HP, Compaq Deal Now in Hands of Adviser

NEW YORK – The fate of the largest computer merger in U.S. history now rests largely on a small Maryland firm charged with advising some of the nation's largest index and public pension funds.

Hoping to salvage their much-maligned merger, Hewlett-Packard Co. and Compaq Computer Corp. have stepped up preparations for several crucial meetings with analysts at Institutional Shareholder Services, likely to take place next month.

Merging companies typically place a great deal of weight on such meetings since ISS recommendations influence the voting habits of some of the largest U.S. stockholders.

But for Hewlett-Packard and Compaq, ISS' recommendation takes an even greater sense of importance following last Friday's events -- when HP's largest shareholder, the David and Lucile Packard Foundation, joined other members of the firm's founding families and said it would vote against the deal.

"We would liken the (merger's) prospects to the (best-of-seven-games) World Series in which proponents of the deal have lost the first two games and are behind in the third,'' said George Elling, a Deutsche Banc analyst, in a research note. "From here, HP and Compaq management can still get the merger done, albeit it will be more difficult.''

ISS will not make its formal recommendation on HP/Compaq until two or three weeks before the official shareholder vote. The companies have not yet announced that date, in part because they are trying to wrap up various regulatory approvals first, but it is expected to be some time late in the first quarter.

FAMILY MATTERS

The companies have already been in communication with ISS informally, however, and are supplying the firm with data supporting the merger, sources said.

Still, in a series of meetings Friday night after the Packard Foundation released its decision, executives of both companies concluded the odds still favored getting the deal approved, according to sources close to the discussions.

While the Hewlett and Packard families control roughly 18 percent of HP's outstanding shares, slightly more than half of the company's shares are in the hands of institutional holders, which tend to be more influenced by a merger's strategic rationale than emotional issues, such as job losses.

The Packard family has opposed the merger because they believe it will create a less stable asset and dilute the company's traditional printing franchise by injecting it into the lower-margin personal computer market and competitive computer services market.

The companies, however, contend the deal will give the company better depth long-term, particularly if it is able to grow the services unit and focus more on high-end computers.

Since HP and Compaq need only to have a majority of the voting shares approve the merger, the executives decided they could still win approval, sources said.

An essential component to winning those votes, however, is a thumbs-up recommendation from ISS, which serves more than 700 institutional clients worldwide. About half of those clients, including several that hold Hewlett-Packard or Compaq shares, either let ISS vote their shares or are greatly influenced by the Rockville, Maryland-based group's recommendations.

A HORSE RACE

"The belief is if we win ISS, then it's a horse race again,'' said one source familiar with the companies' thinking.

Indeed, the strongest source of optimism lies in ISS' methodology, which places great weight on a merger's rationale and the board's diligence putting it together.

"At the top of the list for us always are ... the economics of the deal itself. Does this deal make sense?'' said Patrick McGurn, director of ISS' corporate programs. "Our horizon is probably mid-term. We're not looking 10 years down the road, but we aren't looking a quarter ahead either.''

On that point, Hewlett-Packard and Compaq are confident they can win. Even the Packard Foundation, several executives note, said it understood the deal's strategic rationale.

ISS also almost always supports friendly mergers, proxy experts said. When deals are contested or become hostile, the odds of a positive recommendation drop to about half.

LEAP OF FAITH?

Some analysts argue the deal's hurdles may be higher than the firms think.

Bear Stearns analyst Andrew Neff said Monday he believes ISS' decision would be based partially on a Booz Allen analysis the foundation used to decide against the deal.

And, there is no guarantee the institutional clients will follow ISS' lead this time. ISS is thought to have direct influence over between 10 percent and 15 percent of Hewlett-Packard's shares and influence over a "significant minority'' on top of that, according to two sources.

But many, given the merger's high profile, may make their own decision, regardless of their arrangement with ISS.