Hewlett family opposes Compaq deal

Analysts and investors are one thing, but now the family of Hewlett-Packard's co-founder is knocking the proposed merger.

Michael Kanellos Staff Writer, CNET News.com
Michael Kanellos is editor at large at CNET News.com, where he covers hardware, research and development, start-ups and the tech industry overseas.
Michael Kanellos
6 min read
Descendents of Hewlett-Packard co-founder William Hewlett said Tuesday that they plan to oppose the company's blockbuster merger with Compaq Computer.

See special coverage: A Fight to the Finish Three of William Hewlett's children--Walter Hewlett, Eleanor Hewlett Gimon and Mary Hewlett Jaffe--as well as the family's trust said in a statement that they will vote against the deal if it is brought to a shareholder vote. Walter Hewlett, a member of HP's board as well as chairman of the William and Flora Hewlett Foundation, said the foundation has also reached a preliminary conclusion to vote its Hewlett-Packard shares against the merger.

"After careful deliberation, consultation with my financial adviser, and consideration of developments since the announcement of the merger, I have decided to vote against the transaction," Walter Hewlett said in a statement. "I believe that Hewlett-Packard can create greater value for stockholders as a stand-alone company than as a company combined with Compaq."

The Trust, the Hewlett Foundation and the family members together own more than 100 million shares of Hewlett-Packard stock, representing about 5 percent of HP's shares.

The Hewlett family's announcement is the latest and most high-profile criticism of the deal, although a number of investors and analysts have also panned the merger. Last month, Matrix Asset Advisors, which owns stock in both companies, sent a letter to directors of both companies urging them to abort the merger.

Although Matrix has stated its opposition, other shareholders have offered either grudging or outright support for the deal. Before Tuesday's announcement from the Hewlett family, most analysts had forecast that the deal would go through despite opposition.

The move comes as a slap to HP CEO Carly Fiorina and Compaq CEO Michael Capellas, who have been travelling the country in an effort to win support from investors and analysts.

Shares of both companies have plummeted since the deal was announced in September. Originally valued at $25 billion, the deal's price has shrunk as HP shares have lost value.

HP stock watch
HP and Compaq announced a stock-swap deal worth $25 billion. Because of fluctuations in the stock, the value of the deal may change. This is the approximate value (20-minute delay):
News of the opposition cheered investors, who have been critical of the merger since it was announced. After drifting along at about $17 per share, HP stock jumped about 15 percent immediately after the foundation's announcement reached traders Tuesday. Compaq shares, however, declined 49 cents to $8.50.

The foundation's concerns added to the growing sentiment that the deal will not be completed.

Under the agreement, Compaq shareholders would receive 0.63 shares of the combined company. With HP shares now trading at $19.70, Compaq shares should be trading closer to $12.41, nearly 50 percent above their current price. The disparity in the share prices indicates that investors are skeptical the deal will go through.

HP said it will press on with the merger effort. "While we regret very much the Hewlett family's decision, we are not surprised," the company said in a statement. "The HP board of directors and HP and Compaq remain fully committed to the merger and expect shareholder approval."

A source familiar with the matter said HP and Walter Hewlett had been in talks since the merger was announced, but it became clear in recent days that the company was not going to gain the Hewlett family's support.

A Compaq representative declined to comment on the Hewlett family's action but said that the company remains committed to the merger. "The fundamentals of the deal remain unchanged," he said.

Hewlett lists objections
Walter Hewlett, who originally voted in favor of the merger as an HP director, offered a laundry list of reasons for his opposition to the deal. Hewlett said acquiring Compaq would significantly increase HP's exposure to the PC market, which he said is "neither growing nor profitable." The merger also would substantially dilute HP's current shareholders' interest in the company's profitable printer and imaging business, Hewlett said, and increase HP's exposure in the lower-end server business, which he said is less profitable for HP than the higher-end segment of that business.

Additionally, Hewlett said that "Compaq's services business, which is more focused on support than outsourcing and consulting, is not the type of services business that Hewlett-Packard should be seeking to grow." He added that the merger is distracting to HP's management and is causing uncertainty that could prompt customers to shift business to other computer makers.

Finally, he pointed to the problems of integrating the two companies, as well as to a declining outlook for Compaq's business since the deal was announced. He said these issues make it even less likely that HP would enjoy any benefits from the merger.

The Hewlett family's contention that the merger would plunge HP deeper into the PC market is borne out by Compaq's financial results. Approximately 42 percent of Compaq's $7.5 billion in revenue in the third quarter came from its PC group, and a substantial portion of revenue from its so-called Enterprise group came from selling Intel-based servers, which are subject to the same sort of price pressures as PCs. Furthermore, a large portion of the revenue from Compaq's services group comes from providing PC support to corporations.

Last quarter, only the services group turned a profit for Compaq.

Currently, HP and Compaq executives are putting together a plan for integrating the two companies, assuming the deal goes through. Sources close to HP have said that one of the ideas HP is contemplating is how to exit, or at least downplay, the consumer PC market.

An even harder sell
Analysts said the family's opposition will make it much harder for the company to promote the plan.

Merrill Lynch analyst Tom Kraemer noted that the Hewlett family, along with the family of co-founder David Packard, control a significant block of HP's stock, though far from a majority. Merrill pegged the Packard stake at 10 percent, but added that when and if a shareholder vote does occur, it requires a majority of the shares voted to make or break a deal, and no all shareholders will vote.

"Given this, if the Hewletts and the Packards voted together, their shares combined could be a larger percentage of the shares actually voting," Kraemer said in a research note published after the Hewlett announcement. "If this size of a block votes against the merger, it could make it substantially more difficult for the merger to go through."

A representative of the David and Lucile Packard Foundation was not immediately available for comment.

By itself, the Hewlett family's move "is (not) enough to kill the deal," said ABN AMRO analyst Bill Shope, "but it should start to raise some more questions (among) shareholders and management...about how good a deal this is. Analysts and now the family are questioning it."

"This deal didn't make much sense to begin with," Shope added. "This is just going to make it a lot more difficult to pull off."

Should either computer maker pull out of the deal, the company could be on the hook for a $675 million breakup fee, according to a regulatory filing made in September.

Shope also said the lack of family support made the companies look bad. "I would have imagined it would have been important to have family support for this deal" before it was announced, he said.

The Hewlett family's opposition could create momentum for other major shareholders to come out against the deal, noted Ashok Kumar, an analyst with US Bancorp Piper Jaffray.

"If they fall on the side of the Hewlett family, it would be highly unlikely that the merger would go through," he said, adding that the merger does not help HP overcome its chief problem of being concentrated in too many diverse, low-margin businesses.

News.com's Margaret Kane contributed to this report.