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Answer. In 2001, although HP was the second largest computer company (behind IBM), it
was struggling under difficult economic conditions as its net earnings declined 89% on an
8% decline in revenue. Earnings from printing and services divisions helped offset the
computer divisions US $ 400 million loss. Under these circumstances the following are the
benefits or the broad objectives which HP sought to get through the merger deal:
The merger could help to achieve economies of scale and generate cost savings. A
consolidated company would be better positioned to negotiate terms with suppliers.
HP could also leverage Compaqs progress in developing direct sales capabilities to
compete effectively with Dell.
By combining Compaqs competencies in industry standard servers with HPs Linux
and Unix offerings, the consolidated company could have an industry-leading product
line in servers. In addition, Compaq dominated the overall storage market. Adding
HPs capabilities in high-end storage, the consolidated company could become the
market leader in both the enterprise storage segment and the storage area network
segment. With an extensive portfolio of products and services, the merged company
could be better positioned to provide integrated solutions to customers. As a result of
having a larger sales team, the consolidated company would have more power to bid
for customer contracts globally.
The consolidated company could have a stronger services business. It would have
65,000 IT staff operating in 160 countries. The merger could provide an extensive
customer base. The combined support business could produce a stable stream of
cash flow.
The merger was expected to generate cost synergies of about US$2 billion in 2003,
the first full year of operations. Fully realised annual cost savings were projected to
reach US$2.5 billion by mid-2004. HP expected to gain these synergies through
streamlining the two companies product lines; efficiencies in administration;
procurement, manufacturing and marketing; as well as savings from improved direct
distribution of products. With improved profitability over time, HP could increase
investment in the imaging and printing business.


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Answer. The following were the risks associated with the merger as perceived by Walter
Hewlett:
Although the merger could increase HPs market share to about 70% in the low-end
PC business, neither HP nor Compaq had a strong PC business model. Furthermore,
neither company had successfully developed capabilities in direct distribution to
match Dell. Analysts estimated that approximately 3% of HPs sales and 2030% of
Compaqs sales were direct. Compaq had made limited progress in the US but almost
none in the rest of the world and analysts estimated it could take several years for
Compaq to match Dell. In addition, the PC market was expected to grow at less than
half the rate of the imaging and printing market in the next several years. This
meant that the merger could dilute HP shareholders interest in the profitable
imaging and printing business and increase their exposure to an unprofitable PC
business.
History showed that no significant technology merger had ever met expectations and
therefore the integration risk of the merger could be substantial. In addition, the
management of both HP and Compaq had no experience with a merger of this
magnitude. There were 39 total acquisitions (9 for Compaq and 30 for HP) that could
possibly add to the experience and capability for handling the merger. However, very
few acquisitions were close to the asset size of the HP-Compaq merger of US$25
billion. Most of HPs acquisitions were small (small private companies or a certain
part of larger companies) and therefore such experience might not add to the new
companys integration capability. Even though Compaq might have more relevant
experience with large acquisitions, some of its acquisitions (eg, the integration with
DEC and Tandem) did not go smoothly. It was doubtful whether the new company
could leverage the integration experience gained by Compaq.
Market reaction to the merger had been harsh, with both the shares of HP and
Compaq trading down almost immediately after the announcement. On November 5
2001, two months after the initial announcement, HPs share price trailed the pre-
announcement level by 27%. During the same period, an index of comparable
companies increased by9.9%. Walter Hewlett viewed the markets reaction as a sign
of significant shareholder dissatisfaction. He also believed that the plunge in stock
price confirmed his expectation that the merger could destroy value for HP
shareholders.
On the announced terms of the merger, HPs shareholders would own 64.4% of the
combined company and HP would contribute 66.5% of the combined companys net
income in 2002. Based on First Calls revised estimate, HP would pay 82.6 times
Compaqs 2002 earnings, rather than the agreed upon multiple of 22.2. William
Hewlett was concerned that HPs shareholders were getting too little of the combined
company relative to HPs contribution to earnings.
Even if the cost synergies were achieved, Walter Hewlett believed that merger-
related revenue losses could offset or exceed them. The deal could also divert
managements attention and take resources away from HPs profitable imaging and
printing business. In this fast moving market, HP could not afford to wait for its other
businesses to become profitable. Diversion of the managements attention during the
integration process and under-investment in the imaging and printing business could
have a negative impact on HPs leading position. The merged balance sheet could be
worse than HPs original balance sheet, resulting in lower credit rating, greater equity
risk and a higher cost of capital.
HPs strategic position would not change significantly after the merger. The proposed
merger would not substantially improve HPs market position in mid-range and high-
end servers or in high-end services. Compaqs market share in servers was primarily
in the low end of the market, where margins were low. In the mid-range and high-
end server markets, the consolidated companys market share could not match that
of IBM. In terms of storage, Compaqs storage business was unattractive, and it was
also relatively small and did not justify taking the risks of the proposed merger.
The merger might not strengthen HPs consulting and outsourcing capabilities. HP
management acknowledged that high-growth consulting and outsourcing capabilities
were needed to compete with IBM. However, Compaqs service business, like that of
HP, was focused on the lower-growth, lower-margin hardware support and
maintenance segments.


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Answer. As per Fiorina, the Merger Deal between HP and Compaq was a strategic fit as it
was very much in accordance with the HP values of creativity, change and innovation. She
said that the merger would eliminate one player in an oversupplied PC marketplace. It would
also improve HPs market share across the hardware line and double the size of HPs service
unitboth essential steps in being able to compete with industry-giant IBM. Also the merger
would create a full-service technology firm capable of doing everything from selling PCs and
printers to setting up complex networks. The merger would eliminate redundant product
groups and costs in marketing, advertising, and shipping, while at the same time preserving
much of the two companies revenues. The chief driver for the HP-Compaq merger was
competitive positioning. Fiorina pointed out that the distinguishing characteristic of
successful mergers is the focus on consolidation, not diversificationexactly what HP
planned to do after its merger with Compaq.