January 25, 2002 1:20 PM PST

Capellas: HP deal is a "winning hand"

NEW YORK--In the hunt for shareholder support for the merger between Hewlett-Packard and Compaq Computer, Michael Capellas has picked up the elusive trail of investors who might be inclined to say "Aye."

The Compaq CEO, speaking at the company's annual meeting for investors and analysts in New York, said he thinks that the company's largest shareholder, Putnam Investment Management, is behind the deal.

"They will not tell us point blank, but it is my belief that they are favorable," he said.

The merger proposal, despite widespread criticism of it, will stand on its own merits, with the keys being strategy and profitability, Capellas said.

The companies "have the winning hand," he said.

Capellas was responding to a question about David Woodley Packard's slamming of the merger in an advertisement in The Wall Street Journal on Wednesday. A footnote to the ad acknowledges that Packard worked at HP for three summers in the late 1950s.

"I am happy to hear that he was an intern, but when all is said and done the merger will depend on the strategic vision and whether you can make money at it," said Capellas, adding that institutional and individual investors will weigh the deal on its merits.

Armed with a bevy of slides, Capellas outlined the combined companies' product roadmap and said that HP and Compaq ?can cover the entire market with little overlap.?

In a question-and-answer session, Capellas and executives sounded ready to let shareholders decide on the deal. Capellas said the merger vote will take place March 28 or earlier. He added that he will meet early next week with Institutional Shareholder Services, a key player in the proxy fight, and said he will also get together with other big shareholders shortly. HP's Carly Fiorina met with ISS this week.

Capellas acknowledged there were challenges with the merger, but he said he was pleased with the planning process.

See special coverage: Big iron: HP to buy Compaq In response to criticism that tech mergers never work, Capellas said "there's no reason to believe that the consolidation of other industries can't happen here."

"It is the maturation of the tech sector," he said. "I don't think we are so different anymore, although some people may not want to admit it."

The European Union is expected to hold a hearing about the merger on Feb. 1, Capellas said, expressing optimism that the EU would view the deal favorably.

Capellas laid out Compaq's goals for 2002, which include building on the company's efforts in enterprise software and services, and striving to make its PC business profitable. The CEO said he was cautiously optimistic about a recovery in the economy and the information-technology sector.

The analysts' meeting comes at an interesting time for Compaq. The PC and IT giant is attempting to show it can survive as a standalone entity while stumping for its proposed $25 billion marriage with HP. Simply put, Compaq is playing both angles.

The company projected revenue growth of 1 percent for 2002, specifically revenue of $34 billion and earnings of 32 cents a share. "If the market does better or we do better, there is upside to this guide," said Compaq Chief Financial Officer Jeff Clarke.

Meanwhile, HP is in a battle with some of its shareholders to approve the proposed merger. The disagreements between HP and heirs David Woodley Packard and Walter Hewlett has aired almost daily in regulatory filings, press coverage and newspaper ads.

For its part, Compaq has been trying to stay above the fray and convince analysts that the company is on track. Last week, the Houston-based company delivered a surprise fourth-quarter profit, topping earnings estimates courtesy of strong server and services sales.

The implicit message of the meeting is that the company can thrive even if the HP deal collapses. Compaq's top executives will be available throughout the day to discuss key topics such as adaptive infrastructure, enterprise storage, and access and services, which the company has touted in recent days, trumpeting a 28 percent jump in outsourcing bookings.

A healthy Compaq, a healthy merger
Analysts also cited another motive for Compaq's efforts to woo Wall Street. If the company can show it has its financial ducks in a row, it can help HP by squashing worries about the merger, analysts said. One of the key criticisms of the HP-Compaq merger is that HP's earnings would be exposed to the cutthroat consumer PC business, where Compaq is a big player.

Following Compaq's earnings report, a slew of analysts noted that the company's performance in the fourth quarter may indeed make it easier for HP to sell the merger. In fact, a few analysts didn't even mention HP in their research notes when analyzing Compaq's earnings report.

"Compaq had more than enough incentive to report an upside surprise in December in view of the backlash of the Hewlett and Packard families to HP's proposed acquisition," Needham analyst Charles Wolf said in a recent research note. "Although we still assign a low probability that HP's shareholders will approve the merger, Compaq's upside December increases the chances that they will."

Wall Street observers agreed with Wolf's conclusion and acknowledged that that Compaq has been executing well.

"We supported the merger coming in today, and now we are further convinced," said one hedge fund manager and Compaq shareholder. "I think the sentiment about this deal is shifting. Alliance Capital is supporting the deal and the sell-side analysts seem to be much less negative."

The resistance from Walter Hewlett and David Packard should be discredited because they don't have the analytical framework to understand the merger, the hedge fund manager said.

"The fact is that the PC industry is maturing and (Walter) Hewlett and (David) Packard are hanging on to the collegial vision and romantic attachment to the old HP," he said. "That is nice, but the tide has shifted."

James Poyner, an analyst with C.E. Unterberg, Towbin, said that Compaq is setting itself up well no matter what happens with the HP deal. He said though the odds are low that the HP deal will pass, Compaq's stock price can gain if the company continues to deliver. If the merger goes through, Compaq can also gain, he added.

"At this point, the stock looks like 'heads you win, tails you win,'" he said.

Compaq and HP executives are meeting every Wednesday to hash out the integration, alternating between HP's headquarters in Palo Alto, Calif., and Compaq's Houston base.

Compaq spokesman Arch Currid said that the companies' integration team, led by the president of HP's business customer unit, Webb McKinney, and Compaq's Clarke, has made a lot of progress and hopes to integrate the companies quickly much in the way HP split off Agilent Technologies in just a few months.

"The progress they have made is just incredible," he said. "The plans are advanced." Among other topics covered at the meeting:

 Compaq is aiming to sell 65 percent of its industry standard servers direct in 2002.

 The company said its storage unit is focusing on providing management software. Compaq currently gets 10 percent of its storage revenue from software but is targeting 25 percent over the next few years. There was some buzz at the meeting about a potential tracking stock for the storage unit, but Capellas said that would not make sense; he said the storage unit should remain a part of Compaq.

 Compaq said its migration to Intel's Itanium chip is on track for its high-performance computing products. However, that migration may take awhile. The company plans to update its Alpha chip and release three iterations of its Himalaya server before migrating to Itanium in 2004.

 The PC unit will focus on cutting inventory while pushing its direct sales through its Web site and retail kiosks. Roughly 30 percent of Compaq's consumer PC sales are direct. The company predicted its PC business should be profitable in the third quarter.

 

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