Wall Street: HP plus Compaq may not add up

Early in the day, investors rallied around Compaq, but by the market's close, the company's stock had sagged $1.27, or 10 percent, to $11.08 on heavy trading. HP dropped throughout the day to close at $18.87, down $4.34, a loss of 18 percent.

The stock movement by and large jibed with analysts' takes on the deal.

Although the merger is supposed to begin adding to the bottom line by 2003, there will be "immense execution issues that will only be addressed over a multiyear period," said Goldman Sachs analyst Laura Conigliaro.

Added Merrill Lynch analyst Thomas Kraemer: "The jury is still out on this one. They have two years of no growth and then a massive integration."

The idea behind the deal is that combining the two tech giants will put them in a powerhouse position in almost all facets of the computer market, allowing them to ride out shrinking sales and an economic slowdown. The companies are hoping that combining their market shares will help them flatten competitors such as Dell Computer, which has surged to the top of the PC market.

And while companies such as Gateway could feel pressure from a new giant in the PC market, Dell may actually benefit from the merger. Dell "is well-positioned to leverage its business model with 7 percent operating margins versus below breakeven for both (HP's) and (Compaq's) PC divisions," said U.S. Bancorp Piper Jaffray analyst Ashok Kumar.

And Bear Stearns analyst Andrew Neff, who upgraded Dell to "buy" from "attractive" Tuesday, pointed out that Dell, the No. 1 player in the PC market, will have a year in which the No. 2 and No. 4 players are distracted with integration issues.

Dell was up 93 cents, or 4 percent, to $22.31 when the market closed, while Gateway dropped a nickel to $8.92. The CNET PC Hardware index was off just under 2 percent.

The problems posed by Dell have not been about who is bigger, but which company is better run and has a more profitable business model, wrote Goldman Sachs analyst Joe Moore. "Both companies have already tried to replicate the direct model, but the disparity in profitability between Dell's model and its competitors is still exceptionally high," he said.

And the deal does nothing to address other problems that have plagued the two companies over the past few years, including HP's "underinvestment in technology in the mid-1990s and its lack of focus, and Compaq's execution challenges and cost disadvantages (relative to Dell), which led to losses in market share and the bottom line for both," Neff wrote in a research note.

Although the deal looks good "on paper," Neff said, the two companies will still be left with the problems that put them in trouble before the announcement of the merger. He added that "it is unclear to us at this point how one plus one will equal more than two, if that much."

Indeed, while the merger is expected to save the two companies money--up to $2.4 billion in "synergies" by fiscal 2004--revenue is expected to slip by less than 5 percent in the next two years, said HP Chief Financial Officer Robert Wayman.

Neff also foresees problems integrating the companies, pointing out that HP does not have experience handling a big merger. Compaq has undertaken a big deal before--its 1998 acquisition of Digital Equipment. That merger "had difficult integration issues," he wrote.

"I understand why Compaq is doing it, but I don't understand why HP is doing it. HP had trouble managing itself, and the key is execution with the integration," Neff said.

Forrester Research analyst Charles Rutstein agreed it would take a lot of work to bring the two companies together. "We're talking a couple of quarters to clear the deal," he said. "Then, we're talking about probably at least six quarters of massive confusion internally, trying to figure out which moving parts are moving where."