HP to acquire Compaq for $25 billion

Hewlett-Packard plans to buy Compaq Computer in a stock swap worth about $25 billion, creating a technology company second in revenue only to IBM.

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
7 min read
Hewlett-Packard will acquire Compaq Computer in a stock swap worth about $25 billion, the companies announced late Monday.

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):
As earlier reported, the deal, one of the largest in technology history, would merge two of the biggest names in computers, printers and computer servers, and would have total revenue only slightly less than that of IBM, the largest computer company.

Carleton "Carly" Fiorina, the chairman and chief executive of HP, will become the new company's chairman and CEO, while Compaq Chairman and CEO Michael Capellas will become president of the new entity. Capellas and four other Compaq board members will join HP's board.

The companies touted the complementary aspects of the union--on both the organizational and the product fronts--and predicted a shake-up for the industry.

"We think, obviously, it makes us a more effective competitor and a more effective partner, and for those who don't believe us, watch," Fiorina said in a press conference Tuesday.

In Fiorina's estimation, the company that should be watching over its shoulder most vigilantly is IBM. In a letter e-mailed to HP's employees and filed with the Securities and Exchange Commission among the merger documents, she wrote: "And, for the first time in a very long time, IBM will have a competitor that's strong enough, bold enough, and talented enough to take them head-on in the enterprise space."

The deal was approved unanimously by both companies' boards of directors. Compaq shareholders will receive 0.6325 of newly issued HP shares for each share of Compaq. HP shareholders will own 64 percent and Compaq shareholders will own 36 percent of the combined company.

The combined entity, which will take the Hewlett-Packard name, will be based in Palo Alto, Calif., HP's hometown, and retain a "significant presence" in Houston, where Compaq is headquartered.

The combined company will have operations in more than 160 countries, employ more than 145,000 workers, and have annual revenue of $87.4 billion, HP said.

Layoffs are planned. The two companies said they expect to let go at least 15,000 people as part of the merger.

The companies expect the acquisition to generate significant "cost synergies" annually. The deal should save them $390 million in fiscal 2002, with that figure growing to $2 billion in fiscal 2003. HP and Compaq expect to see "synergies" of $2.4 billion by fiscal 2004, with about three-quarters of that figure coming from layoffs and the remainder coming from logistical improvements.

But while the merger will save money, top-line growth is unlikely. Revenue will likely decline by less than 5 percent in the next two years, said HP Chief Financial Officer Robert Wayman.

"It's not our intention to lose momentum, but it's possible there will be revenue loss," Fiorina said at the press conference. "We're being realistic."

Analysts suggested that the deal would be closely scrutinized by regulators, including the Justice Department.

PC powerhouse
Carly Fiorina photo • HP is acquiring Compaq Computer in a stock swap valued around $25 billion, one of the largest deals in technology history. Compaq shareholders will receive 0.6325 shares of newly issued HP stock for each share of Compaq stock. HP shareholders will own about 64 percent and Compaq shareholders will own 36 percent of the combined company.

• HP Chairman and Chief Executive Carleton "Carly" Fiorina will be CEO of the combined company, to be called HP. The combined entity will be headquarted in HP's hometown of Palo Alto, Calif., with "significant presence" in Houston, where Compaq is headquarted.

• The combined company will have expected annual revenue of $87.4 billion based on the past year's results. It will have operations in more than 160 countries and more than 145,000 employees.

• The companies estimate that cost savings will reach $2.5 billion annually. Analysts predict that layoffs will result from the buyout.

No deal killers
The deal is subject to regulatory approval. But Rich Gray, a Silicon Valley-based antitrust attorney, said he didn't see any serious threat to the merger.

"If there is a soft spot, it's at the high end with the Tandem (servers)," he said. "If I were the government, I'd be talking to customers in the financial and airline sectors about how they see this acquisition."

Gray predicted that in the worst-case scenario, HP might have to spin off some portion of its high-end server business. "It's not a deal-killer," he said.

The combined company will be organized around four operating units: an imaging and printing group led by Vyomesh Joshi, now president of imaging and printing systems for HP; an access business led by Duane Zitzner, now president of computing systems for HP; an information-technology infrastructure business led by Peter Blackmore, currently executive vice president of sales and services for Compaq; and a services business headed by Ann Livermore, now president of HP services.

The chief financial officer of the combined company will be Robert Wayman, currently the chief financial officer of HP.

The acquisition would dwarf the last big merger between PC companies. In 1998, Compaq bought Digital Equipment for approximately $9.6 billion. Through the acquisition, Compaq hoped to graduate from being a manufacturer of PCs and low-cost servers to a full-service computer provider with high-end hardware, an international services and consulting group, and chip technology.

"If you look back at Compaq and Digital, it really wasn't until today that they were really integrated--the Digital acquisition came in at a time when Compaq was struggling," said Technology Business Research analyst Lindy Lesperance. "It's a tough market out there right now for both companies. When markets are growing and business is good, these things are a lot easier to pull off."

But Lesperance said the combination of Fiorina and Capellas could be the right one to make the merger work.

"Each of them, what they've been criticized for, what they've been praised for, certainly complements each other. Carly seems to be more somewhat focused on high-level strategy, whereas Michael Capellas is more keen on operations and getting down to the nitty-gritty," Lesperance said.

"I have a lot of faith in Michael Capellas' integration skills because of what he did with Digital," Lesperance added.

Common ground
But Ashok Kumar, an analyst at U.S. Bancorp Piper Jaffray, said HP's buyout of Compaq would be fraught with difficulty. The two companies are very much alike: Roughly one-third of HP's revenue comes from PCs, notebooks and servers, while about half of Compaq's earnings come from the same sources. Their Unix server businesses are similar.

Layoffs are to be expected, Kumar added. Both companies are being squeezed finanicially in nearly all of their markets.

Fiorina and Capellas photo "There are so many overlapping units there is no complementary benefit," he said. "The problem with HP is that they have a lot to deal with, and if they want to get Compaq, it is going to be really tough."

HP may be buying Compaq for its services business, Kumar speculated. Compaq gets 23 percent of its revenue from services, Kumar pointed out, but the revenue largely comes from basic support and maintenance. The margins for the services business come to only 14 percent.

Another issue that will likely come up is how to integrate the PC divisions. HP outsources 100 percent of its manufacturing. Compaq has been trying to move to a build-to-order manufacturing model for several years.

High-ranking executives from both HP and Compaq earlier this year said that mergers and acquisitions between PC companies were fraught with difficulty and rarely worked.

"It is hard to find a successful example of one PC company buying another," Webb McKinney, vice president of Hewlett-Packard's personal computing group, said in an April interview.

The aversion to acquisitions comes from the nature of PCs themselves. Computers made by one company are generally similar to PCs from another. By purchasing a smaller PC company, a larger company is mostly acquiring only the customer base.

"But are customers loyal? No. The reality is that you can't really buy a customer," McKinney said. "By and large, the consolidation should happen the old-fashioned way: by gaining market share."

Though their backgrounds are vastly different, Fiorina and Capellas have been on similar tracks of late. Capellas and Fiorina were both named as CEOs of their respective companies in July 1999, first Fiorina and, days later, Capellas.

Gartner analyst Andrew Butler says Hewlett-Packard and Compaq Computer have not made a convincing case for their proposed merger.

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In a vote of confidence, both executives were named to chair their respective companies' boards in September of last year.

Although Capellas and Fiorina have been working independently to revamp their respective companies to get more revenue from services amid slowing hardware sales, the two have collaborated on occasion. In May 2000, Compaq, HP and other companies announced a project to establish an e-commerce parts-procurement effort.

A slumping PC market and price pressure from Dell Computer has spurred talk of consolidation.

In January, Bear Stearns analyst Andrew Neff raised eyebrows when he issued a blunt report calling for massive consolidation. Among his recommendations was that HP should buy Compaq.

Neff also suggested Gateway should sell out to either a Japanese company or to Dell and that IBM should sell its PC business in exchange for more services business.

News.com's Jeff Pelline, Steven Musil and Joe Wilcox contributed to this report.