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The Starting Line: HP's quarter could make or break merger

Investors are inclined to shrug their shoulders at the company's fourth-quarter results, but analysts say they should take notice for two good reasons.

Hewlett-Packard will report its fiscal fourth-quarter earnings Wednesday--an otherwise routine quarterly check-up that could impact the course of its proposed mega-merger with Compaq Computer.

Consider that the company's largest shareholder will be watching the results. The David and Lucille Packard Foundation, owner of almost 12 percent of HP shares, is carefully deciding how it should lean in a vote that could make or break the merger. Analysts have also suggested that the performance of HP's printer business could indicate whether it is truly better off on its own, or paired up with Compaq.

Although shareholders might not be paying close attention to the quarterly numbers, it's worth noting that HP's previous publicly announced multibillion-dollar deal was called off when it reported fourth-quarter results. HP abandoned its bid for PricewaterhouseCoopers on Nov. 12 of last year, the same day the computer and printer maker reported lower-than-expected profits.

This time Wall Street has been shrugging its shoulders about HP's fourth-quarter report because it is largely expected to meet revenue and earnings estimates.

"It is unlikely that HP's fourth-quarter call will be a material event," said Sanford C. Bernstein analyst Toni Sacconaghi in a research note titled "Does anyone really care about the fourth quarter, even HP?"

The biggest reason for the nonchalance is that expectations have already been trimmed. "Given that expectations have come down a lot--(by) close to $1 billion in revenue--there isn't a big risk of the company missing estimates," Sacconaghi said in phone interview.

According to First Call's consensus estimates, analysts are expecting the company to report earnings of 8 cents a share on revenue of $9.87 billion. Initial earnings estimates had been as high as 17 cents a share. HP earned 41 cents per share on revenue of $13.3 billion in the fourth quarter of fiscal 2000.

ABN AMRO analyst Bill Shope also said he expects the company to report results in line with lowered estimates, and he doesn't expect management to comment much on the merger. "They'll just reiterate the fact that they're still committed to it," he said.

Analysts have also speculated that Hewlett-Packard CEO Carly Fiorina could be prevented from making forecasts about next year's results due to uncertainties in the merger situation.

However, Wall Street should pay attention to the company's results for other reasons.

Big shareholders setting opinions
Hewlett-Packard has not yet announced when shareholders will vote on the merger, but the watchful eyes of its biggest shareholder, the David and Lucille Packard Foundation, are the primary reason investors should care about the quarterly report. Some analysts have pegged the chance of the merger's success at about 50/50, making the opinions of such large shareholders critical.

The David and Lucille Packard Foundation's vote will basically make or break the deal, said some analysts.

HP's earnings report and what Fiorina may say on the company conference call will be two of the biggest variables influencing the foundation's decision, said George Vera, chief financial officer of the Packard foundation.

Vera declined to speculate about how different scenarios in the company's fourth-quarter results might affect the foundation's vote--such as how well HP's printer business fares, or whether or not the company meets estimates--but he did say the foundation is still in the "analysis phase" of its decision.

Another major element the foundation will consider in its vote is HP's proxy statement, which will provide details about the combined businesses. The proxy was expected to be filed last Friday, but is now expected on Monday.

"The merger comes down to one question: Which way does the David and Lucile Packard Foundation vote?" said Lehman Brothers analyst Dan Niles.

"Should it vote (against the merger), we estimate 65 percent to 75 percent of institutional shareholders will need to approve the deal," wrote Morgan Stanley analyst Rebecca Runkle in a research note.

That kind of approval is highly unlikely considering the history of stock gyrations since the deal's proposal, and the votes of other family members, who are also institutional shareholders.

Since Sept. 3, when HP announced that it intended to snap up rival Compaq for $25 billion, investors made their dislike for the merger obvious. After falling from the mid-twenties after the merger was first proposed, stock prices hovered in the mid-teens, rising only after certain events made the deal look less likely.

For example, HP shares rose sharply last week when the heirs of company founders William Hewlett and David Packard announced that they oppose the deal.

The Hewlett family, which controls 6.7 percent of shares, has uniformly rejected the deal. Three of William Hewlett's children, as well as the family's trust and Walter Hewlett, a member of HP's board and chairman of the William and Flora Hewlett Foundation, have all said they will vote against the deal.

Investors applauded the news, sending shares up to the $19 range after it was announced.

The merger's approval looked even less likely after David Packard's rejection. Packard spoke for himself as well as the Packard Humanities Institute, which owns about 1.3 percent of HP stock.

Printers vs. computers
The Packard Foundation likely will scrutinize the results of HP's printer business--another reason investors should pay attention to the company's fourth-quarter results.

Hewlett said acquiring Compaq would increase HP's exposure to the PC market, which is "neither growing nor profitable." He also said it would water down HP's profitable printer and imaging business.

"People will be focused on how the printer business is holding up because that is where the core value of the company is," Sacconaghi said. In many observers' eyes, the healthier its printer division, the more value a standalone HP would have.

But according to most analysts' predictions, printers won't fare much better than the company's flailing computer business.

Niles speculated business might be so bad that the company will have to lower estimates for fiscal 2002 by as much as 5 cents a share. "Given that the (printing and imaging) division is over 100 percent of the profits and over 40 percent of the revenues, this could be a larger issue than we even realize," Niles said.

ABN AMRO's Shope also predicted that the printer supplies business will be weak after last quarter's double-digit growth.

But the printer business is still marginally better than the company's computer division, which is expected to show declines in all its segments.

"Computer systems results should be tough," said Salomon Smith Barney analyst John Jones.

Jones said he expects that revenue has declined on a year-over-year basis in all sections of the company's computer business. He anticipates a decline of 8 percent for software, 16 percent for Unix, 49 percent for PC servers, 21 percent for storage and 48 percent for workstations. The PC business is by far the worst, with revenue expected to fall by 54 percent, Jones said.

Analysts have speculated that uncertainty about the merger could cut even deeper into the company's slowing PC business, but they said it will be too early to tell in the fourth-quarter report.

Uncertainty over HP's future could affect the results of another computer maker. Dell Computer, which will report its third-quarter results Thursday after market close, is expected to show some market share gain thanks to the merger situation.

In fact, HP rescheduled its fourth-quarter report from Thursday, when it was originally planned, to avoid releasing results at the same time as Dell.

"Dell is executing well in the current weak-demand environment while exploiting turmoil created by the HP-Compaq merger," said Robertson Stephens analyst Eric Rothdeutsch.

Nevertheless, analysts expect Dell to report revenue that's flat with last year's, and earnings in line with First Call's consensus estimates of 15 cents a share.

It'll be tough to make up for the weak demand in the PC sector, with or without its boost from HP's troubles.