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Rev. Nov. 19, 2009

THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):


STRATEGY AND VALUATION
No large-scale high-tech merger has ever workedeverMelding two large and
fiercely competitive organizations is a formidable challenge in any industry. The
benefits of scale and scope in mature industries, like oil or financial services, can
sometimes outweigh the time and energy squandered in the long integration
process. But in high technology, no company has ever attempted this trade-off and
come out ahead. In fast-moving industries, while the acquirer sorts out its product
portfolio and redraws organizational lines, unencumbered rivals seize their
chance to race ahead.1
David B. Yoffie
Harvard Business School
Kathryn Macalester, manager of a $5 billion equity fund that owned 16 million shares in
the Hewlett-Packard Company, had recently received the joint proxy and prospectus statement
recommending shareholder approval for the merger of HP and Compaq. In early 2002, most
technology stocksincluding HPswere trading at less than half their 2000 highs, and there
was little optimism for a strong turnaround before year-end. The fund, which was heavily
invested in technology and growth stocks, took a value approach to investing and, as such, was
more interested in the long-term value proposition of the proposed merger than any short-term
arbitrage opportunities. Accordingly, Macalester had instructed her research associate to provide
background material on the merger, an assessment of the strategic value, and various valuation
analyses to assist Macalester in evaluating the merger. On March 14, 2002, the Thursday before
the Tuesday, March 19, 2002, shareholder vote, Macalester began her review of the materials
provided by her associate.

David B. Yoffie and Mary Kwak, HP and Compaq Should Return to Their Roots, Wall Street Journal,
December 17, 2001.
This case was prepared by Anna D. Buchanan under the supervision of Robert F. Bruner. It was written as a basis
for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright
2004 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order
copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of this publication may be reproduced,
stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any meanselectronic,
mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School Foundation. Rev.
11/09.

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The Proxy
Effective February 4, 2001, Hewlett-Packard Company and Compaq Computer
Corporation filed with the Securities and Exchange Commission a joint proxy statement and
prospectus related to a proposed merger of the two companies. A March 19, 2002, meeting was
scheduled for HP shareholders of record (as of January 28, 2002) to vote on the merger.
Compaqs shareholders were to convene March 20, 2002, to vote on the merger.
Opposition by the Hewlett and Packard families foundations and trusts, who together
owned 18.6% of the collective 18.7% of HP shares controlled by insiders, had focused the
markets attention on the much-anticipated vote of HPs institutional shareholders. Considering
the traditionally poor response rate of individual shareholders and the fact that institutional
shareholders controlled 57% of HP voting rights, the contest hinged on the decisions of these
institutional investors.

Background of the Merger


HPs history
Famously founded in 1939 by Bill Hewlett and Dave Packard in a Palo Alto, California,
garage and initially capitalized with $538, Hewlett-Packards founders remained integrally
connected with the successful growth of the business for decades after its founding (Hewlett
retired as vice chairman in 1987 and Packard retired as chairman in 1993). Hewlett and
Packards corporate philosophy and values were known and appreciated throughout the
organization, and The HP Way, which came to symbolize innovation, integrity, flexibility,
teamwork, and individual contribution, did not materially change throughout the companys
meteoric growth over the next half century.2
By the end of 1943, its fifth year in business, the company had revenues of $953,294 and
45 employees, and by 1957, Hewlett-Packard was a public company with $28 million in
revenues and nearly 1,800 employees. As a clear reflection of the companys views on the value
of its employees, HP began what theretofore was the uncommon practice of granting stock to
employees. Throughout the latter half of the twentieth century, HP grew into a worldwide leader
in computing technology, and by 2000, HP had 85,500 employees and revenues of $48.8 billion,
and was ranked 13th among the Fortune 500.
At the dawning of the new millennium, however, changes were afoot at HP. The
technology sector had undergone substantial transformation during the 1990s, and HPs
executives were recognizing the need to adapt. Although innovation was still critical to longterm success, HPs industry was maturing, and with that came the additional pressure of
slimming margins, the importance of distribution efficiencies, and a more critical need for
2

For additional reading, see David Packard, The HP Way: How Bill Hewlett and I Built Our Company, ed.
David Kirby and Karen Lewis (New York: HarperBusiness, 1995).

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developing long-term relationships with customers. Simply being a component manufacturer was
not a viable long-range plan for HP.
In July 1999, HPs CEO, Lew Platt, retired and named Carleton (Carly) S. Fiorina as
president and CEO. After nearly 20 years at AT&T and Lucent Technologies, Carly Fiorina
became the first company outsider to be named CEO in HPs 60-year history. Considering that
many existing HP managers had developed under Bill Hewlett and Dave Packards tutelage and
reveled in the Bill and Dave stories that remained a cherished part of HP lore, Fiorinas
challenge to lead HPs reinvention as a company that makes technology work for businesses
and consumers was no small task. Named chairman of the board of directors on September 22,
2000, Fiorina began the delicate process of transforming HP into the hottest new company of
the Internet era without losing contact with the old-time commitment to quality and integrity that
made the Hewlett-Packard name so trusted.3
Events leading up to the merger announcement
In the midst of an increasingly competitive business environment, throughout 1999 and
2000, Hewlett-Packards board of directors and executive management evaluated numerous
alternatives for business growth to secure the companys future viability. Although HPs
Imaging and Printing Group (IPG) dominated its market segment, the company did not rank
among the top three competitors in personal computers, servers, storage, or services.
Furthermore, HPs long-term dominance in imaging and printing was continually being
challenged by Lexmark and Epson, which were selling inexpensive, lower-quality printers in a
bid for market share. Recognizing the need to build strong complementary business lines while
maintaining its strength in imaging and printing, the board of directors evaluated the following
options, paying particular attention to improving the companys position in enterprise computing
and services:

Go-it-alone strategies for both organic growth and growth through acquisitions in its
current business lines

A spin-out, sale, or divestiture of its PC business

A services-focused strategy related to IT outsourcing and systems-integration projects

Imaging and printing strategies ranging from a spin-out of IPG to expansion into digital
imaging and high-end printing businesses

End-to-end solutions strategy for server, storage, and services businesses achieved
through acquisitions of significant industry participants

Perhaps influenced by IBMs very successful turnaround in the mid-1990s, HPs board
and management settled on a strategy of developing the companys IT-services business by mid2000. IBMs Global Services Group, which offered tailored end-to-end hardware, software,
3

Robert M. Fulmer, Philip A. Gibbs, and Marshall Goldsmith, The HP Way: Leveraging Strategy with
Diversity, Leadership Development and Decentralization, Strategy & Leadership (OctoberDecember 1999): 22.

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and business-process solutions to customers, was the success story that emerged from the
outmoded, pre-turnaround Big Blue. In gaining and retaining technology customers by viewing
them as the business clients they ultimately were, IBM Global Services really had no other single
solutions competitor in the highly fragmented IT-services sector. As described by Louis Gerstner
in his 2002 account of the IBM turnaround, in 1994, IBM saw services as key to growth:
I believed that the industrys disaggregation into thousands of niche players
would make IT services a huge growth segment of the industry overall. All of the
industry growth analyses and projections, from our own staffs and from thirdparty firms, supported this. For IBM, this clearly suggested that we should grow
our services business, which was a promising part of our portfolioServices, it
was pretty clear, would be a huge revenue growth engine for IBM.
However, the more we thought about the long-term implication of this trend, an
even more compelling motivation came into view. If customers were going to
look to an integrator to help them envision, design, and build end-to-end
solutions, then the companies playing that role would exert tremendous influence
over the full range of technology decisionsfrom architecture and applications
to hardware and software choices.
This would be a historic shift in customer buying behavior. For the first time,
services companies, not technology firms, would be the tail wagging the dog.
Suddenly, a decision that seemed rational and straightforwardpursue a growth
opportunitybecame a strategic imperative for the entire company.4
In 2000, HP was pursuing a strategy to expand its services business through both organic growth
(fueled by increased investment in its services business) and possible acquisitions. HP
subsequently entered into discussions to acquire the consulting-services business of
PricewaterhouseCoopers LLP (PwC); however, by fall 2000, HP had terminated the negotiations
and continued to evaluate its strategic alternatives. In early 2001, HP retained the services of
McKinsey & Company to assist in its continued effort to implement the new strategy.
Also in 2000, Compaq directors had grown impatient with Compaqs poor performance,
and were encouraging Compaqs CEO, Michael Capellas, to explore a potential business
combination with another computer company. Capellas subsequently presented to the board the
relative strengths and weaknesses of potential pairings with such companies as Dell, Sun, EMC,
and Hewlett-Packard, among others. According to Capellas, the strengths of a combined HP and
Compaq were intuitively obviousWe wanted to be the next IBM.5
Discussions of a business combination between Hewlett-Packard and Compaq first arose
in June 2001, during conversations between the two companies concerning Compaqs potential
4

Louis V. Gerstner, Jr., Who Says Elephants Cant Dance? (New York: HarperBusiness, 2002), 124.
George Anders, Perfect Enough: Carly Fiorina and the Reinvention of Hewlett-Packard (New York: Penguin
Group, 2003), 117.
5

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licensing of HPs UNIX (HP-UX) business. Carly Fiorina contacted Michael Capellas to discuss
Compaqs interest in licensing HP-UX. After a period of deliberation, Capellas contacted Fiorina
to discuss the potential for a broader strategic relationship based on synergies between the two
companies.
Following a June 22, 2001, meeting between Fiorina, Capellas, and members of their
staffs regarding HP-UX licensing, HP initiated an internal analysis of potential business
combinations between the two companies, with the assistance of McKinsey & Company. During
a June 24, 2001, telephonic board meeting, HPs board of directors authorized Fiorina to further
explore a business combination between the two companies. By June 29, 2001, HP and Compaq
had executed a confidentiality agreement, and the companies commenced mutual business-duediligence investigations.
In late July 2001, after a month of additional discussions regarding a combination of the
two companies, HP retained Goldman, Sachs & Co. to act as its financial adviser in connection
with the business combination, and Compaq engaged Salomon Smith Barney as its financial
adviser. By August 5, however, the merger negotiations had stalled, owing, in part, to
disagreement over Capellass role in the combined company. Compaq called off the talks, and
the deal remained on hold until late August.6
Between June 24, 2001, and August 31, 2001, HPs board met eight times and the
Compaq board convened eight times (including an August 30 meeting that Fiorina attended to
present to the Compaq board the proposed benefits of the merger) to consider a combination of
the two companies. By August 30, 2001, a number of issues remained unresolved regarding the
potential merger of HP and Compaq, including, most significantly, the issues of exchange ratio
and management retention.
On September 2 and 3, 2001, HP and Compaq executives, together with their respective
financial and legal advisers, met to negotiate the final terms of the merger agreement. At these
negotiations, mutual agreement was reached on an exchange ratio of 0.6325 share of HP
common stock for each share of Compaq common stock. The companies boards of directors
convened separately on September 3 to review the final merger agreement and consider the
fairness opinions of their financial advisers. Both boards unanimously approved and executed the
merger agreement, effective September 4, 2001. On the evening of September 3, 2001, HP and
Compaq issued a joint press release announcing the merger agreement.

Merger Rationale
Based on the February 4, 2002, proxy, shareholders were to weigh the risks of the merger
against the expected rewards. Described by insiders as a merger of equals, HP and Compaq
had different strengths in their lines of business, which together produced a complementary set
6

Peter Burrows, Backfire: Carly Fiorinas High Stakes Battle for the Soul of Hewlett-Packard (Hoboken, NJ:
John Wiley & Sons, 2003), 184.

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of products and services, better able to serve customers at lower cost. The companies attributed
both strategic and financial benefits to the merger.
Strategic benefits
Before the merger discussions, HP and Compaq had focused on growing their enterprisecomputing and IT-services businesses, two areas in which each company had strengths
Compaq was the more significant player in enterprise systemsbut in which neither company
was dominant across the board. By merging, the newly combined companies would be a major
force in enterprise computing and perhaps among the top three in services. Furthermore, with
customers looking to maintain strong relationships with fewer technology vendors, the merger
better positioned the new company to provide its clientele with a wider spectrum of products and
services.
In February 2002, HPs three primary business lines were (1) Imaging and Printing; (2)
Computing, consisting of desktops, notebooks, servers, and storage products; and (3) IT
Services. Although HP was the market leader in imaging and printing, its computing and ITservices businesses noticeably lagged the competition, and the company did not have an organic
growth strategy for these businesses. Unlike Compaq, which had moved toward a directdistribution model in response to Dells cost competitiveness and now shipped a majority of its
PCs directly to customers, HP shipped only 15% of its PCs directly to customers. To lower costs,
HP had recently announced plans to outsource its PC-manufacturing operations, although it still
acknowledged the need for further cost reductions.
Compaqs three primary divisions were (1) Access, consisting of commercial and
consumer PCs; (2) Enterprise Computing, which included servers and storage products; and (3)
Global Services. The company was the market leader in PCs and shipped more units
internationally than within the United States. Although direct distribution had helped lower its
costs, Access still operated at a negative margin. By merging with HPs PC business, Compaqs
management believed that positive operating margins could once again be achieved through
economies of scale. Compaq was also the market leader in fault-tolerant computing and industrystandard servers; in the former, HP did not have a presence, and in the latter, HPs position was
not strong. Conversely, Compaq was not strong in the UNIX market, where HP-UX was a top
supplier. On a revenue basis, Compaq was the worlds leading supplier of storage systems, and
HP was strong in high-end servers.
The new company would be a dominant leader in servers and be well positioned to
exploit the fast-growing trend of storage area networks in the storage market. By combining
these complementary server and storage lines, the new company could reduce costs, offer a
comprehensive array of products for enterprise customers, and more effectively allocate R&D
for growth in its enterprise-computing business.

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-7Financial benefits

In addition to strategic benefits, the merger would deliver significant financial benefits to
shareholders. Through major cost savings and improved profitability of business lines,
substantial earning improvements for shareholders would be realized. Management projected
recurring, annual, pretax cost savings of $2.5 billion by mid-2004 (Figure 1):
Figure 1. Annual pretax cost savings as a result of proposed merger.
Administrative/IT costs

$625 million

Cost-of-goods-sold benefits

$600 million

Sales-management benefits

$475 million

Research-and-development efficiencies

$425 million

Indirect-purchase benefits

$250 million

Marketing efficiencies

$125 million

Management projected these cost savings to have a value of $5 to $9 per share, even taking into
account revenue losses of $4.1 billion in 2004 (of total projected 2004 revenue of $92.8 billion),
resulting directly from the merger. Based on managements estimates, the companys break-even
overall revenue loss in 2004 would have to be $20.6 billion, or more than five times the revenue
losses projected by management, in order to completely offset the expected $2.5 billion in annual
cost savings.
After realizing the cost savings from the synergies described above, management
expected a substantial improvement in operating margins beginning in the companys 2003 fiscal
year, for which it projected an overall operating margin of 8% to 10%. Segment operating
margins were expected to improve (Figure 2).
Figure 2. Changes in segment operating margins as a result of proposed merger (in percent).

Enterprise systems
Personal systems
Services

Projected Operating Margins for


FY2003
9.2
3.0
13.7

HPs FY2001 Operating Margin


for Comparable Business Segment
3.2
4.2
4.5

Market Reaction
At the close of trading on September 4, 2001, the first day of trading after the merger was
announced, HPs stock price dropped 18.7 percent to close at $18.87, and by September 10,
2001, the last trading day before the World Trade Center attacks, HPs shares had fallen to
$17.89, for a total post-announcement price drop of 22.9% (Exhibit 1).

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On November 6, 2001, Walter B. Hewlett announced his intent to vote against the
proposed business combination of Hewlett-Packard and Compaq. In response, HP shares, which
were still lower than their announcement-day levels, closed up 17.3%. The market certainly
seemed to be agreeing with Walter Hewlett (Exhibit 2).

Walter Hewletts Opposition to the Merger


Son of HP cofounder William R. Hewlett and a member of HPs board of directors,
Walter B. Hewlett had attended five of HPs eight summer 2001 board meetings, where the
merger was discussed, as well as the September 3, 2001, HP board meeting, where he joined
other board members in voting unanimously for the merger. On November 6, however, Hewlett
said, After careful deliberation, consultation with my financial advisor and consideration of
developments since the announcement of the merger, I have decided to vote against the
transaction.7
Citing the markets strong negative reaction to the announcement, Hewlett expressed
concerns over diluting HPs high-margin printing and imaging business with Compaqs lowmargin, fiercely competitive PC business. With this transaction, we get what we dont want, we
jeopardize what we already have, and we compromise our ability to get what we need, said
Hewlett.8
On November 16, 2001, Hewlett filed with the SEC a 71-page report that detailed his
reasons for opposing the merger. In addition to the business-portfolio shift from imaging and
printing to PCs, Hewletts filing identified three other areas of concern: (1) the merger would not
solve HPs strategic problems, as he believed the company would still be poorly positioned to
lead in either enterprise computing or services; (2) the financial impact on shareholders was
unattractive, as substantiated by the dramatic post-announcement decline in HPs stock price;
and (3) integration risk was substantial, as the two companies were widely believed to have very
different cultures and values.9
Thus began an active campaign by Walter Hewlett for a negative vote on the merger
proposal. Over the following months leading up to the proxy vote, Hewlett amended his initial
information filing with the SEC numerous times by providing hundreds of pages of
documentation supporting his claim that the merger rationale was flawed. Hewlett succeeded in
creating a very public public-relations battle that sought to sway the opinions of shareholders,
analysts, and industry observers, and as Hewlett managed to keep the HP-Compaq merger

Hewlett against Compaq, CNN/Money, November 6, 2001, http://money.cnn.com/.


A Stunning Reversal for HPs Marriage Plans, BusinessWeek online, November 19, 2001,
http://www.businessweek.com/.
9
Friedman Fleischer & Lowe and The Parthenon Group, Report to the Trustees of the William R. Hewlett
Revocable Trust on the Proposed Merger of Hewlett-Packard and Compaq, filed with the SEC by Walter B.
Hewlett on November 16, 2001.
8

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controversy at the forefront of coverage by business-news reporters and Wall Street analysts,
other high-profile dissenters entered the fray.
On December 7, the Packard Foundation, which controlled 10% of outstanding HP shares
and was the single largest HP shareholder, decided to oppose the merger. This move prompted
the following comments from Patrick McGurn of Institutional Shareholder Services, an
independent group that analyzed proxies and advised clients on how to vote: If they lose both
families, I cant see it going throughIts a real mess now.10

HPs Response to Hewletts Opposition


In light of the growing number of no votes, as well as Hewletts intensified publicrelations efforts to encourage shareholders rejection of the merger, HP began its own PR
campaign. On December 19, 2001, HP filed with the SEC a package of slides that it had prepared
for shareholders in order to rebut Hewletts criticisms. In summary, HP claimed that Walter
Hewlett had (1) presented a static and narrow view of HP and the industry, (2) selectively
ignored synergies in several key areas of analysis, (3) displayed simplistic antimerger bias by
ignoring empirical evidence of successful mergers, and (4) offered no alternatives.11 See Exhibit
3 for a summary of the pro and con positions on the merger as provided by the Walter B. Hewlett
and HP SEC filings.

Valuation
While much of Walter Hewletts basis for opposing the merger was related to strategic
issues, he also claimed that it was just a bad deal financially. Largely discounting the value of
synergies, Hewlett contended that HP was paying too much for Compaq and that shareholder
value would be destroyed by the merger.
Understanding the value of the HP-Compaq merger was no small undertaking for
shareholders at a time when the NASDAQ had suffered a 30% drop during the past 12 months of
highly volatile trading activity, markets were still skittish as a result of the September 11, 2001,
terrorist attacks, and many technology firms were projecting continuing losses for 2002.
Arguably, the world was a much different place in early 2002 than it had been on September 3,
2001, when the deal was announced, and it was certainly fair to question whether a good deal
had been struck. Valuation multiples for comparable companies, as well as recent comparable
transactions, were broadly distributed owing to the uncertain but largely negative outlook for the
tech sector specifically and the economy overall (see Exhibits 4, 5, and 6).
10

Family Affair: H-P Deals Fate Rests with Skeptical Heirs of Company FoundersA No from Packard Bloc
Could Doom Takeover of Struggling CompaqNew Courtship of Investors, Wall Street Journal, November 9,
2001.
11
Summary Observations on Walter Hewlett Filings, section of HPs presentation slide package HP Position
on Compaq Merger, provided to shareholders and filed with the SEC on December 19, 2001.

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Kathryn Macalesters associate had summarized the valuation ranges using multiples,
discounted cash flows, and recent market prices for both HP and Compaq (see Exhibits 7 and 8).
Macalester knew, however, that valuation of synergies was critical to the acquisitions success.
On the one hand, by the 2004 fiscal year, management was predicting annual cost savings of
$2.5 billion (even with annual revenue losses of $4.1 billion) and a substantially positive
earnings increase. On the other hand, Walter Hewlett, an informed HP insider and experienced
technology executive, was contending that management had underestimated revenue losses and
that synergies would not materialize owing to integration debacles. Having a significant impact
on the discounted-cash-flow analysis, correct valuation of synergies could clearly mean the
difference between success and failure. Macalester picked up the proxy report and reviewed the
section on synergies valuation (Exhibit 9).

The Decision
Given the expected close vote, both the Hewlett-Packard and Walter Hewlett camps had
heavily lobbied institutional shareholders in hopes of swaying their vote. Macalester, whose fund
held approximately 1% of the outstanding shares of HP stock, reflected on the presentations she
had attended. Carly Fiorinas presentation had convinced her of the need for change at HP and
had illuminated the risks of doing nothing. Walter Hewletts presentation had made her wonder
about the strategic value of the merger with regard to growing HPs services business, and had
caused her to question the value of synergies. Both sides had made convincing arguments for
their positions, and both had conducted sophisticated investor-relations campaigns.
Macalester studied the analysis provided by her associate, including a history of monthly
stock prices (Exhibit 10), capital-markets cost-of-debt data (Exhibits 11 and 12), and the Value
Line tear sheets for both HP and Compaq (described in Exhibits 13 and 14). Macalester prepared
to assess the strategy and valuation of the proposed merger of HP and Compaq. She jotted down
the following questions as she pored over the materials spread across her desk:
1. What would a SWOT analysis reveal?
2. Was the merger strategy sound?
3. What was the value of synergies?
4. What was the appropriate valuation range for the merger?

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-11Exhibit 1
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Trading History of Compaq and Hewlett-Packard Stock (in dollars)
(surrounding September 4, 2001, announcement date)

Date
8/27/2001
8/28/2001
8/29/2001
8/30/2001
8/31/2001
9/4/2001
9/5/2001
9/6/2001
9/7/2001
9/10/2001
9/17/2001

HWP
Closing
Price
25.02
24.61
23.95
23.40
23.21
18.87
18.21
17.70
18.08
17.89
16.02

HWP
Percentage
Change
0.4
1.6
2.7
2.3
0.8
18.7
3.5
2.8
2.1
1.1
10.5

CPQ
Closing
Price
13.27
13.32
13.13
12.69
12.35
11.08
10.41
10.35
10.59
10.35
8.75

CPQ
Percentage
Change
2.8
0.4
1.4
3.4
2.7
10.3
6.0
0.6
2.3
2.3
15.5

Implied
CPQ
Price
15.83
15.57
15.15
14.80
14.68
11.94
11.52
11.20
11.44
11.32
10.13

Implied
Premium
for CPQ
19.3
16.9
15.4
16.6
18.9
7.7
10.6
8.2
8.0
9.3
15.8

Data source: DataStream.

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Data source: Yahoo! Finance.

Timeline and HP Share Prices against S&P 500 (in dollars)

THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):


STRATEGY AND VALUATION

Exhibit 2

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-13Exhibit 3
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Summary of Opposing Positions as of December 2001
HP Position on Merger1

Walter Hewletts Position on Merger2

Information technology industry


continues to undergo rapid change
and HP must continue to address
challenges of new environment

Status quo has its risks

Enterprise customers are


increasingly looking to:
Improve return on IT spending
Migrate to a select few global
providers of integrated end-to-end
solutions
Benefit from the economics and
flexibility of standards-based
platforms
Partner with primary industry
innovators to navigate transitions

PC industry dynamics are


demanding lower cost structures
and increasingly favoring direct
distribution model

Success in Imaging and Printing


requires continued investment for
growth and tighter linkages with
enterprise IT

Resulting business portfolio is worse


than existing HP portfolio

Larger PC position will increase risk


and cash drain

Contrary to professed strategy of


migrating to higher margin, less
commodity-like businesses

Diluted interest in Imaging and


Printing

Lower margins, growth and return


on invested capital

Compaq merger is the uniquely


compelling strategic alternativeno
other option offers such
comprehensive benefits and
opportunities

Bolsters enterprise position

Accelerates improvement of
Access with Compaqs direct
capabilities and lower cost
structure

Delivers key benefits for Imaging


and Printing

HP Response to Hewletts Opposition3

Presents a static and narrow view of


HP and the industry

Fails to account for rapidly


changing industry dynamics and
customer requirements such as a
desire for end-to-end solutions, shift
to industry standard architectures,
narrowing number of strategic
vendors

Paints negative picture of industrystandard server market while failing


to acknowledge the increasing
importance of this market to
Acquisition will not solve HPs
customers, its on-going
strategic problems
encroachment into the higher-end

Market position remains weak in


UNIX market or the relevance of
key attractive sub-segments (high
Compaqs direct capabilities
end servers, high end services)

Dismisses combined storage

PC economics remain unattractive


position based on its current size

No material change in Imaging and


while ignoring high growth rates,
Printing
strong margins and server pull
Combined entity remains stuck in
through dynamics, as well as
the middle in servers behind Dell
Compaqs leadership in the
at the low end and Sun/IBM at the
emerging and attractive SAN
high end
category

Services remain heavily weighted to

Illustrates the challenges facing HP


lower margin support, not
Enterprise business while
outsourcing and consulting
incorrectly implying that the
business can be sustained or
Financial impact on shareholders is
improved without substantial
unattractive
strategic change

Market reaction is very negative

Acknowledges the challenges facing

Relative contribution of earnings


the PC industry but ignores the need
favors Compaq
to achieve economies of scale and

HP dilution vs. Compaq accretion


obtain a more effective distribution

Increased equity risk and cost of


capability to meet the challenges of
capital
a maturing industry

Assumes that Imaging and Printing


results can continue to support other
businesses while meeting its own
competitive challenges and
reinvesting for growth

1
Executive Summary, section of HPs presentation slide package HP Position on Compaq Merger, provided to shareholders and filed
with the SEC on December 19, 2001.
2
Friedman Fleischer & Lowe and The Parthenon Group, Report to the Trustees of the William R. Hewlett Revocable Trust on the
Proposed Merger of Hewlett-Packard and Compaq, filed with the SEC by Walter Hewlett on November 16, 2001.
3
Summary Observations on Walter Hewlett Filings, section of HPs presentation slide package HP Position on Compaq Merger,
provided to shareholders and filed with the SEC on December 19, 2001.

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UV3981

-14Exhibit 3 (continued)
Summary of Opposing Positions as of December 2001

HP Position on Merger
Combination addresses industry
dynamics and customer
requirements, creates stronger
company and is financially
compelling

Significantly improved
profitability and operating margins
in Enterprise, Access and services

Highly complementary R&D


capabilities

Broad improvement in projected


financials

Substantial accretion to HP
earnings of 13% in first full year
(FY03)

Synergies (net of revenue loss


impact are worth $5 - $19 per HP
share)

Value created by combination


outweighs premium paid
Management is experienced and
focused on execution, and integration
planning is ahead of schedule

Integration planning is sharply


focused on value creation

Leadership has deep experience


with complex organizational
changes

Walter Hewletts Position on Merger

HP Response to Hewletts Opposition

Integration risk is substantial

No precedent for success in big


technology transactions

Most acquisitions fail, particularly


when market reaction is negative

Integration difficulties are obvious

Revenue risks offset cost synergies


Very difficult to mesh cultures

Selectively ignores synergies in several


critical analyses (Here, HP critiques
individual charts in Hewletts report and
points to incorrect assumptions.)
Exaggerates the impact of potential
revenue losses

Walter Hewlett Filing assumes each


dollar of revenue loss results in
$0.25 of profit loss

The 25% contribution margin is


grossly exaggerated because
revenue losses are likely to occur in
businesses that carry substantially
lower contribution margin (e.g. PCs
and industry-standard servers)

The 25% contribution margin


assumption significantly distorts
accretion / dilution analysis
Displays simplistic anti-merger bias,
ignoring empirical evidence of
successful mergers

Walter Hewlett filings fail to view


transaction in the context of industry
conditions

Consolidation has been a vehicle for


superior value creation in maturing
industries
Acquirers in recent largest M&A

transactions have outperformed


peers who face similar industry
dynamics. (Here, HP provides a
chart comparing average acquirer
price performance relative to
applicable S&P Industry Index and
the S&P 500, without citing specific
examples.)

Initial market reaction has not been


a good predictor of success. There
are several examples of successful
technology mergers that had initial
negative market reactions
(Veritas/Seagate Software; BEA
Systems/Web Logic; Nortel/Bay
Networks; Veritas/Open Vision)
Offers no alternatives

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3571
3576
3571
3571
7373
3571
3570
3570
7371
3571
3571
3571
7373

SIC

30,126

3.2

33.0

Data sources: ONeil Database, Bloomberg, Research Insight.

nm = not meaningful

* First Call Consensus at FYE 2001

Averages

Apple Computer Inc


Cisco Systems Inc
Compaq Computer Corp
Dell Inc
Fujitsu Ltd (ADR)
Gateway Inc
Hewlett-Packard Co
Hitachi Ltd (ADR)
IBM Corp
NEC Corp (ADR)
Silicon Graphics Inc
Sun Microsystems Inc
Unisys Corp

Company Name

Sales
Gross
3-yr
Profit
Sales
CAGR Margin
(in $000) (%)
(%)
5,363
3.4
24.9
22,293
38.1
55.0
33,554
2.5
25.3
31,168
19.5
18.4
37,646
4.6
34.2
5,938
7.4
21.1
45,226
1.3
28.6
60,104
3.0
29.3
85,866
1.7
41.9
38,354
1.7
27.6
1,854 15.7
41.0
18,250
23.1
51.9
6,018
5.8
30.0
0.6

EBIT
Margin
(%)
6.2
0.1
1.4
7.3
1.5
3.5
4.5
1.5
10.8
1.3
16.7
10.1
4.5
45,156

Market
Value
(in $000)
5,441
140,671
16,592
71,666
15,183
2,605
32,651
24,550
208,371
13,830
272
51,197
4,002
35.6

1-yr Total
Return
(%)
39.8
70.6
34.6
5.2
42.2
55.3
63.3
15.4
43.0
46.8
62.9
65.4
14.3
35.8

Est. 2002
EPS
Growth*
(%)
nm
46.0
94.0
23.0
nm
nm
4.0
nm
2.0
nm
nm
nm
54.0
47.0

nm
nm
nm
57.3
nm
nm
52.6
nm
25.8
nm
nm
52.4
nm

P/E

Financial Information on Peers (data presented at 2001 year-end)

1.50

1.31
1.82
1.49
2.21
1.12
2.04
1.48
1.15
1.24
1.69
0.98
1.82
1.20

Beta

THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):


STRATEGY AND VALUATION

Exhibit 4

-15-

0.55

0.08
0.00
0.05
0.11
1.33
0.00
0.27
0.78
0.68
2.83
nm
0.14
0.35

D/E

18.6

ROE
ROI
(%)
(%)
0.9
0.9
3.7
3.7
5.1
4.8
26.5
23.9
44.8 17.4
74.1 57.5
4.5
3.5
21.0
9.9
32.7
19.5
54.8 13.5
nm 186.9
9.3
8.1
2.4
1.7
5.6 11.2

ROA
(%)
0.6
2.9
2.4
9.2
8.3
33.9
1.9
4.9
8.7
6.2
38.5
5.4
0.9

UV3981

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Digital Equipment
Stratus Computer
Sulcus Hospitality
Meridian Data
Texas Micro
Diamond Multimedia
Sequent Computer Sys.
Mylex
Data General
Nichols Research
Telxon Corp
Blue Wave Systems
General Semiconductor
SCI Systems
Compaq Computer
IKOS Systems

Target Name
Compaq Computer
$9,124 $9,063
Ascend Comm.
$970
$835
Eltrax Systems
$71
$71
Quantum Corp
$94
$93
RadiSys Corp
$120
$120
S3 Inc
$183
$183
IBM Corp
$809
$811
IBM Corp
$261
$258
EMC Corp
$1,410 $1,409
Computer Sciences
$401
$396
Symbol Technologies
$571
$571
Motorola Inc
$120
$119
Vishay Intertechnology
$890
$660
Sanmina Corp
$6,336 $4,812
Hewlett-Packard
$25,263 $25,175
Mentor Graphics
$115
$116
Averages $2,921 $2,793
Averages w/o DG/EMC $3,022 $2,886

Acquirer Name
0.69 34.67
1.20
9.97
1.22
nm
5.08
nm
1.44 37.63
0.32
nm
1.02
nm
1.77
nm
0.97 186.20
0.87 18.51
1.57
nm
3.24 33.19
1.37
8.74
0.55 20.88
0.62 13.51
1.91
nm
1.49 40.36
1.52 22.14

15.45
5.08
26.16
nm
24.68
nm
166.50
nm
13.68
13.93
nm
25.42
6.21
11.18
7.66
nm
28.72
30.23

32.99
na
10.90 19.1
nm 159.6
nm 168.9
34.38 68.7
nm 13.9
nm
3.3
nm 20.0
74.80 72.8
30.18
6.9
2.21 27.9
30.63 2.2
20.25 43.0
48.17 19.6
nm 18.9
nm 36.7
31.61 43.3
26.21 41.2

na
53.3
149.6
189.6
66.6
21.6
6.7
17.8
63.5
9.0
40.0
4.2
40.6
27.8
10.2
46.7
49.3
48.2

1 wk
prior

na
33.4
260.5
213.8
75.5
4.5
52.4
108.7
31.1
24.6
32.1
12.4
40.9
44.5
2.0
111.5
67.9
70.6

4 wks
prior

None
None
None
None
Lockup
None
None
None
Lockup
None
None
Lockup
None
None
None
None

Cash, Stock
Stock
Stock
Stock
Stock
Stock
Cash
Cash
Stock
Stock
Stock
Stock
Stock
Stock, Liabs
Stock
Cash

Defensive Consideration
Tactics
Offered

UV3981

* Equity Value Based on Financials. This value is calculated by multiplying the actual number of shares outstanding from the target's most recent balance sheet
by the offer price per share plus the cost to acquire convertible securities. Source: Securities Data Corporation.

01/26/98
08/03/98
11/11/98
05/11/99
05/24/99
06/22/99
07/12/99
07/27/99
08/09/99
09/20/99
07/26/00
02/21/01
04/02/01
07/16/01
09/04/01
12/07/01

Ann Date

Premium over Stock Price


(%)

Equity
Equity
Value/
Trans Equity Value/ Equity Target Equity
Value Value* Net Value/ Cash Value/ 1 day
($ mil) ($ mil) Sales EBIT Flow Net Inc prior

Deal Multiples

Information on Recent Computer-Related Transactions (completed transactions; acquisition of 100% interest)

THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):


STRATEGY AND VALUATION

Exhibit 5

-16-

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Target Name
MCI Communications
Citicorp
BankAmerica
First Chicago NBD
Chrysler
Ameritech
Tele-Communications
GTE
Amoco
Mobil
AirTouch Communications
ARCO
MediaOne Group
US WEST
CBS
Warner-Lambert
Pharmacia & Upjohn
Time Warner
Bestfoods
SDL Inc
VoiceStream Wireless
Associates First Capital
JP Morgan & Co
Texaco
Compaq Computer

Equity
Equity
Value*
Value /
($mil) Net Sales
$37,407
2.45
$72,185
2.03
$61,415
2.54
$29,421
2.86
$40,467
0.65
$62,554
3.84
$60,192
7.90
$53,451
2.19
$47,902
1.40
$78,907
1.25
$60,212
12.90
$27,224
2.52
$44,768
15.53
$46,298
3.69
$39,434
5.78
$99,710
7.71
$26,521
3.70
$164,800
6.03
$20,895
2.41
$35,172 188.09
$29,104
12.14
$30,938
2.36
$33,716
1.72
$35,993
0.78
$25,175
0.62
$50,555
11.72
$51,195
4.38
Equity
Value /
EBIT
33.46
12.40
11.38
12.96
7.26
16.50
196.07
10.95
14.57
4.82
65.45
nm
nm
15.30
62.50
38.61
31.02
27.31
15.44
1056.21
nm
4.85
10.48
10.25
13.51
75.97
25.63

* Equity Value Based on Financials. This value is calculated by multiplying the actual number of shares outstanding from the targets most recent balance sheet
by the offer price per share plus the cost to acquire convertible securities. Source: Securities Data Corporation.

Ann Date
10/01/97
04/06/98
04/13/98
04/13/98
05/07/98
05/11/98
06/24/98
07/28/98
08/11/98
12/01/98
01/18/99
04/01/99
04/22/99
06/14/99
09/07/99
11/04/99
12/20/99
01/10/00
05/02/00
07/10/00
07/24/00
09/06/00
09/13/00
10/16/00
09/04/01

Trans
Value
Acquirer Name
($mil)
WorldCom
$41,907
Travelers Group
$72,558
NationsBank
$61,633
BANC ONE
$29,616
Daimler-Benz AG
$40,466
SBC Communications
$62,593
AT&T
$53,592
Bell Atlantic
$53,415
British Petroleum Co
$48,174
Exxon Corp
$78,946
Vodafone Group
$60,287
BP Amoco
$27,224
AT&T Corp
$49,279
Qwest Commun Intl
$56,307
Viacom Inc
$39,434
Pfizer Inc
$89,168
Monsanto
$26,486
America Online
$164,746
Unilever PLC
$25,065
JDS Uniphase
$41,144
Deutsche Telekom AG
$29,404
Citigroup
$30,957
Chase Manhattan
$33,555
Chevron
$42,872
Hewlett-Packard
$25,263
Averages Total Sample
$51,364
Averages without JDS/SDL $51,790

Premium over Stock Price (%)

UV3981

Equity
Value /
Target Equity
Cash
Value / 1 day 1 wk
Defensive
Flow
Net Inc prior
prior 4 wks prior Tactics Consideration Offered
13.17
68.26 102.99 100.99
94.29 None
Stock, Liabs
10.91
19.72
7.9
10.4
19.0 None
Stock
9.80
18.81
0
0.3
2.8 None
Stock
np
19.26
26.5
38.0
34.1 Lockup
Stock
4.89
14.31
48.8
54.3
45.7 None Newly Issued Ord Sh
9.83
27.78
np
np
np None
Stock
30.55
Nm
np
np
np None
Stock, Other
6.11
23.52
2.7
2.7
4.9 Lockup
Stock
8.16
22.84
np
np
np Lockup Newly Issued Ord Sh
np
27.31
26.3
34.7
32.2 Lockup
Stock
34.77
89.74
40.6
50.2
71.5 None
Cash, Ord Sh
107.61
nm
27.2
29.9
54.4 None Newly Issued Ord Sh
47.48
31.31
12.1
13.0
22.8 None
Cash, Stock, Liabs
8.74
31.47
32.5
50.1
49.8 None
Stock, Liabs
31.88
579.92
0.1
4.0
8.5 None
Stock Type B
33.86
57.53
25.3
29.7
40.8 None
Stock
np
37.30
1.1
5.5
13.5 Lockup
Stock
15.18
84.08
70.9
55.8
70.2 None
Stock
12.95
28.51
42.3
35.7
53.3 None
Cash
781.60 1395.71
77.2
68.6
106.3 None
Stock
nm 25.4 20.3
20.2 None
Cash, Ord Sh, Liabs
nm
4.78
20.57
50.8
52.8
45.6 None
Stock
7.45
15.90
14.7
21.5
32.4 Lockup
Stock
6.92
15.55
17.7
22.6
17.5 None
Stock
7.66
nm
18.9
10.2
2.0 None
Stock
56.87
125.21 27.88 29.71
34.57
17.19
51.40 22.34 24.37
27.26

Deal Multiples

Information on Recent Jumbo Deals (Transaction Value > $25 Billion)

THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):


STRATEGY AND VALUATION

Exhibit 6

-17-

-18-

UV3981

Exhibit 7
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Compaq Triangulation Diagram

Valuation Method
Net Sales Multiple (0.5 to 1.5)
DCF (Stand-alone)
Cash Flow Multiple (6 to 26)
Latest Mkt. Price ($12.00 to $12.40/share)
LTM Mkt. Price ($12 to $20/share)

High
$50.3
$20.8
$31.8
$21.1
$34.1

Low
$16.8
$15.9
$7.3
$20.4
$20.4

Difference
$33.5
$4.9
$24.5
$0.7
$13.6

Net Sales Mult

DCF

Implied Equity Value at 2/4/02

Data source: Securities Data Corporation.

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customerservice@harvardbusiness.org or 800-988-0886 for additional copies.

-19-

UV3981

Exhibit 8
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Hewlett-Packard Triangulation Diagram

Net Sales
Mult

EBIT
Mult
DCF

Data source: Securities Data Corporation.

This document is authorized for use only by Zhi Cheng Low (nico_ocheng@live.com). Copying or posting is an infringement of copyright. Please contact
customerservice@harvardbusiness.org or 800-988-0886 for additional copies.

-20-

UV3981

Exhibit 9
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Valuing Synergies
The following description of HPs synergies valuation is excerpted from pages 60 and 61 of the joint proxy
statement/prospectus dated February 4, 2002.
[The] cost savings have a net present value of approximately $5$9 per share of the combined company calculated
by applying a range of price/earnings multiples to the estimated earnings per share impact of the cost savings in
calendar year 2004 and discounting those amounts to the present. This analysis is based on the following
assumptions:

$2.5 billion of pretax cost savings in calendar year 2004;

A range of price/earnings multiples of 1525 which is supported by the average one-year forward
price/earnings multiple for HP in the last year (20.8) and the last three years (22.2);

A discount rate of 15% which is based on the weighted cost of equity of the combined company on a pro
forma basis;

An assumed effective tax rate of 26% for the combined company, which is based upon the weighted
average of the effective tax rates of each HP and Compaq;

Marginal pretax profit decline of approximately $500 million in calendar year 2004 resulting from
estimated overall revenue loss for the combined company resulting from the merger in calendar year 2004
of approximately $4.1 billion (representing 4.5% of overall estimated revenue for calendar year 2004 of
$92.8 billion or 4.9% of estimated revenue for the fiscal year 2003), which is based upon potential revenue
loss in businesses of the combined company as follows: 18% in home PCs; 11% in UNIX servers; 8% in
business PCs; 7% in appliances; 6% in NT servers; and 5% in storage. We have assumed that our combined
imaging and printing business will not experience material revenue losses as result of the merger because
Compaq does not have an imaging and printing business. In addition, we have assumed that our combined
service business will not experience material net revenue losses as a result of the merger;

A weighted average contribution margin of 12%, which represents the marginal pretax profit decline
resulting from revenue loss. We have assumed a weighted average contribution margin of 12%, reflecting
an assumed contribution margin of 11% for the combined companys Personal Systems business (which is
expected to account for 66% of 2004 revenue loss) and 14% for the combined companys Enterprise
business (which is expected to account for 34% of 2004 revenue losses); and

Our estimate of the net present value of the cost savings resulting from the merger excludes both the cost
savings expected to result from the merger in calendar years 2002 and 2003 and the expected non-recurring
cash costs of achieving those cost savings (e.g. costs of integration) during those calendar years, as well as
the pretax profit decline resulting from estimated revenue loss in calendar years 2002 and 2003. Our
estimate of the net present value of the cost savings resulting from the merger does not account for possible
revenue increases resulting from the merger.

Based upon the revenue loss assumption described above, and a weighted average contribution margin of 12%, the
combined company would have to lose approximately $20.6 billion of overall revenue in calendar year 2004 as a
result of the merger (i.e. more than five time the amount of our assumed revenue loss resulting from the merger) in
order to completely offset our anticipated annual cost savings of $2.5 billion resulting from the merger.

This document is authorized for use only by Zhi Cheng Low (nico_ocheng@live.com). Copying or posting is an infringement of copyright. Please contact
customerservice@harvardbusiness.org or 800-988-0886 for additional copies.

-21-

UV3981

Exhibit 10
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Monthly Stock Prices

Sep-98
Oct-98
Nov-98
Dec-98
Jan-99
Feb-99
Mar-99
Apr-99
May-99
Jun-99
Jul-99
Aug-99
Sep-99
Oct-99
Nov-99
Dec-99
Jan-00
Feb-00
Mar-00
Apr-00
May-00
Jun-00
Jul-00
Aug-00

CPQ

HWP

Ratio of
CPQ to
HWP

Price Beta

Price Beta

Price

31.63
31.63
32.50
42.00
47.63
35.38
31.69
22.31
23.69
23.69
24.06
23.16
22.88
19.13
24.44
27.06
27.25
25.13
27.00
29.19
26.25
25.56
28.06
34.06

26.47
30.13
31.28
34.16
39.19
33.22
33.91
39.44
47.16
50.25
52.34
52.69
45.38
37.09
47.44
56.88
54.13
67.25
66.44
67.50
60.09
62.44
54.59
60.38

1.19
1.05
1.04
1.23
1.22
1.06
0.93
0.57
0.50
0.47
0.46
0.44
0.50
0.52
0.52
0.48
0.50
0.37
0.41
0.43
0.44
0.41
0.51
0.56

na
na
1.07
1.15
1.15
1.36
1.35
1.29
1.25
1.15
1.13
1.12
1.06
0.95
0.95
0.97
0.94
0.98
0.96
0.91
0.95
0.94
0.90
0.94

na
na
1.34
1.35
1.36
1.47
1.45
1.47
1.35
1.34
1.30
1.28
1.33
1.21
1.23
1.28
1.28
1.16
1.06
1.04
1.08
1.08
1.11
1.13

CPQ

HWP

Ratio of
CPQ to
HWP

Price Beta

Price Beta

Price

27.58
30.41
21.50
15.05
23.71
20.20
18.20
17.50
15.99
15.32
14.94
12.35
8.31
8.75
10.15
9.76
12.35
47.63

48.50
46.50
31.63
31.56
36.85
28.85
31.27
28.43
29.32
28.60
24.66
23.21
16.05
16.83
21.99
20.54
22.11
67.50

1.21
1.24
1.44
1.44
1.46
1.53
1.43
1.34
1.34
1.33
1.33
1.32
1.41
1.43
1.47
1.46
1.46
1.53

0.57
0.65
0.68
0.48
0.64
0.70
0.58
0.62
0.55
0.54
0.61
0.53
0.52
0.52
0.46
0.48
0.56
1.23

39.92 1.32

0.62

Low
8.31 0.90 16.05 1.04
Volatility 18.3%
15.4%
Proposed Exchange Ratio

0.37

Sep-00
Oct-00
Nov-00
Dec-00
Jan-01
Feb-01
Mar-01
Apr-01
May-01
Jun-01
Jul-01
Aug-01
Sep-01
Oct-01
Nov-01
Dec-01
Jan-02
High

1.04
1.05
1.25
1.28
1.37
1.40
1.40
1.33
1.33
1.34
1.40
1.45
1.55
1.54
1.55
1.55
1.48
1.55

Average 23.60 1.20

0.6325

na = not available
Data source: Standard & Poors Research Insight 7.9, a division of the McGraw-Hill Companies.

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-22-

UV3981

Exhibit 11
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Yield Curve for U.S. Treasury Bonds
Date
2/4/2002
3/14/2002
change

1 mo
1.7
1.79
0.09

3 mo
1.77
1.86
0.09

6 mo
1.87
2.06
0.19

1 yr
2.19
2.59
0.4

2 yr
2.99
3.63
0.64

3 yr
3.52
4.2
0.5

5 yr
4.29
4.83
0.54

7 yr
4.69
5.24
0.55

10 yr
4.94
5.4
0.46

20 yr 30 yr
5.57 5.35
6.05 N/A
0.48

Data source: U.S. Department of the Treasury.

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customerservice@harvardbusiness.org or 800-988-0886 for additional copies.

-23-

UV3981

Exhibit 12
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Basis-Point Spreads: U.S. Industrials to U.S. Governments (as of March 14, 2002)

Bond Rating
Term
3 Mo
6 Mo
1 Yr
5 Yr
10 Yr
20 Yr
30 Yr

AAA
40.00
37.00
43.00
48.00
67.00
17.00
74.00

AA
46.00
43.00
60.00
60.00
82.00
55.00
93.00

A
91.00
82.00
113.00
103.00
125.00
90.00
119.00

BBB
134.00
132.00
157.00
164.00
185.00
144.00
174.00

Data source: Bloomberg.

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-24-

UV3981

Exhibit 13
THE MERGER OF HEWLETT-PACKARD AND COMPAQ (A):
STRATEGY AND VALUATION
Adapted from Value Line report on Compaq, January 18, 2002
The fate of the proposed acquisition of Compaq by Hewlett-Packard is uncertain. Theresa
Brophy, analyst for Value Line Publishing, cites opposition to the deal from the Hewlett and
Packard families and the related foundations, who own 18% of the outstanding shares, as the
obstacle. The proposed deal involves a tax-free exchange of one Compaq share for 0.6325
Hewlett-Packard shares. The original value of the deal was $25 billion. Wall Street has doubts
that the deal will be completed. Consequently, the value of Compaq shares, which traded at a
12% discount in October, now trade at a 25% discount.
The concern of those opposed to the deal appears to be Compaqs unprofitable computer
business. Compaq ( = 1.5) and Dell are locked in a price war that started in 2000. Brophy states
that a post-merger Compaq will probably be stronger: Compaq would probably benefit from the
merger, as its PC exposure would fall from 48% of revenues to 33%, and it would diversity
further via the addition of HPs profitable printer business. Compaqs earnings prospects are
weaker in the absence of a merger and it seems that price discounting is extending to the server
business. In addition to the problems in the PC sector, price discounting has intensified in
industry-standard servers, which may be becoming a more commodity-like business.
Projected earnings could improve through cost-cutting measures and stronger consumer demand.
Brophy concludes by recommending that investors wait to see what happens with the merger and
for earnings to rebound before investing.

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-25-

UV3981

Exhibit 14
THE MERGER OF HEWLETT PACKARD AND COMPAQ (A):
VALUATION AND STRATEGY
Adapted from Value Line report on Hewlett Packard, January 18, 2002
In September, 2001 Hewlett-Packard ( = 1.2) announced a proposed merger with Compaq
Computer Inc. Compaq shareholders would receive 0.6325 shares of HP stock for each of their
shares. The proposed deal would position HP as the second largest company in the computer
field, surpassing Dell in the personal computer market, only behind IBM.
George Niemond , analyst for Value Line Publishing, wrote that the proposed deal does not have
universal support and since the announced proposed merger, and the price of both stocks have
declined sharply. The Hewlett and Packard families and related foundations own about 18% of
the outstanding shares and are voting against the deal. They are concerned that the combined
company would be, too heavily dependent on the low-margined commodity personal computer
market, and the deal would dilute HPs lucrative printing and imaging operations.
HPs management is fighting to complete the deal. According to Niemond, Management argues
that a merger would result in a stronger company, with an improved market position, that would
be better able to compete in the cutthroat personal computer and server industry, and that the
companies combined services businesses would provide a steady revenue stream. In addition
HP management estimates at least $2.5 billion in annual cost savings, and a 13% increase in
earnings in the first full year after the acquisition is completed. The shareholder vote could come
as soon as March.
Niemond forecasted increased demand for HPs servers as the economy recovers in the spring of
2002. Printer sales and sales of printer supplies will continue to be strong. Add that to HPs cost
cutting initiative and the result should be wider margins. In spite of these projections, Niemond
recommends waiting for the outcome of the merger before investing.

This document is authorized for use only by Zhi Cheng Low (nico_ocheng@live.com). Copying or posting is an infringement of copyright. Please contact
customerservice@harvardbusiness.org or 800-988-0886 for additional copies.