HP-Compaq Merger Analysis

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HP-Compaq Merger - Analysis : 

Group 9 Shrikanth K (51) Surya Rao (55) Nilangsu Mahanty (87) PVR Bharadwaja (88) Simeen Mirza (113) HP-Compaq Merger - Analysis

Compaq pre-merger : 

Compaq pre-merger Compaq – Founded in 1982 Primary strength - Innovation Compaq’s primary business divisions – Access, commercial and consumer PCs Enterprise computing: servers and storage products Global services Market leader in PCs, with more international sales than US Market leader in fault tolerant computing and industry standard servers

Compaq pre-merger : 

Compaq pre-merger Compaq had successfully created a direct model in PCs #2 in the PC business, stronger on the commercial side Continuously weakening performance made Compaq directors impatient Dell became strong competitor through cost efficiency Compaq missed the online bus and its made-to-order system through its retail outlets failed to take off due to bad inventory management

Compaq pre-merger : 

Compaq pre-merger To bring Compaq to the online market, Capellas (CEO) bought Digital Equipment (AltaVista) Acquisition was incohesive resulting in 15000 layoffs and loss in 1998 New management lacked the cutting edge to maintain stability Bad investments Got caught in a cycle of cost cutting and layoffs Firm was too small and poorly run to maintain its wide array of products and services

Hewlett Packard – pre-merger : 

Hewlett Packard – pre-merger Started in 1938 by two Stanford graduates – William Hewlett and David Packard. HP incorporated in 1947 HP introduced its first PC in 1980 and the LaserJet (company’s most successful product) in 1985 In 2000, HP had 85,000 employees and revenues of $48.8 bn Ranked 13th among Fortune 500

Growing problems at HP : 

Growing problems at HP HP was not adapting to technological innovation fast enough Margins were going down IPG (HP’s Imaging and Printing Group) was the leader in its market segment but did not rank anywhere among top 3 in servers, storage or services Printing line was facing competition from Lexmark and Epson which were selling lower-quality inexpensive printers Needed to build strong complementary business lines

Fiorina tries to rejuvenate HP : 

Fiorina tries to rejuvenate HP Carly Fiorina joined in 1999 hoping to excite a complacent HP Cut salaries, laid off employees Wanted to make high end computers HP’s focus According to her, home and business PCs, UNIX servers were the biggest areas of growth

Pre-merger statistics for Compaq and HP : 

Pre-merger statistics for Compaq and HP

HP’s position before merger : 

HP’s position before merger By 2001, as the industry stumbled, meeting growth targets became difficult for HP and it was forced to cut jobs and scrap plans As a result HP stock price dropped drastically. Turning the company around required more than just strategy from within

Falling stock prices prior to merger : 

Falling stock prices prior to merger Back

Potential impact of Merger : 

Potential impact of Merger Merger would create a full-service technology firm capable of doing everything from selling PCs and printers to setting up complex networks 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.

Market Benefits : 

Market Benefits Merger will creates immediate end to end leadership Compaq was a clear #2 in the PC business and stronger on the commercial side than HP, but HP was stronger on the consumer side. Together they would be #1 in market share in 2001 The merger would also greatly expand the numbers of the company’s service professionals. As a result, HP would have the largest market share in all hardware market segments and become the number three in market share in services. Improves access to the market with Compaq’s direct capability and low cost structure The much bigger company would have scale advantages: gaining bargaining power with suppliers; and scope advantage: gaining share of wallet in major accounts .

Operational benefits of Merger : 

Operational benefits of Merger HP and Compaq have highly complimentary R&D capabilities HP was strong in mid and high-end UNIX servers, a weakness for Compaq; while Compaq was strong in low-end industry standard (Intel) servers, a weakness for HP Top management has experience with complex organizational changes Merger would result in work force reduction by around 15,000 employees saving around $1.5 billion per year

Financial Benefits : 

Financial Benefits Merger will result in substantial increase in profit margin and liquidity 2.5 billion is the estimated value of annual synergies Provides the combined entity with better ability to reinvest

Considerations for Merger : 

Considerations for Merger HP’s strategy is to move to higher margin less commodity like business, hence merging with Compaq is a strategic misfit. Larger PC position resulting from the merger is likely to increase risk and dilute shareholders interest in imaging and printing Lower growth prospects on invested capital Market position in key attractive segments remain same Services remain highly weighed to lower margin segment No precedent for success in big technology transactions Market reaction for the merger is negative Revenue risk might offset synergies HP and Compaq have different cultures Increased equity risk and hence cost of capital

Summary of Deal : 

Summary of Deal

Reverse Triangular merger : 

Reverse Triangular merger A subsidiary Heloise Merger Corporation was created solely to facilitate the merger Result : A tax free reorganization in which HP would control all of Compaq’s assets through a wholly owned subsidiary Hewlett Packard Heliose Merger Corp Compaq Shareholders Compaq Stock (Cash for fractional shares) Stock

TRADING PERFORMANCE IN THE WAKE OF THE ANNOUNCEMENT : 

TRADING PERFORMANCE IN THE WAKE OF THE ANNOUNCEMENT

Deal Valuation : 

Deal Valuation

Deal Valuation (Contd..) : 

Deal Valuation (Contd..) Acquisition Premium Acquisition Premium is the difference between the worth of a Compaq share as valued by HP and the market valuation of a Compaq share The Premium will depend on the length of the period considered while determining the market valuation of Compaq

Valuing the Merger was a challenge because…. : 

Valuing the Merger was a challenge because…. Recession : The largely negative outlook for the economy overall and the tech sector in particular circa 2001 Volatile trading activity : NASDAQ suffered a 30% drop in the 12 months preceding the merger announcement Valuation multiples for comparable companies and recent comparable transactions were broadly distributed.

Valuation of Synergies : 

Valuation of Synergies $2.5 billion pre-tax cost savings in year 2004 NPV of Cost savings estimated at $5 to $9/share of the combined entity The result is based on the following estimations : P/E multiples ranged from 15x to 25x Weighted cost of equity of HP-Compaq – 15% Effective tax rate of the combined entity – 26% Pre-tax profit decline of close to $500 million in 2004 resulting from overall revenue loss of approximately $4.1 billion for the combined entity Weighted average contribution margin of 12%

Deal Multiples vs. Market Multiples : 

Deal Multiples vs. Market Multiples Value of Synergies > Price of Synergies HP’s Valuation of a Compaq share at the time of deal announcement : $14.68 Compaq’s share price at the time of announcement : $12.35 Price paid for Synergies as per market valuation : $ 2.33 Synergies valued at $5-$9 per share !!

Compaq capital structure : 

Compaq capital structure Compaq capital structure The authorized capital stock of Compaq consisted of: 3,000,000,000 shares of Compaq Common Stock, par value $0.01 per share 10,000,000 shares of preferred stock, par value $0.01 per share At the close of business on June 30, 2001: 1,753,000,000 shares of Compaq Common Stock were issued and outstanding 59,000,000 shares of Compaq Common Stock were issued and held by Compaq in its treasury Stock Options : As of the close of business on August 14,2001 ESOP :279,538,000 shares of Compaq Common Stock are subject to issuance pursuant to outstanding options to purchase Compaq Common Stock

Merger Team Structure : 

Merger Team Structure

Post Merger integration : 

Post Merger integration Merger Integration Team Size: 1200 Big Bang concept: Communicate merger to Channel partners, customers Both companies are in similar businesses: Combine Product road maps Deliver on the short-term synergies in six to 12 months They don't need two Unix or NT development teams 15,000 Jobs Eliminated HP:6000 Compaq: 8500 Problems with sackings: Even talent packs their bags Achieving the integration will be tied to peoples compensation packages

Operational Efficiencies : 

Operational Efficiencies Achieved merger-related cost savings of more than $1.3B annually Restructured direct material procurement to save $450M annually Redesigned products & re-qualifying components to save $300M Consolidated multiple mfg sites achieving $120M in annualized savings Achieved manufacturing savings of $200M annually Reduced supply chain headcount by 2,700 Realized logistics savings of $100M+ annually Indirect Procurement negotiated annual savings of $220M

Post Merger integration : 

Post Merger integration

Strategic Integration : 

Strategic Integration Out-compete Dell: The new HP needed a highly competitive direct sales model - 50% of retail shelf space was occupied by HP & Compaq - Direct sales model benefited from Compaq direct sales model Out-compete IBM - Manage the high level relationships with global enterprise customers - With help of Compaq consultants managed 40 big deals in competition with IBM

Shareholder value : 

Shareholder value Myth: A strategically poor integration will be reflected by the stock market’s pushing the combined company's stock price down , an illustration of how mergers can destroy value Fact : In mid-July 2007, five years after the merger announcement, HP's total shareholder returns were up 46 percent. Over the same period, the Standard & Poor's IT index had sunk 9 percent, rival IBM was down 23 percent, and even Dell was up only 2 percent.

HP vs. S&P 500 : last 5 years : 

HP vs. S&P 500 : last 5 years Link

HP vs. IBM : last 5 years : 

HP vs. IBM : last 5 years

HP vs. Dell : last 5 years : 

HP vs. Dell : last 5 years

HP vs. Sun : last 5 years : 

HP vs. Sun : last 5 years

HP vs. Canon : last 5 years : 

HP vs. Canon : last 5 years

PC business : 

PC business Myth: HP, even after combining with Compaq, cannot fight Dell’s direct-sales model with their retail (indirect) plus direct model Fact : HP’s PC business has steadily improved and is bringing competition to Dell that Dell has not seen for the past 5 or 10 years Dell's PC shipments worldwide share fell to 15.2 % from 18.2 % last year, a particularly sharp decline given that the overall market grew 10.9 percent Hewlett-Packard holds 19.1 percent of the world PC market Even in the US, HP and Dell have 24.2 and 26.8 % of the PC market in 2007

Printer business : 

Printer business Myth: HP is pursuing only market share in printers instead of ROI Fact : In HP’s printer business, “good” share consists of devices that deliver color, photos, lots of output, and perform multiple functions. Those characteristics lead to more pages printed, and more profitability. HP has extended that business, leaving low-end, single-function printers to competitors. The company also refused to respond to Dell price-cutting intended to weaken HP's market share in printers

Server business : 

Server business Myth: Pursuing more market share in PCs will divert resources and distract attention from its strengths in printers and servers Fact :

Market shares and operating margins : 

Market shares and operating margins

Revenues and earnings from operations : 

Revenues and earnings from operations

Achieved benefits for customers : 

Achieved benefits for customers HP now offers a one-stop shopping experience for global corporate customers— The company has the ability to procure everything from PDAs to commercial printers and servers from the same source The economies of scale have helped HP focus on its legacy of manufacturing innovation It can build and deliver precisely the product that customers need and want to buy.

Achieved benefits for customers : 

Achieved benefits for customers Ease of doing business The supply chain strategy allows a single point of collaboration with HP, simplifying suppliers’ interaction with HP, increasing business collaboration, and lowering costs for both parties. Enhanced supply and demand visibility This visibility improves participants’ ability to predict demand. It also enables suppliers to build purchasing, manufacturing, and logistical efficiencies into their own supply chains. Further, it enables suppliers to pass associated discounts onto customers such as HP Elimination of non-value-added steps, such as administration, and costs

The Rationalized Product Portfolio : 

The Rationalized Product Portfolio HP branded: Notebooks Desktops, workstations Servers (complete range from high-end to low-end), blade servers, storage Printers & printing consumables Scanners IT Solutions Compaq Desktops Notebooks

References : 

References Buchanan, Anna D., The Merger of HP and Compaq, Case (A) and (B), Darden Business Publishing, 2004 Hoopes, Charlotte L., The Hewlett-Packard and Compaq Merger: A Case Study in Business Communication, Marriott School of Management Supply Chain Management for the adaptive enterprise, HP’s Internal Document www.nasdaq.com Strategic Analysis: The Integration of Hewlett-Packard and Compaq, Tiffany Adams and Renee Poutous Compaq and Hewlett-Packard, Mergent Online, www.mergent.com Burgelman, Robert A. and Webb McKinney, Managing the Strategic Dynamics of Acquisition Integration: Lessons from HP and Compaq, Aug 2005

Contributions : 

Contributions Simeen Mirza –Premerger Scenario Pingali Bharadwaja V R - Rationale Shrikanth K – Deal financials Surya Prashant S N Rao - Integration Nilangsu Mahanty – Evaluation of merger But finally, everybody worked on everything..

Thank You : 

Thank You

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