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HP merger opponent gains support

A Prudential Securities analyst picks apart Walter Hewlett's recent arguments against the Compaq merger and agrees with some of his points. She also predicts the merger will fail.

A Wall Street analyst on Wednesday said she agrees with many points made by dissident Hewlett-Packard board member Walter Hewlett, including that HP should reconsider a spinoff of its lucrative printing and imaging businesses.

In a research note issued late Wednesday, Prudential Securities analyst Kimberly Alexy wrote that she recently met with Hewlett and agrees with some of his criticism of the proposed $22 billion acquisition of Compaq Computer. While many analysts have issued their own analysis of the merger, Alexy's report was one of the few to offer a point-by-point critique of Hewlett's opposition.

Compaq and HP announced their intentions to merge last year, but the plan has run into sharp criticism from some descendants of HP's founders. Most notably, as an HP director, Hewlett voted to pursue the merger, but he has since launched a public campaign to derail it.

After viewing a presentation by Hewlett, Alexy wrote, "We tend to agree with Hewlett's points and continue to oppose the proposed transaction." But she added, "With or without the deal, however, we believe the near-term outlook for HP remains murky."

In particular, Alexy was intrigued with Hewlett's endorsement of spinning off the printing and imaging division into a separate business--a move HP's board considered at the time it spun off its test and measurement business, now called Agilent.

"According to Hewlett, a three-way spin was viewed as overly complex at the time and the board preferred a two-step approach with a chance to reassess the...spin-off after Agilent was complete," Alexy wrote. "He feels the greater focus and accountability from separate boards and separate CEOs would be a net positive for both sides."

When HP announced the Agilent spinoff in March 1999, then-CEO Lou Platt said the company had considered spinning off the printing division but decided there was too much overlap with the PC business.

If completed, the HP-Compaq merger would be the largest in the tech industry's history, leading to massive consolidation in the PC sector and greatly altering two of the industry's oldest icons. As shareholders prepare to cast their votes next month, they are being heavily lobbied by proponents and opponents.

In her report, Alexy agreed with Hewlett's contention that HP shareholders would face a greater risk as the volatile PC business diluted the lucrative printer and imaging businesses.

She also agreed with Hewlett's analysis that the deal would dilute the value of HP's shares and that the merger would lead to a cost savings of $2.2 billion, rather than the $2.5 billion HP has projected.

On the other hand, Alexy disagreed with Hewlett's assessment that HP is paying too high a price to acquire Compaq.

"We believe (share price) to revenue is a more fair way to value Compaq, given that the earnings are severely depressed and (price per share) to earnings is somewhat irrelevant," she said. "Using the (price-to-revenue model), HP's purchase price for Compaq strikes us as fair."

A spokeswoman for Hewlett said her client still feels HP is paying a huge premium for Compaq and declined to comment on Alexy's method for valuing the deal.

Representatives from HP were not immediately available for comment.

In crunching the numbers, other analysts have different conclusions about the merits of the pending merger. Steven Milunovich, a Merrill Lynch analyst, is recommending that investors snap up HP shares on expectations the merger will go through. George Elling, an analyst with Deutsche Banc Alex Brown, also favors a merger.

"We remain of the opinion that the merger with Compaq would significantly enhance (HP's) long-term prospects," he wrote in a recent research note.

In addition to commenting on Hewlett's financial analysis, Alexy concluded the merger would be defeated by a narrow margin of 55 percent against the deal. Shareholders will cast their votes March 19.

"In an all-out marketing war, we would give HP management the upper hand. However, when it comes to substance--we favor the Hewlett argument," Alexy said. "While we still believe investors will ultimately vote down the proposed merger, we believe the HP marketing machine has been effective and we would concede that momentum is in HP management's favor."

Several other analysts said HP's stronger-than-expected earnings last week would help boost the deal's chances of approval.

Milunovich said he now thinks the merger has a "better than 50 percent chance" of being OK'd, while Bear Stearns analyst Andrew Neff noted that HP's leaders can point to two quarters of better performance to bolster its case that it can handle the merger.

"It appears that investors are being swayed by management's arguments and are concerned by the lack of alternatives," Milunovich said.