HP vs. Compaq: the 100,000 foot financial view

Here are three extracts from a September 4th, 2001 New York Times story about HP's plan to acquire Compaq:

Investors in both Compaq and Hewlett-Packard have suffered in the current decline in technology stocks, although Compaq's woes have taken a greater toll. That stock is down 76 percent from its peak, reached in early 1999, while Hewlett-Packard is off 66 percent from its peak, reached last summer.

Combined, the company will have about 145,000 employees, after layoffs announced earlier this year are completed -- 8,500 jobs at Compaq and 9,000 jobs at Hewlett-Packard. Further reductions seem likely, as the companies said that they expected annual cost savings of $2.5 billion by the middle of their fiscal year in 2004.

In its most recent 12 months, Hewlett-Packard reported revenues of $47 billion, while Compaq had revenues of $40 billion. The combined $87 billion is close to the $90 billion reported by I.B.M., and far above the $33 billion for Dell Computer, which now ranks fourth and would move to third if the merger is completed.

In its latest financial report, for the nine months through July, Hewlett-Packard said its net income fell 82 percent, to $506 million. Compaq, reporting on the six months through June, said it suffered a net loss of $201 million for the period.

Compaq had hoped that Digital Equipment technology would provide a competitive edge in the new generations of computer servers. But it recently chose to not use that technology, known by the Alpha name, and instead go with the technology developed by Hewlett-Packard and Intel in its new servers.

In reality Compaq bought DEC's service organization as a favor to Microsoft, but that's another story - what's important here is that when the deal finally closed in May of 2002, HP's shares had fallen to the point that the total value received by Compaq's shareholders was only $19 billion instead of the promised 25.

But what's happened since?

The answer is simple: HP's imaging division grew its revenue by more than $7 billion between 2001 and 2006 while HP's consolidated revenues rose by only about $5 billion over the period - meaning that the non imaging businesses are smaller now than they were at the time of the merger.

The printing business also became more profitable: sending 14.9% of its revenues to earnings from operations in 2006 versus only 10.2% in 2001 while the other businesses have yet to recover to their year 2000 levels.

For 2000, the last full year before the merger announcement, HP was slowing but Compaq reported year over year revenue growth in the 10% range. Here's a bit from the press release:

Revenue for the year ended December 31, 2000, totalled $42.4 billion, an increase of 10 percent over the prior year, or 15 percent in constant currency.

Net income from operations was $1.7 billion, up more than three-fold over the prior year. Including non-recurring items, net income for the full year was flat with last year at $569 million, or $0.33 per diluted common share.

"While market conditions will be difficult in the first half of the year, we will continue to differentiate ourselves by developing innovative products, integrating them into solutions and serving the global market," Capellas continued. "The importance of information technology continues to grow, and customer acceptance of our offerings is high.

"For the full year 2001, we are comfortable with analyst estimates of earnings per share growth in the 20 to 25 percent range," he said.

Of course most of that preceded the dot dumb burst, but if they'd recovered to that growth rate after the 2001 setbacks, Compaq today would be just about exactly where HP, stripped of its imaging and printing division, is.

What these numbers suggest to me therefore is that the merger effectively destroyed every cent of HP shareholder value outside the imaging division -a bottom line every shareholder and manager affected by Wall Street's expectations should be concerned about as merger mania continues to drive consolidation in our industry.

Oh, and if you're into the wildly speculative: if HP had IPO'd its imaging division instead of acquiring Compaq: total shareholder value would probably be four to six times what it is now, HP would still be a viable PA-RISC/HP-UX based competitor to Sun, the imaging company would be the size of Dell, and what you see as HP today would still be operating under its real name: Compaq.