December 7, 2001 4:40 PM PST

Packard Foundation opposes HP-Compaq

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In a blow that could derail Hewlett-Packard's proposed $25 billion takeover of Compaq Computer, the David and Lucile Packard Foundation reached a preliminary decision Friday to oppose the deal.

"The board of trustees understands the strategic considerations being addressed by management, but after thorough study and analysis the board has preliminarily decided, on balance, that the best interests of the foundation would be better served by Hewlett-Packard not proceeding with the proposed transaction," Packard Foundation Chairman Susan Packard Orr said in a statement.

The foundation holds a roughly 10 percent stake in HP, meaning that 18 percent of HP shares have now been pledged against the merger.

Walter Hewlett, an HP board member and the son of co-founder William Hewlett, and David W. Packard, son of HP co-founder David Packard, previously said they will oppose the deal. In total, family members opposing the deal hold nearly 8 percent of HP's shares.

Despite the setback, HP and Compaq reaffirmed their commitment to completing the merger.

"Over the coming weeks, we'll continue to provide additional information to shareowners about the merger, and we believe they will increasingly understand its benefits," an HP representative said.

The Packard Foundation's move also doesn't bode well for HP CEO Carly Fiorina. Some analysts have said they don't expect Fiorina to remain as CEO if the deal fails.

Fiorina has been outspoken in support of the merger, and in a recent letter to employees, she lashed out at the media and at analysts who oppose it.

If the Compaq acquisition does not go through it would be the second failed deal for Fiorina. HP had been in talks to acquire the consulting business of PricewaterhouseCoopers, but later abandoned the plan.

Hurdles ahead
To get the Compaq merger approved, HP needs to win more than 50 percent of the shares in a vote scheduled to take place at a special meeting of shareholders in the first half of next year.

Walter Hewlett praised the Packard Foundation's move in a statement and formally committed to soliciting proxies against the deal should HP and Compaq put the matter to a shareholder vote.

"I am confident that partnering with Compaq will not give Hewlett-Packard what it needs most to create additional stockholder value: expansion of its printer and imaging and higher-end server and services businesses," he said in the statement. "The combination would dramatically increase the company's exposure to the unattractive PC business, while reducing stockholders' interest in the profitable printing and imaging business by over one-third."

Hewlett had already hired a proxy solicitation firm and filed documents with the Securities and Exchange Commission indicating he might solicit proxies. But until now, he had not formally committed himself to waging a proxy battle.

David W. Packard declined to comment on the foundation's decision.

"This is definitely an enormous blow to the deal, and I think it will be very diffcult for HP to recover," Sanford Bernstein analyst Toni Sacconaghi said of the foundation's vote. "Not only is the momentum against them from both families coming out against it, it is a blow" because of the number of shares the foundation controls, he said.

Terry Shannon, a longtime Compaq watcher and author of the "Shannon Knows Compaq" newsletter, agreed.

Although there's still a possibility that a majority of shareholders could vote in favor of the merger, he said, the situation doesn't look good for the deal. "Today's action by the David and Lucile Packard Foundation may well render Dec. 7 Pearl Harbor Day for the proposed acquisition," he said.

Added Dan Niles, an analyst with Lehman Brothers, "You'd have to say the deal's on life support."

A psychological blow
The Packard Foundation's importance goes beyond the size of its stake, said John Heath, executive vice president for The Brenner Group, a San Francisco-based firm that provides financial advice to corporations.

"In terms of percentage ownership, they're not that great. But psychologically, it's a pretty negative vote," Heath said. "It's a pretty strong condemnation...It's going to be tough to overcome that."

On Nov. 6, Walter Hewlett said that he, two sisters and a family foundation would oppose the deal. David Packard announced his opposition a day later, saying that his foundation, the Packard Humanities Institute, was unlikely to approve the deal.

Assuming the Hewletts and both family foundations vote against the deal in the end and assuming just 25 percent of individual shareholders who vote oppose the deal, then one analyst estimates that HP needs a whopping 61 percent of institutional investors to vote in favor of the deal for it to pass. By contrast, if the Packard Foundation favored the deal, only 42 percent of institutional investors would need to approve the deal, estimated Joel Wagonfeld, an analyst with Banc of America Securities.

The proposed takeover of Houston-based Compaq was announced on Labor Day. At the time, the deal was valued at $25 billion. After the announcement, the deal's value plummeted as HP shares tumbled. However, HP shares have been recovering along with the general market recently, returning the value to the $25 billion range, based on where the stock was trading Friday.

Pessimism among investors surrounding the deal's chances of survival had led to a large spread between Compaq's share price and the value of the HP shares that Compaq shareholders would get if the deal went through. Compaq shareholders are supposed to receive 0.6325 HP shares for each share of Compaq.

At one point after Walter Hewlett came out against the deal, Compaq's shares were trading nearly 60 percent below the comparable amount of HP stock they would represent once a deal closed. However, that gap has narrowed and was about 33 percent before Friday's trading, according to a Sanford Bernstein report.

The spread widened after the close of trading Friday as investors sent HP shares up and Compaq shares down. Compaq share prices dropped 12 percent in after-hours trading to $10 from a closing price of $11.32. HP shares rose 6 percent after hours to $25.01 from a close of $23.52.

Critics of the HP-Compaq deal have abounded since it was announced in September. Heath asserts that HP and Compaq let the deal's opponents seize control of the media. "I don't think that HP has been as vocal in the public press on the positives of this transaction as they could have been," he said.

In the near term, shares of Compaq and HP should benefit if the deal is canceled, said Niles, who believes Compaq is worth $13 a share based purely on the company's value as an independent entity. HP shares probably won't rise as much, Niles said, because the collapse of HP-Compaq would probably result in the departure of Fiorina and Chief Financial Officer Robert Wayman--thus creating new uncertainty about HP.

"Obviously, their vision and the vision of the shareholders are completely different," Niles said. "And this is a really tough time to be a rudderless ship."

Staff writer Sergio Non and News.com's Dawn Kawamoto and Michael Kanellos contributed to this report.

 

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