S&P Downgrades HP Debt, Cites Compaq Merger Risks

Standard & Poor's Thursday cut Hewlett-Packard Co.'s long- and short-term debt ratings because of risks arising from the company's proposed merger with lower-rated rival Compaq Computer Corp.

The downgrade prompted a quick response from the Palo Alto, California-based computer and printer maker, which said it is "disappointed" with the rating agency's decision.

Hewlett-Packard faces a March 19 shareholder vote on the bitterly contested all-stock merger, which is valued at nearly $22 billion.

S&P cut HP's senior unsecured debt three notches to "A-minus," its fourth-lowest investment grade, from "AA-minus," and its short-term debt rating two notches to "A-2" from "A-1-plus." It warned of the possibility of further downgrades.

It rates Houston-based Compaq's senior debt "BBB," two notches below Hewlett-Packard's new rating.

"While the merger offers the scale and market positions in hardware that could lead to greatly improved profitability, the execution risks are significant," S&P analyst Martha Toll-Reed said in a press statement.

Led by Chief Executive Carly Fiorina, Hewlett-Packard already faces opposition to the merger from Walter Hewlett, a son of company co-founder William Hewlett. He has assembled a bloc of roughly 20 percent of shareholders to oppose the deal.

The company, however, got two boosts this week: On Wednesday, it won Federal Trade Commission approval for the merger, and a day earlier, the influential Institutional Shareholder Services advisory firm endorsed the link-up.

In its downgrade, S&P said the merger has "strategic validity" that can improve the combined company's market position. Hewlett-Packard also enjoys a "strong financial profile and balance sheet" for an "A-minus" company, it said.

"However," it added, "these positive factors are offset by the heightened level of operational and strategic execution risk inherent in a merger of this size in the highly competitive and rapidly evolving technology market."

S&P said even had Hewlett-Packard not announced the merger, its ratings would have fallen to a "comparable" level. If the merger is completed, S&P said it will affirm Hewlett-Packard's new ratings with a "negative" outlook.

Responding to the downgrade, Larry Tomlinson, Hewlett-Packard's treasurer, said the merger "addresses many of the issues raised by S&P" and creates a "healthy PC business capable of generating significant cash."

Though it remains rare, companies are more often responding publicly to negative actions by credit rating agencies, which can boost their borrowing costs and weaken investor sentiment. Other companies to respond to such actions in recent months have included software maker Computer Associates International Inc. and tire maker Goodyear Tire & Rubber Co.

Moody's Investors Service rates Hewlett-Packard's long- and short-term debt "A2" and "P-1," one notch above S&P's new ratings.

Hewlett-Packard shares traded Thursday lunchtime on the New York Stock Exchange at $20.04, down 14 cents. They have fallen about 14 percent, from $23.21, since the merger was announced Sept. 3.