The Merger of Hewlett-Packard and Compaq (A):

Strategy and valuation

Submitted by:

Avinash Mali EPGP -06- 106

Nikita Salluja EPGP - 06 - 109
Rupal Mishra EPGP - 06 -124
Rahul Bhatnagar- EPGP 06 -117
Shivanshu Gandhi - EPGP 06 -136

The Merger of Hewlett-Packard and Compaq (A): Strategy and Valuation

1. Why would HP acquire Compaq? Is the industry attractive? What are the trends affecting the
industry structure?
Why would HP acquire Compaq ?
After Sept11, there was a slowdown and companies were undergoing a stagnant situation and
hence HP executives did not wanted to be action less and looked forward for the merger.
HP is also feared that it has reached a standstill moment and it must take some action in order to
move ahead in business.
Investors and shareholders also have been creating pressure to look out for this merger.
Compaq has certain product lines where HP is not there and can leverage on the different expertise
of both companies.

Is industry attractive ?
Industry has slowed down and there is economic slowdown in the market. However, companies are
developing on their current expertise and are innovating. IBM has recently done very well in IT
service, end to end services. Hence, all players are looking up for new avenues to create new
products and services in the market. Dell has created the innovate value chain to benefit the
customers and change the industry dynamics. There is pressure on companies to be innovative to
sustain market and economic changes.
Walter gives a perspective to be innovative in current industry situation and create synergies there
and do reach cost excellence in PC businesses.

Trends affecting the industry structure

Economic Slow Down may affect new market investments and consumer expenditures. The inflation
and share prices would also be hit due to Sept11.
There were 3 main platforms and growth was still expected. UNIX by 11% in PC businesses. So,
positivity is still there.
Investors and shareholders have been creating pressure for merger as that would increase the share
price.

The Merger of Hewlett-Packard and Compaq (A): Strategy and Valuation

2. What would a SWOT analysis of both reveal?

Strengths
1. Strong brand recognition
2. Different business excellence hence high synergy.
3. HP excellence in UNIX and high end servers.
Compaq had its unique strength of good distribution management and excellence in cost saving
techniques whereas HP had unique advantage of being innovative, high on quality and integrity.
Both the companies had good brand recognition. Both had different business excellence, HP was
good in manufacturing computers, high end servers, imaging and printing, UNIX. Compaq had
advantage in enterprise technology and solutions. Hence, both had high chance of beating
competition together.
Weakness
1. Same product lines
Very distinct focus not only in business but for employees also. HP had high vision and dreams to
make revenues and lead the IT services, however Compaq did not had a vision to be innovation and
main focus was on fierce competition by cost saving. Many product lines are overlapping and hence
conflict.
Opportunity
1. Economies of scale
2. High bargaining power with vendors and suppliers.
It seemed like Compaq accretion could cost dilution of HP image and value and work culture. Though
there were economies of scale but the thought and direction of work was given low preference.
Both the companies wished to foray in IT services field. This could well get them high bargaining
power in market with vendors and suppliers.

Threats
1. Fight for same customer
2. Not substantial effect on share price
Many product lines are overlapping and hence conflict, so in field both the companies will be
fighting with each other for one customer. The culture differences can be a big cause for further
slowdown and as is HP share prices have fallen and the merger will not be able to give it a raise, the
news itself was not perceived positively by public.

The Merger of Hewlett-Packard and Compaq (A): Strategy and Valuation

3. Was the merger strategy sound?

1. On theory, it was a sound merger. Profits by business excellence. Many business like cost
saving on PC business, UNIX edge could be of good strategic decision. Both the companies
would emerge as a giant power to compete against IBM service model or DELL distribution
network. Storage Compaqs leading position and HPs leadership in high end integration is
hopeful to bring in more profits. There were many strategic synergies.
2. Cost saving - It is mandate for any organization in IT industry to carry out innovations and R
& D, with the 2 companies coming together, the cost efficiencies will also be achieved. As
addressed by CEO of HP, the solution will be of global level.
3. Numbers were positive - The merger certainly had all the needed synergy and sounded
good. Also, the adequate steps were taken for the valuation of merger.
4. Growth Along with the two companies, vendors will also come together, 100 plus vendors
will lead to consolidation.

On the critical side,

1. The cultural differences can be a major gap area, which is under estimated now. Compaq no
fault tolerance culture and where HP has a American style of working where they learn by
creating and doing mistakes on the way.
2. Human Resource orientation is crucial The nesting and go live stage is very essential and
they must ensure to hold on to the employees. The employees lay off, where both the
companies have common function and hence those employees will create unrest in the
environment.
3. However, Walter disapproved of the merger, because the share price were not increasing
and that was where the initial thought had originated.
4. There are also conflict in Walter numbers 5.2% EBIT & 7.2% ROC were calculated.
Alternate to the earlier calculations, where 8.1% EBIT & 10.7% ROC was reported. Over
optimist picture was reported. Annual growth of over 20% was reported.
5. Weak economy may not be a good stage to plunge investment for the company and
employees. The market uncertainties would be high and hence decision making power
needs to be more than sure in such rough times.
6. Development and mapping of product lines Many product lines are overlapping and hence
managing of the same is very important. The direction from management should be very
clear else it may lead to cannibalisation within the merged company.

The Merger of Hewlett-Packard and Compaq (A): Strategy and Valuation

4. What is the value of projected synergies?

Recurring, annual, pretax cost saving as projected by management = 2.5 billion by mid 2004
Annual Pretax cost saving

Administrative/IT-Cost

$625 Million

Cost of goods sold benefit

$600 Million

Sale-Management Benefits

$475 Million

R&D efficiencies

$425 Million

Indirect Purchase Benefits

$250 Million

Marketing efficiencies

$125 Million

Total

2.5 Billion

As projected by management, these cost saving to have value of $5 to $9 per share. even
taking in to account revenue losses of 4.1 billion in 2004.

Expected an overall increase in operating margin of 8% to 10%

The Merger of Hewlett-Packard and Compaq (A): Strategy and Valuation

Projected Operating
Margin FY20013

Operating Margin
FY 2001

Enterprise systems

9.2

-3.2

Personal systems

3.0

-4.2

Services

13.7

4.5

PV = No. of shares * Share price

Therefore,
PV of HP = 1936 * 18.87 = 36532
PV of Compaq = 1689 * 11.08 = 18714.12
As given in the case, lets take discount rate as 0.15
TV = 2500/0.15 = 16666.66
PV of HP and Compaq = PV(HP) + PV(Compaq) + PV (Synergy)
= 36532 + 18714.12 + 16666.66
= 71912.71
Since Compaq has 36% share, the value of the Compaq in merger is = 0.36 * 71912.71
=25888.57
Therefore, value of synergy = EV(Compaq) PV(Compaq)
= 25888.57 - 18714.12
= 7174.45 Million

The Merger of Hewlett-Packard and Compaq (A): Strategy and Valuation

5. What is the appropriate value for Compaq ?

Valuation range of merger of Compaq can be calculated as difference between its current value and
expected value ie value with synergy.
Hence,
PV (Compaq) = 1689 * 11.08 = 18714.12
Expected Value (Compaq)

= PV (Compaq) + Synergy
= 18714.12 + 7174.45
= 25888.57

Therefore,
Valuation Range of Compaq = (18714.12, 25888.57)