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PC sales channels key to HP-Compaq deal

The merger between the computer makers is expected to get stiff regulatory review, with European regulators taking an especially close look at PC distribution, say legal specialists.

The merger between Hewlett-Packard and Compaq Computer is expected to go through stiff regulatory review, with regulators taking an especially close look at PC distribution, say legal specialists.

If there are stumbling blocks, they could be the new entity's near lock on PC distribution in Europe and the possibility that the merger might prompt consolidation among suppliers, distributors and dealers in the United States.

On Thursday, the American Antitrust Insitute raised concerns that the proposed merger would "lessen competition in a number of ways" and called on the government to intervene. Among other things, AAI contends that both companies are responding to a short-term sales slump by taking drastic measures that would weaken competition.

"From a national perspective, a permanent loss of competition is not an appropriate solution for what appears to be a temporary economic problem," AAI said.

The two companies must convince the Justice Department or the Federal Trade Commission in the United States, as well as the European Union's Competition Commission, that the merger is justified and poses no anticompetitive threat.

Europe is likely to be more skeptical of the merger, but observers in the legal community say that, with modifications, the deal stands a good chance of getting the go-ahead on both sides of the Atlantic.

"My early inclination is that we'll see approval in some form, but it's hard to know without seeing the hard numbers," said Andy Gavil, an antitrust professor with the Howard University School of Law who sees no immediate, serious challenges to the merger. "Every sector they compete in is a very competitive sector."

But he cautioned: "That conclusion is based on what little we know now."

Big mergers and anticompetition cases of the recent past may provide only limited insight into the review of the present proposal. The FTC, which handled Compaq's 1998 acquisition of Digital Equipment, cleared that deal fairly easily, as did the European Commission. But the $9.6 billion merger was nowhere near as complex as the approximately $20 billion HP-Compaq deal, as the two companies overlap in more markets.

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Barry Reingold, an anti-trust and technology attorney at Perkins Coie, discusses whether the marriage of HP and Compaq will be held up by anti-trust regulation. (2:23)  
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That overlap will be important to regulators as they examine the new entity's potential to compete unfairly or to fix prices, either on its own or in collusion with competitors.

Outside the high-tech sector, European regulators earlier this year surprised General Electric and Honeywell by blocking their proposed $43 billion merger, which had been approved in the United States.

Microsoft, meanwhile, continues to be the focus of long-running antitrust examinations, though no merger was involved. A U.S. appeals court has upheld eight separate antitrust violations against the software maker, while the European Union is expanding its investigation of the company.

Spokeswomen for the European Commission and the Justice Department declined to comment on the proposed HP-Compaq merger. The FTC could not be reached.

A 30-day deadline
How quickly the approval process moves forward depends on a number of factors. Regulators in Europe and the United States initially have 30 days after receiving notice from the companies to approve the merger or initiate further investigation. In Europe, such action could add as much as four months to the approval process.

The U.S. review will not begin until the Justice Department and FTC decide which agency would take ownership. Although both agencies could choose to conduct a review, typically only one would.

The reviewing agency could go beyond the one-month period in evaluating the merger, according to Jonathan Baker, an antitrust professor at American University's Washington College of Law.

"On a small fraction of the transactions, one or the other or both agencies may want to take a more serious look," he explained. "If that happens, they stop the clock and issue what is called a ?second request??--essentially, a subpoena for additional information.

In the case of Compaq and Digital, the FTC made a second request. The European Commission did not expand its investigation.

In a merger the size of an HP-Compaq union, "a second request would be plausible," Baker added. Gavil agreed. "I think it's safe to expect a second request," he said.

HP and Compaq then would provide additional information to the reviewing agency, which after receiving it would have another 30 days to decide whether to bring a court case, Baker said. "If they don't do it within that time, or the time isn't extended by the agreement of the parties, then the merger can go forward."

U.S. regulators have a five-point merger guideline to use in evaluating the deal. Four of the points apply to HP-Compaq: market concentration, which involves market share and market definition; competition, or potential anticompetitive effect; efficiencies, pertaining to whether the new entity is more efficient than the old ones; and ease of entry, or how the new entity affects how easy it is for competitors to get into the particular business or segments.

AAI pointed out that while regulators' merger guidelines do not address this problem, the 1950 amendment to the Clayton Act prohibits mergers that may "lessen competition."

Rich Gray, a Silicon Valley-based antitrust attorney, said that one trouble area could come from Compaq's high-end Himalaya servers, which are widely used in the financial sector and airline industry.

Dealing with dealers
In Europe, the main issue is likely to be the new HP's potential to dominate PC distribution. The majority of PCs there are sold through indirect channels, where HP and Compaq lead the pack.

"There is something like 40,000 resellers throughout Europe of one size or another," said Context analyst Jeremy Davies. "With the vast majority of these resellers--both in volume and value--HP and Compaq are either the No.1 or No. 2 supplier to the vast majority of these. So the channel is key in Europe, unlike the U.S."

Context estimates that a combined HP-Compaq would have a lock on well above 50 percent of PC distribution in Europe.

"That's a big number, and the Competition Commission are bound to be looking at that," Davies said.

Given that predominance, European regulators could conclude that HP-Compaq would have the power to fix prices. "This is something they obviously would be concerned about," Gavil said.

On the other hand, HP-Compaq could argue that combining two separate companies with strong presences actually could open up competition. Competitors may see exactly that situation, Davies said.

"The signs we're getting (are that) the excitement this merger has generated by the competition--Fujitsu Siemens, Toshiba, IBM, Dell--is palatable," he said. "All of the guys with a channel presence are saying, ?Yes, this is an opportunity for us.?"

U.S. regulators would not likely see distribution as a problem, even though the new company would have strong presence in its homeland, Gavil said. "It doesn't look like you could make a convincing econometrics study that, together, either of them would raise prices or collude with an IBM or Dell. If anything, it's a real dog-eat-dog world and a very competitive market."

In the United States, about 60 percent of PCs are sold through dealers and retailers, with a large part of the remainder coming directly from the manufacturers, such as Dell Computer or Gateway, according to NPD Intelect.

Although the new company, according NPD Intelect, would command nearly 45 percent of all computer products sold through distribution--peripherals as well as PCs and servers--the new entity would not likely be able to fix or control pricing.

"The fact the direct side is growing faster than the store side is enough to say you can do a merger," said NPD Intelect analyst Stephen Baker.

But AAI raised concerns that because of the merger "the remaining firms in the industry will for strategic reasons seek merger partners to offset the combined HP/Compaq's new power with retailers and suppliers. If there is likelihood that this gigantic merger event will trigger a rapid consolidation of the industry, then the government should intervene."

NPD's Baker acknowledged that widespread consolidation would likely follow the merger, particularly among distributors and suppliers. "As the major customers for components get bigger, that means the guys behind them in the supply chain are going to have to get bigger," he said. "When somebody gets really big, everybody else has to find a way to deal with that size and scale."