HP-Compaq - A Failed Merger?

The case gives an overview of the merger between two leading players in the global computer
industry - Hewlett -Packard Company (HP) and Compaq Computer Corporation (Compaq). The case
explores the reasons for HP's failure to realize the synergies identified prior to the merger. It
highlights that the leadership, legacy and cultural issues play an important role in mergers. The case
describes in detail the rationale for HP -Compaq merger, problems faced in integrating the merged
entities and whether the merger made business and economic sense. It also describes the product
profile of the merged entity and how the new HP compares with its major competitors, IBM and Dell
Computers.

Issues:

The basic objectives underlying the merger move between HP and Compaq
The possible reasons for unsuccessful mergers
How mergers fail to create shareholders' value
Role of a leader in making merger successful
The importance of cultural compatibility in making mergers successful
The global PC industry structure

Finally, the case presents the challenges faced by the new CEO of HP, Mark Hurd, in mid -2005. The
case is designed to help students critically analyze a merger deal and understand the various issues
involved such as product synergies, cost savings and technological compatibility. The case also
provides an insight into the possible hurdles that might crop up while implementing a mega - merger.

On September 04, 2001, two leading players in the global computer industry - Hewlett-Packard
Company (HP) and Compaq Computer Corporation (Compaq) - announced their merger. HP was to
buy Compaq for US$ 24 billion in stock in the biggest ever deal in the history of the computer
industry. The merged entity would have operations in more than 160 countries with over 145,000
employees, and would offer the industry's most complete set of products and services.

However, the stock markets reacted negatively to the merger announcement with shares of both
companies collapsing - in just two days, HP and Compaq share prices declined by 21.5% and 15.7%
respectively. Together, the pair lost US$ 13 billion in market capitalization in a couple of days. In the
next two weeks, HP's stock went down by another 17%, amidst a lot of negative comments about the
merger from analysts and the company's competitors. Industry analysts wondered what benefits HP, a
global market leader in the high margin printers business, would reap in acquiring a personal
computer (PC) manufacturer like Compaq at a time when PCs were fast emerging as low-margin
commodity products
Though the merger helped HP in achieving economies of scale in the PC business, it faced fierce
competition from Dell Computers (Dell),2 a low-cost, direct-marketer of PCs.

The merger also did not help HP to compete with IBM, which not only sold PCs3 but was also a
market leader in the high-margin consulting and service businesses. In June 2005, HP's shares
hovered around US$ 23 per share, below the price just before the merger was announced. This
indicated that the merger had failed to create shareholder value. In contrast, the share price of US-
based Lexmark, HP's major competitor and the second largest company in the printers business, rose
by 60%, while Dell's share price moved up by 90% in the same period. With the PC and other
hardware businesses of HP making miniscule profits, analysts opined that the company's printer
business should be spun off into a stand-alone company

The Rationale for the Merger

In the late 1990s, the PC industry slipped into its worst-ever recessionary phase, resulting in losses of
US$ 1.2 billion and 31,000 layoffs by September 2001. According to analysts, with the computer
industry commoditizing and consolidating very fast, mergers had become inevitable.

The HP-Compaq merger thus did not come as a major surprise to industry observers. The details of
the merger were revealed in an HP press release issued soon after the merger was announced. The
new company was to retain the HP name and would have revenues of US$ 87.4 billion - almost
equivalent to the industry leader IBM (US$ 88.396 billion in 2000).

Under the terms of the deal, Compaq shareholders would receive 0.6325 share of the new company
for each share of Compaq. HP shareholders would own approximately 64% and Compaq shareholders
36% of the merged company. Fiorina was to remain Chairman and CEO of the new company while
Capellas was to become the President.

The Merger Integration

The new HP developed a white paper giving complete details of its post-merger product strategy. The
HP and Compaq brand names were retained for desktop PCs and notebooks for both consumers and
commercial segments. The merged entity supported Compaq's brand name for its servers while it
continued with HP for workstations. The electronic shopping sites of both the companies were also
integrated.

To make the merger work, the new HP initially focused on two areas - avoiding culture clashes
internally and reducing any problems to the customers. The company devoted a significant amount of
time in planning to minimize any instance of culture clashes that usually happened in such mega-
mergers. The task of ensuring this was given to Susan Bowick, HP's Senior VP of HR. She put all
employees through a training workshop named as 'Fast Start,' designed to explain the merged entity's
new organizational structure and allow employees overcome concerns about their new co-workers.
HP also made efforts to strengthen its image as a single unified company
Does the Merger Make Business Sense

Soon after the HP-Compaq merger deal was approved by the HP's board and its shareholders in
March 2002, industry analysts termed the deal as a strategic blunder. Critics ridiculed Fiorina by
saying that one bad PC business merged with another bad PC business does not make a good PC
company.

Many analysts felt that the synergies HP foresaw would not materialize easily. They said that the
merged company would have to cut costs drastically in order to beat Dell in PCs, while constantly
investing money in research and development and consulting to compete with IBM and Sun
Microsystems.

In the high-end server markets, IBM and Sun Microsystems were constantly introducing new
products. Since more than half of the new HP's sales came from low-margin PCs, analysts expressed
concerns that it would not have enough cash to invest in R&D in order to compete in the high-end
market

Does the Merger Make Economic Sense

A few HP divisions that were big revenue earners were not able to contribute correspondingly to
profits. An analysis of the company's business segment revenues in the fiscal 2004 revealed that the
Enterprise Storage & Servers and the Personal Systems divisions, the erstwhile Compaq strongholds,
brought in revenues of US$ 39.774 billion, comprising approximately 50% of HP's total revenues
(Refer Table II for HP's business segment information for the fiscal 2002 to 2004).

However, the operating profits from both these divisions combined were US$ 383 million, less than
1% of the divisions' revenues. Moreover, the total contribution of these two divisions in the overall
operating profits of HP of US$ 5.473 billion was just 7%. Another major business of the erstwhile
Compaq, HP services which generated revenues of US$ 13.778 billion, witnessed a fall in operating
profits from US$ 1.362 billion in fiscal 2003 to US$ 1.263 billion in fiscal 2004. HP's own imaging
and printing was the only business division that posted respectable operating profits of US$ 3.847
billion
The Challenges Ahead

Due to her inability to revive the performance of hardware businesses, HP's board asked Fiorina to
step down as the company's Chairman and CEO on February 09, 2005. The day Fiorina resigned; the
shares of HP increased by 6.9 percent on the New York Stock Exchange. Commenting on this, Robert
Cihra, an analyst with Fulcrum Global Partners said, "The stock is up a bit on the fact that nobody
liked Carly's leadership all that much. The Street had lost all faith in her and the market's hope is that
anyone will be better