are fundamental differences between the two proposed deals and the competitive environments in which the companies operate. (757K WAV) or (757K AIFF)
Fiorina said the companies are expecting a six-to-nine month review by antitrust regulators and she does not anticipate problems getting approval. "We have looked very carefully at antitrust aspects of this," she said. "We're comfortable we can reach an agreement in this kind of time frame."
The companies said the merger ultimately will save $2.5 billion a year, with about three-quarters of those savings coming from staff cuts. Executives said that the merger will lead to the elimination of about 15,000 jobs. Those cuts come on top of about 15,000 job cuts the two companies have separately announced this year. The combined entity will have about 145,000 employees worldwide.
HP Chief Financial Officer Robert Wayman, who will continue to hold this title after the merger, said the deal will hurt earnings slightly in the first quarter after it's completed, and then add to profit per share thereafter. He and Fiorina said they expect revenue to slip less than 5 percent in both 2002 and 2003 as the company initially focuses on integrating the two companies and cutting product lines.
"It is not our intention to lose momentum in (the) marketplace," Fiorina said of the projected drop in revenue. "But in keeping our desire to be realistic ... we have modeled it in."
Compaq, one of the fabled success stories of the tech sector, grew from a sketch on the back of a placemat in a Houston restaurant to become the youngest company to reach the Fortune 500.
HP, created in 1939 to make network testing equipment called oscilloscopes, is considered the original Silicon Valley company, and the Palo Alto garage where it was formed is now a national monument.
The new HP will hold the No. 1 positions in servers, PCs, handheld computers, and imaging and printing systems.
It will have four key operating divisions: a $20 billion imaging and printing franchise; a $29 billion access devices business, comprising PCs and handheld computers; a $23 billion information technology Infrastructure business, encompassing servers, storage and software; and a $15 billion services business with approximately 65,000 employees in consulting, support and outsourcing.
Of all their business lines, PCs have proven to be the heaviest drag on revenue and earnings amid slack demand, especially among consumers, and increased pricing pressure.
Click here for CNNfn.com's special report: Scrambling for PC sales
Fiorina said Tuesday that HP had even considered getting out of the PC business before deciding to do the deal with Compaq. "It doesn't make sense to get out of that business," she said. "It's an important part of the solutions bundle. But don't think we didn't look at it (getting out of PC sales) carefully. We did."
Under the deal, Compaq shareholders will get 0.6325 of a newly issued HP share for each Compaq share, valuing the deal at about $25 billion, the companies said. That equates to about a 19 percent premium for Compaq shareholders based on Friday's closing prices of the two stocks.
Shares of Compaq rose in early trading but fell after noon. HP shares dropped more than 14 percent. Both stocks are off more than 60 percent from their 52-week highs.
Tuesday's deal could help spark further price cuts for consumers, and make the personal computer sector even more competitive, according to analysts.
Click here for a look a look at computer and peripheral stocks.
"It's definitely the end of the PC market as an expanding industry," said David Buik of the Cantor Index. "I suspect other companies will be looking at similar mergers."
HP stockholders will own about 64 percent of the new company while Compaq holders will own the rest. The combined company will continue to be called Hewlett-Packard.
The merger arose out of discussions between the two companies about the licensing agreements between the two, said Compaq's Capellas.
"We started thinking about licensing of intellectual property, and boom, it (the discussion) got bigger," Capellas said. "It just started snowballing, building momentum. It just made logical strategic sense." 
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