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HP's incredible shrinking deal

The company's merger with Compaq originally was valued at $25 billion, but investors have not looked kindly upon the deal.

Shares of Hewlett-Packard continued to fall Thursday, days after Wall Street first got word of the company's plan to acquire Compaq Computer.

The merger was initially valued at $25 billion, based on the Friday closing price of HP's stock. But investors have not looked kindly upon the buyout, and HP's stock has lost nearly one-quarter of its value since Friday.

HP stock closed Wednesday at $18.12; in early trading Thursday, shares had lost another 52 cents to $17.69. At this share price, the deal is now valued under $20 billion.

Unlike some mergers, which have "collars"-- share price thresholds where one of the companies can walk away from a deal--HP's deal with Compaq is at a fixed ratio, meaning the two companies--and their share prices--are joined at the hip.

The terms of the deal call for every share of Compaq stock to be exchanged for 0.6325 of a share of HP stock.

HP and Compaq executives have hit the investment conference circuit to pitch the deal. On Wednesday, HP CEO Carly Fiorina said at an SG Cowen conference in Boston that the companies fit together well and can change the industry, two themes she had sounded when the deal was announced.

Executives from both companies have had a tough time selling the merger to miffed shareholders.

Merrill Lynch analyst Steven Fortuna summed up the consensus view on Wall Street in a research report Wednesday:

"We are puzzled (as to) why HP would acquire Compaq as well as why Compaq would sell out to HP at what is little to no premium," Fortuna said. "If we were Compaq shareholders, we would be disappointed by this proposed transaction given the combined company would have a high degree of customer and product overlap."

Fortuna added that all Compaq shareholders seem to be getting is a "bigger, but less well-managed version of the original company." He said Compaq or HP would have been better off buying a services company such as Computer Sciences or KPMG International.

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):
Wall Street also doesn't have the patience to wait and see if HP can successfully integrate Compaq. "We think it will be mid-2003 at the earliest before investors gain a strong sense of how well the integration is or is not proceeding," said Rebecca Runkle, an analyst at Morgan Stanley.

And HP's competition also seems just as puzzled about the deal. Sun Microsystems president Ed Zander had plenty of one-liners about the HP deal. Speaking at the Salomon Smith Barney technology conference in New York Wednesday, Zander started off his presentation with, "So what is this Hewlett-CompaqArd?"

Zander, like other HP rivals, argued that his company will be able to pick up market share while HP is mired in integration muck. "When I'm sick I try to take medicine," Zander said. "They put two sick companies together and I don't see the medicine. Tech mergers just haven't worked."

Meta Group says that integrating these two competitors will require two to three years of painful restructuring.

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Meanwhile, Moody's Investors Service downgraded HP's long-term debt, saying that the merger created a "weakening financial outlook" and posed "incremental operational risks" as the two businesses pursue their integration.

Moody's lowered HP's long-term debt to A2 from Aa3 and said it would place some of Compaq's debt under review.

The company also is concerned that "integration efforts during the planned 6- to 9-month approval process will lead to further operational turmoil, potential customer disruption, and...will also provide an opportunity for competitors to gain business from each of HP and Compaq customer bases."

That's been a key criticism of the deal by analysts. In particular, industry watchers expect companies such as Dell Computer and Sun Microsystems to profit from the distraction that the merger will cause.