HP earnings enough to seal merger?

Some analysts raise an eyebrow over HP's operating profit being roughly equal to the profit from its printing business. But strong earnings may help it close the Compaq deal.

3 min read
Analysts found some sticking points in Hewlett-Packard's earnings report Wednesday but said the better-than-expected profit will likely boost the company's odds of winning shareholder approval for its merger with Compaq Computer.

Topping already raised expectations, HP on Wednesday reported stronger than expected sales and earnings, thanks in large part to strong consumer demand. However, analysts took issue with several aspects of the report, including the fact that HP's overall operating profit was roughly equal to the amount of money it made from its printing business.

"Despite the hoopla over the rebound in home PC sales, the fact remains that ink saved the day," Needham analyst Charles Wolf said in a research note Thursday. "On a net operating income basis, the profits on HP's printer business accounted for 96 percent of total company profits."

Several analysts said the strong report makes approval of the deal more likely, despite continued opposition from dissident director Walter Hewlett and other members of the Hewlett and Packard families, along with family foundations. Together, these parties represent 18 percent of HP shares.

Bear Stearns analyst Andrew Neff said that shareholders tend to support management in general and that now HP's leaders can point to two quarters of better performance to bolster its case that it can handle the merger.

Merrill Lynch analyst Steven Milunovich said he now thinks the merger has a "better than 50 percent chance" of being OK'd.

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

With all the jitters surrounding accounting issues these days, Milunovich asked HP's management on Wednesday's conference call for assurances that HP didn't "metaphorically do anything to goose the numbers."

HP CEO Carly Fiorina responded, "I will metaphorically, literally and in every other conceivable way look you in the eye and say these numbers are exactly what they appear to be: solid execution across the board in an environment that continues to be a challenge."

see special coverage: Big iron: HP to buy Compaq However, Toni Sacconaghi, an analyst at Wall Street brokerage Sanford Bernstein, noted that strong earnings from HP can be spun both ways with regard to the merger.

"On one hand, solid execution should raise confidence in (HP's) management team," Sacconaghi said in a research note. "On the other hand, HP's standalone business is doing better than many investors had expected, underscoring Walter Hewlett's and our belief that a merger with (Compaq) takes on significant risks for shareholders without significant opportunity for upside over the next 6-8 quarters."

Hewlett has argued that the deal would hurt HP's printing business while exposing the company to the risks of the PC market.

Several analysts noted that a key milestone will be an upcoming report from Institutional Shareholder Services, which advises a number of HP's large shareholders and will be the deciding factor for some.

"About 20 percent of HP's shareholder base will be influenced by ISS's recommendation," Needham analyst Charles Wolf wrote in a research note. "If (the recommendation is) yes--as we suspect--the merger should go through. If it's no, the merger is dead."

Shares of HP bounced around Thursday, trading in both positive and negative territory. In the early afternoon, HP shares were up 4 cents to $21.02.

News.com's Stephen Shankland contributed to this report.