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HPQ Deal Premium Analysis

We firmly believe that HP ended with paying huge premiums which it could have diverted to growth of its current businesses.

HPQ Pre Merger (Criticism)

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HPQ deal structure indicated to a hefty premium of 47.7 times the P/E ratio Compaq s share price. Under current terms the HPQ deal would have structuring based on HP shares given 17.2 times the P/E ratio when compared to Compaq which was in considerably poorer state compared to HP. The deal was not only over valued but due to lack of historical precedent of successful technological mergers was a huge risk.

The Deal Structure


Structure: Stock-for-stock merger Exchange Ratio: 0.6325 of an HP share per Compaq share Value: Approximately $25 billion Ownership: HP shareholders 64%; Compaq shareholders 36%.

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The above deal had a negative NPV indicated the poor structuring of the deal. The realistic case involves costs to bring about cost savings which will eventually lead to dilute the said cost savings. Given the merged entity will not soon able to grab a string foot in the PC or the Consulting Arena the P/E factor also would not help the cause of HPQ.

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Compaq s sale from direct selling model is still a modest 21% when compared to industry leader Dell. The operating expenses for Compaq are high when compared to Dell and will add the burden on the bottom line of HP who is already facing concerns itself.

HP-Compaq Post Merger


Ratio Analysis

If we compare Gross profit margin of HP and COMPAQ with Gross profit of the company formed as a result of the merger itself, one can come up to obvious finding. The market where companies operate is competitive enough to keep direct costs at very competitive level. It is clear that even after such powerful merger as HP-COMPAQ companies were not able to get synergy effect at their direct production materials (bargaining power over suppliers) and direct labor (bargaining power over professional labor force market) level. On the other end companies were able to achieve economies of scale in operating expenses. After initial deterioration of Operating Profit margin (-1% in 2002) (which can be considered as normal at the beginning of post-merger period. Company started to recover its profitability starting from 2003 and achieved 5% operating margin in 2004.

Analysis of Profit Margins

Positive outcomes of the given merger can be accessed based on the Profit Margin time series analyses. Starting from 2001 (COMPAQ Profit Margin 2000 was equal to 1.3%) through 2004 company managed to increase its profitability from zero to 4%. Considering the difficulties caused by the merging of two companies cultures and financial operations company managed to recover from negative profit and to add 4% equal economic value to company shareholders pocket in 2004.

Analysis of Fixes Asset Turnover

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Positive synergy can be observed analyzing the Fixed Asset Turnover ratio of the PostMerger HP. Understanding the necessity of growth that is not always equivalent to taking away market share from competitors, creating economic profits, and providing returns to shareholders HP and COMPAQ still decided to unite their Assets and to strive for leading place on the market. By affectively using united fixed assets companies managed to maintain and increase turnover of production plant and equipment (in year 2000 10.9 and 11.8 fixed asset turnover was reported by HP and COMPAQ).

Analysis of Return on Assets

Efficient usage of total assets preserving fixed cost stability is evident from company s Return on Assets employed. After the merger HP achieved increased profits by maintaining stable financial leverage (stable fixed costs). Return on Equity (ROE) has always been the best measure of Merger success. Chart presented below compares ROEs of HP and COMPAQ before merger and continues with Post-Merger company ROE performance. We see that after 2002 negative performance company overwhelmed pre-merger profitability and started to generate two times more value for existing shareholders.

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Cost Savings
The deal promised a cost cut of $2.5 billion for the merged entity. This figure has been reached following the process below:-

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Savings through Layoff of 15,000 employees:- $1.50 billion Savings through restructuring of material :- $ .45 billion Procurement Savings achieved through consolidated :- $ .20 billion Manufacturing Savings through savings on R&D :- $ .35 billion Total Savings $ 2.5 billion

The merger promised the above cost savings but majorly succeeded through layoffs. This was just a onetime saving and HPQ planned to save costs in the following fields in the long run y y y Increase the procurement savings to the tune of $ 1.3 billion over the period of 3 years. Increase the savings through unified product development to the tune of $ 400 million Use of multiple manufacturing sites more strategically leading to cost savings of up to $150 million.

Conclusions
y Although the board members criticism were not unfounded and HPQ merger has still to achieve the promised heights and targets. But also the growth and the increase in profit margins, decrease in direct costs have showed the determination of the leadership to make this merger work. The HPQ as an entity has still a lot of potential synergy it can tap and can achieve greater growth and dominant position among its peer,

HPQ deal has not been a fairy tale but neither has it been a disaster (As most pundits had predicted)