I can't recall a deal that has gotten a worse reception from holders than the recently announced merger of Hewlett-Packard (HWP Quote) and Compaq (CPQ Quote). One of the highest profile deals of the year due to its $20 billion size and the broad consumer recognition of both brands, this merger has received more column inches of coverage than any transaction in recent memory.
Coupled with the detailed presentations on the merits of the merger by H-P's Carly Fiorina and Compaq's Michael Capellas, and the massive outpouring of sell-side research reports on the implications of the deal, investors have had tons and tons of data to sort through to draw their own conclusions on the deal.
The verdict: Thumbs down.
The natural effect of risk arbitrage trading in a fixed-ratio, stock-for-stock merger such as this one lowers the share price of the bidder through the reflexive short-selling of the bidder to lock in the spread, which may account for a few percentage points of decline. Hewlett-Packard shares have, however, essentially crashed since the deal was unveiled Monday morning, collapsing by 23%.
Shareholders of both companies will vote on the merger after the proxy clears
Securities and Exchange Commission review. The target's shareholders always get to vote, and in cases where the number of shares issued is material, generally 20%, the bidder's shareholders are entitled to vote as well. If either group votes down the deal, the merger terminates. With Compaq's board having accepted a deal that turns out to be a painful takeunder, shareholders may wish they could simply turn the clock back to last Friday. Perhaps the market would once again accord Compaq shares a $12.50 valuation rather than the $10 those shares now fetch. And Hewlett-Packard holders might likewise wish for a similar outcome.
This merger is not without its regulatory risks. The companies dominate the sale of PCs through retailers. Should the U.S. or European Union regulators decide that market is relevant for antitrust purposes -- as opposed to all PC sales including the direct-sales method employed by
Gateway and
Dell -- the Compaq/Hewlett-Packard merger could run into the sort of problems that blew up the
GE/
Honeywell marriage. The merger spread, which my firm shorted at the preposterously tight level of 22 cents Monday morning (implying a 4% annualized return over 6 months), has worked its way out to $1 currently, or a more reasonable 20% annualized return.
Shareholders of both companies may, perversely, be best served by the deal being blocked by the regulators. While nothing can completely restore the
status quo ante, the perception that the deal was stymied by antitrust issues would certainly spin better than an admission by the two companies that they can't engender a favorable vote among their own holders or that worse, upon further review, the merger makes no sense. Of course, the single most important market-moving development may be the takeaway from the past two days that both companies are desperate and groping for a radical solution to their own business failings. Simply terminating the deal will not make those issues go away, making a short-term return to previous stock prices unlikely given the lasting damage caused by these tacit admissions.
Assuming the deal passes its antitrust review, could shareholders vote it down? That is sort of a loaded question. When companies know they are going to lose a vote, they simply call off the deal rather than suffer the humiliation of having to announce a losing result. Insiders at H-P own 18% of the company. Compaq inside ownership is inconsequential. Presumably those selling stock down here -- those voting with their feet -- are shifting shares into the hands of buyers who are favorably disposed to the merger. And much can happen during the four months until the votes. Perhaps the management teams can persuade holders to support their deal. But if that vote were to be taken today, it's hard to conclude that anyone would be well served by seeing this merger close.
As much as I would like to see more deals to help fill out a skimpy arbitrage calendar, this one could be DOA.
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David Brail
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