The recommendation by ISS, an adviser to major money managers and pension funds, has long been consideredto the passage of the hotly contested $22 billion merger.
"I think the momentum is clearly moving in our favor," HP Chief Executive Carly Fiorina said Tuesday in a conference call. "We think their recommendation will be viewed as a crucial milestone by many."
ISS's decision likely means that the battle over the merger will remain heated and the outcome unclear until shareholders vote later this month. On the other hand, a "no" vote would have significantly increased the chances that the merger would have failed.
Descendants of HP's founders, who hold 18 percent of the company's shares, have already announced their opposition to the deal.
Walter Hewlett, a member of HP's board, has been one of the deal's most vocal critics. Topping his list of concerns is that HP would become too exposed to Compaq's low-margin PC business, but he has also touched on subjects such as executive pay.
The ISS report takes HP to task for attacking Hewlett personally.
"I think the momentum is clearly moving in our favor."
ISS advises money managers how to vote on proxies and other corporate governance issues. It has about 750 clients, including several large mutual-fund companies.
The ISS recommendation comes exactly two weeks before HP shareholders are scheduled to vote on the deal.
Investors who hold about 21 percent of outstanding shares have publicly said they oppose the deal. That figure includes the heirs and foundations of co-founders David Packard and William Hewlett.
Hewlett: ISS "missed the point"
Predictably, Walter Hewlett took issue with ISS's decision to support the deal.
"We strongly disagree with the ISS decision. We believe ISS has missed the point--we believe that the HP-Compaq merger will destroy stockholder value," Hewlett said in a statement. "It has been widely reported and many clients of ISS have told us they are independently evaluating the financial and strategic implications of the transaction, and we believe they will vote their HP shares against the merger based on the lack of merits of the proposed transaction."
Institutional investors holding about 5 percent of the shares have said they support the deal.
Barclays Global Advisors, one of HP's largest institutional shareholders, with more than a 3 percent stake, plans to let ISS cast its vote based on its decision. Barclays previously said it plans to defer its decision to ISS because of a potential conflict of interest. The firm's chief executive, Patricia Dunn, is an HP director.
But the remaining percentage of shareholders so far are undecided or have not declared their intentions; a sizable group could be influenced by Tuesday's decision by ISS.
Typically, about half of ISS's clients add the proxy-consulting firm's research reports to the mix of other research they have amassed before casting their own vote. In these cases, ISS has no idea how a given investor voted, said Patrick McGurn, director of corporate programs for proxy service Proxy Monitor, which is affiliated with ISS.
In the other cases, ISS plays a greater role in swaying shareholders.
Of the remaining half of ISS's clients, about 60 percent typically allow ISS to cast their ballot, with the company's recommendation serving as the default on how the client votes. Most of the other clients give ISS guidelines on certain criteria that need to be considered when determining how that investor should vote, with the client retaining the right to veto ISS's recommendation before the consulting firm casts the ballot.
Weighing the decision
In this particular merger, more clients are expected to take matters into their own hands because of the contentiousness and size of the merger, potentially the largest ever in the technology industry.
Toni Sacconaghi, an analyst at Sanford C. Bernstein, said he expects that in addition to Barclays, the index funds making up about 9 percent of HP shares will also vote along with the ISS recommendation.
Sacconaghi also noted that although ISS's opinion will carry a lot of weight, evaluating mergers is not the key strength of the company's 30 analysts, who focus largely on other issues of corporate governance.
"Should ISS rightfully have such a large impact in determining the outcome of the (HP-Compaq) merger?" he said in a research note Monday. "No, but the fact is, they do."
Compaq CEO Michael Capellas said in a statement that the ISS's recommendation was an important milestone for the merger process. "We are particularly pleased with the recommendation as ISS conducted a thoughtful, thorough study of the merger," Capellas said.
HP-Compaq merger makes sense
Patrick McGurn, vice president, ISS
"We think odds remain against the deal, however ISS decides," Wagonfeld said in a research note published Tuesday morning.
Doing it their way
Indeed, not everyone has been waiting for the ISS report. A number of shareholders already have against the deal, with more lining up against the deal than for it.
Sunil Reddy, portfolio manager of the Fifth Third Technology Fund, is an ISS client but said last week in an interview that he has already decided to vote against the deal.
"We are interested in what (ISS is) going to say," Reddy said, but he added that he did not see anything the firm could say that would change his firm's mind on the vote.
Bernstein's Sacconaghi said before ISS's announcement that a favorable endorsement of the deal would boost the odds of shareholder approval to 50-50. Sacconaghi had ranked the likelihood of approval at 35 percent before the ISS report and said the odds of the deal going through if ISS were to issue a negative take would have been just 10 percent.
Banc of America's Wagonfeld said before the ISS report that he thought the deal would be voted down regardless ISS's recommendation, estimating that HP still needs the votes of two-thirds of institutional investors to offset the families' opposition.
News.com's Stephen Shankland contributed to this report.