March 5, 2002 5:40 PM PST

ISS merger verdict draws wary response

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HP-Compaq: A fight to the finish

March 10, 2002
Institutional Shareholder Services' decision Tuesday to recommend that its clients support the hotly contested merger between Hewlett-Packard and Compaq Computer drew a lukewarm response from investors and a cautious outlook from HP and Wall Street.

Several HP institutional shareholders who reviewed the ISS report, which recommended voting for the deal, said it doesn't push them any closer to making a decision.

"It seems to be a recapitulation of what both sides said...but not very convincing on the analysis side," said Jerome Dodson, president of Parnassus Investments, which owns 170,000 shares of HP, or less than a 1 percent stake. "It seems like they were on the fence as much as I am but came down on the other side of where I'm leaning. ISS offered no rigorous reasoning or insight into the reasons for their decision."

Parnassus' lackluster response comes as the hotly contested merger--a $22 billion deal that would mark the largest ever in the technology industry--approaches the March 19 HP shareholder vote that will decide its fate. The reaction is somewhat anticlimactic given the hype surrounding the decision by ISS, which advises roughly 23 percent of HP's institutional investors.

Dodson, who expects to make a final decision by Friday, said his firm held off on casting a final vote until the ISS's recommendation was released because it wanted to have as much information as possible before reaching a conclusion.

He said his current opposition centers on HP's potential integration problems with melding two computer giants. He said he's also concerned that the merger could dilute the value of HP's highly profitable printing and imaging business.

State Street is another investor that has yet to make up its mind on the mega-merger. The investment company's decision holds significant weight, given that it has a 2.4 percent stake in HP.

"Before the ISS vote, I was giving the merger a 40 percent chance of success. Now I believe they are modestly above 50 percent."
-Charles Wolf, Needham & Co. analyst
"We're a subscriber of ISS and will consider their recommendation. But it won't be particularly weighty in our final decision," said John Serhant, chairman of State Street's investment committee. "We vote our own shares, and while some of our competitors abdicate their responsibility, we don't."

State Street expects to make its decision in the final days leading up to the HP shareholder vote. Compaq investors, including State Street, will vote March 20.

While ISS's decision is good news for HP, Serhant, analysts and the companies themselves note that the merger is far from a done deal. After all, HP director Walter Hewlett and other Hewlett and Packard family members, along with their respective trusts and foundations, plan to vote their roughly 18 percent stake against the merger.

"Before the ISS vote, I was giving the merger a 40 percent chance of success," said Charles Wolf, a Needham & Co. analyst. "Now I believe they are modestly above 50 percent. ISS could potentially influence 23 percent of HP's shareholders, but the clients are not obligated to follow ISS's lead. On the other hand, we know at least 18 percent of the vote is against the merger. So, in essence, the ISS decision offsets the two foundations and puts us back to square one."

Carly Fiorina, HP chief executive, also acknowledged that the ISS decision doesn't make the merger a slam dunk.

"I think the momentum is clearly moving in our favor," Fiorina said Tuesday in a conference call. "While the ISS recommendation helps, the only thing that seals this deal is a share-owner vote."

HP plans to continue with more institutional investor meetings in the next two weeks, Fiorina added.

"Certainly we are pleased that ISS, who is truly an independent expert, recommended today that this merger serves the best interests of our share-owners," Fiorina said. "This is a significant vote of confidence in the strategic logic of the combination, the economic logic of the combination, as well as the thoroughness of the evaluation undertaken by our board and the integration planning undertaken by hundreds of HP and Compaq people."

But Hewlett, HP director and merger opponent, said the analysis ISS had to conduct in this instance was outside the firm's normal purview.

"ISS has primarily advised its clients on matters related to corporate governance," Hewlett said in a statement. "ISS clearly has a predisposition to support management and makes a general presumption that boards do the right thing. In the post-Enron world, it is obvious that these assumptions need to be questioned."

Hewlett added that many ISS clients have told him they are independently evaluating the merger proposal, and he believes they will vote against it.

Who's really listening?
Ashok Kumar, an analyst at U.S. Bancorp Piper Jaffray, said ISS tends to have the greatest impact on index funds, which track a financial benchmark such as the Standard & Poor's 500. Such funds make up approximately 9 percent of HP shares.

"Never in history has a company been able to buy itself out of mediocrity," Kumar said. "The only guys who will make out on this deal are the bankers and the lawyers."

One small HP investor made its intent public Tuesday. ITUG, a user group that represents customers of Compaq's high-end NonStop Himalaya servers, announced plans to support the merger.

The group voted in favor of the deal because it would raise the profile of the high-end Tandem line, ITUG said. ITUG owns a tiny fraction of the total shares involved--about 1,400 HP shares and 1,000 Compaq shares, according to spokeswoman Amy Goetz.

But the endorsement is symbolically important. ITUG represents more than 800 customers of the ultra-high-end Tandem machines, which run critical computing tasks such as the New York and Tokyo stock exchanges.

"Aligning the research and development programs and marketing resources of Compaq and HP that are focused on enterprise services will result in increased market awareness for the NonStop platform," ITUG Chairman Yves Rouchou said in a statement.

One crucial nod for the deal that HP and Compaq are still awaiting, outside of the shareholder votes, is approval from the Federal Trade Commission.

"We are expecting to hear something any day now, but we have not heard anything yet," Fiorina said.

 

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