Merger and Acquisitions

MERGER AND ACQUISITION(HP & Compaq case)

BY

BILAL NASEEM JANJUAMBA- MARKETINGUNIVERSITY OF WALES

MANAGING THE EXTERNAL ENVIRONMENT (WAMB-4002) 2010

FINANCIAL INTRODUCTION:

Merger and acquisition is a wide term used to explain the phenomenon of expansion that

most of the firms undergo these days. From the beginning of 21 st century most of the

countries fell into the deepest trenches dug by credit crunch. Bearing the effects of

shortage of money in the economy could not allow companies to hold their assets; as a

result most of them either dissolved or go for mergers or acquisitions by larger firms. It

has reached almost every continent of the world and the worst was reported in United

States of America and United Kingdom.

STAGES OF BUSINESS:

1. Survival

2. Break Even

3. Make profit

4. Profit maximization

5. Growth

SURVIVAL:

The very beginning stage of any business launch is the survival stage. At the launch of

the business the first thing focused by company is its sales. During this process threat for

competitors also exist in the market. A research has been conducted in the USA market

resulted that out of every 100 business 80 fail at their first stage that is development of

the product. At this stage companies need very strong advertisement and comparatively

high cost structure.

BREAK EVEN:

After survival stage comes the break even stage. This is the stage when company is

moving towards leveling their cost and revenue structure. It is also considered as the

projection stage for the company towards changing strategy and moving themselves

towards profit.

1 Copyrights Reserved: BILAL NASEEM JANJUA (21133)


MAKE PROFIT:

Making the profit is the next achieving target. Growth for the company starts and more

opportunities opens here. Product has been accepted by the market and company is in a

position to face the competition. Revenue comes to the company and utilized in further

expansion, research and development and to attack the market with different strategy.

Company is comparatively at a safer and secure position in the market.

PROFIT MAXIMIZATION:

Profit maximization refers to the output quantity, in which we determine as to apply the

resources and take maximum out of it. According to (bilal 2009) the difference between

total cost and total revenue gives the total profit figures. This is the maturity stage for the

company when the company is at its boom. Lot of revenue is trickling into the company.

Basically the sales of the company has been increased so far that most of the companies

go for economies of scale; where the unit cost of production has been reduced.



GROWTH

Internal growth

Internal growth is referred to the expansion in the productive capacity. This can be done

by adding new plant or expansion done to the existing plant but the process remains the

same.

External growth

Business grows by merging with other companies. It does go for the expansion but on the

large scale for instance taking off the stocks of other company, merging the departments

of the two companies. Mergers can be done technologically, financially, customer base

wise, acquisition of other company outlets and many more. Interestingly, whenever we

talk about internal and external growth many other different paths diverge out while

doing a business. Our major concern throughout this learning objective will be focused to

the external expansion / growth phenomenon.

TYPES OF MERGERS AND ACQUISITIONS:

Vertical mergers

Horizontal mergers

Congiomerate mergers

Diagonal mergers

Vertical Mergers

Same industry + different level of production = vertical merger

Horizontal Mergers

Same industry + same level of production = horizontal merger

Congiomerate Mergers

Different industry + different level of production = congiomerate mergers

Diagonal Mergers

New product or service line + using current distribution channel = diagonal mergers



HP & Compaq Grounds:

The merger of HP and Compaq is a very good example of “Horizontal Mergers”. HP is

one of the leading computer and printer technological company whereas Compaq has

almost the same profile. They may differ in some products line but their core is the same

that is computers industry. Both companies operate in the market with a distinctive

image, and the worth is excellent. HP & Compaq belong to same industry and have the

same stages of production that’s why this merger is called horizontal merger. Other

statistics disclosing the facts about the company’s merger will be discussed in rest of the

project.

Company Introduction:

Bill Hewlett and Dave Packard were the founders of one of the Technological giant

companies in US, Hewlett Packard. The company started its business in 1939 with the

product of an electronic test instrument used by sound engineers. Its business has been

expanded to 170 countries having 371,000 employees as their workforce all over the world. In

2009 HP’s ranking in fortune 500 company is 9 th. Revenues is coming and company is enjoying

good place in the market.

Another marvelous invention made by Rod Canion, Jim Harris and Bill Murto was

opening the “Compaq Computer Corporation”. The company was inaugurated in 1982

and merged with HP in 2002 making a deal of $87 billion and emerged as a technology

giant in.

Transaction Summary

Structure: Stock-for-stock merger

Exchange Ratio: 0.6325 of an HP share per Compaq share

Current Value: Approximately $25 billion

Ownership: HP shareholders 64%; Compaq shareholders 36%

Accounting: Purchase

Expected Closing: First half of 2002

Merger and Acquisition Synergy:



One of the major benefits that companies want to obtain is that they go for synergetic

benefits. Here the evolution of new financial math took place by demonstrating and

proving the fact that 2 + 2 = 5. According to figures, the company A brings it’s all

resources and company B will also bring it’s all the resources; altogether resulted in a

higher yield. The expertise provided by the company A covers the gap or decencies of

company B and vice versa. This would give chance to both the companies to overcome

market as well as their technological deficiency thus result in better growth and gaining

more market share. In most of the cases and recent mergers “Synergy” is the key word

that is focused by the managers to sustain their existence in the market.

There are basically two types of synergies that are focused by the managers:

1. Cost leadership

2. Increased revenues

21st century mergers were considered as “cross border mergers” and this era emphasis of

cost leadership type of synergy. In cost leadership synergy stage, companies focus to

reduce their cost and more responsive towards achieving economies of scale in terms of

production and also to reduce the disguised employment cost, redundancy cost, and other

overheads. Companies try to merge their departments so to have specialized people

working for specialized jobs.

Whereas increased revenues is the other type and difficult part of synergy concept to

achieve (Peter Burrows et al, 2001).. During this process companies try to generate more

and more profits. According to some researchers the capabilities of one company is

combined with the capabilities of other company for instance the marketing departments

of both the companies work even more hard to capture more profit out of their existing

markets as well as exploring new markets. They are not conscious about costs. They

merely depend upon revenue generation phenomenon.

HP & COMPAQ SYNERGY



Cost leadership:

The synergy benefit followed by HP and Compaq is the cost leadership. According to

Fiorina (CEO) after merger the cost of material purchased has been reduced by 3% - 4%

of both the companies. Here HP focuses upon reduced cost and to capture more market

share. The company is quiet successful in doing so, as the gross profit ratio has been

decreased from 2001 (28.61%) to 2003 (25.51%), as the figures show 3.1% change and

the objective of cost reduction has been achieved.

Strong Growth:

According to Fiorina there is a huge opportunity in the market and industry, which

promotes stronger as well as a stable growth. Predicting the trends in the industry, will

change and expected to grow by 10% so company should align their objectives along

with this growth pattern in order to sustain in the market. According to the figures 2002

sales of HP was $56,588 million which was increased by 29.11% and reached up to

$73,061 million in 2003 which once again got projection of 9.37% and reached the level

of $79,905 million in 2004. Here the objective of the company to grow has been achieved

after doing merger.

HP’s GROSS PROFIT RATIOS (2001 - 2003)

Years 2003 2002 2001

GP Ratio 25.51% 25.81% 28.61%

Direct selling Approach:

The uniqueness of boosting the sale of Compaq is the use of direct selling approach

whereas HP lack in this facility, so after merger they both got benefitted from it (Gupta,

2002). Figures show that after merger both the companies remain successful in reduction

of their selling and administrative expenses.

2002-2003 Expenses 2004-2005 Expenses

Before After Before After



22% 20% 18% 16.7%

The figures prove that the direct selling has the impact on company’s overall expenses

Gupta, 2002). It provides the cost effectiveness to HP and Compaq.

Merging Technological bases:

Bringing forth their utilities for improvement to their products technology wise and

providing better value added services to their customers is another benefit drawn.

Customer is very much simplification oriented. Focusing them (Peter Burrows et al,

2001) Craig Barrett (CEO, Intel Corp) commented "Combining their hardware skills and

service efforts get them much closer to critical mass across the board".( Peter Burrows et

al, 2001)

With the merger there hardware and software companies worked a lot which resulted in

higher sales and decreased costs. Following are the figures of net sales generated by HP.

(HP’s Net Sales from 2002 – 2004)

Year 2004 2003 2002

Net Sales 79,905(millions) 73,061(millions) 56,588(millions)

Size of the Company:

One other benefit drawn from this synergy is the increase size of the company (Lajoux,

2006, P27). Whereas some extra employees who tends to be the burdon on the

organization were downsized to rectify the business processing and cut the additional

cost. Beside this there is a rapid growth shown in the value of assets. According to

financial analysts assets of the company has been increased in 2001-2002 and in 2002 -

2007 by 28%. The main reason for this gradual uplifting trend drives from the benefits of

merger.

Downsizing:



The essene of this merger is not just to cover the technological and market gap on both

the sides of the companies, but also to cut shot those employees who possess burdon on

the organization. According to Moller & Brady (2007) the company estimated to do cost

reduction by rightsizing the employees upto $2.5 billion. The management sets this target

and achieved it so well that it helped them to reduce further $500 million in the next 18

months (Moeller & Brady, 2007). Companies policies were growing more and more

better with the passage of time after merger.



FINANCIAL ANALYSIS

FINANCIAL HIGHLIGHTS OF 2009:


1 9 17 25 33 41 49 57 65 73 81 89 97 105 113 1210

5

10

15

20

25SHARE PRICES GRAPH

Before Merger After Merger


VALUATION RATIO : HPQ

Price Earning Ratio (TTM) 16.72%

Price to Cash Flow 8.67

Price to Sales (TTM) 0.79

PER SHARE RATIO : HPQ

Dividend Per Share (TTM) 0.32

Earning Per Share (EPS) 3.14

Divident Yield 0.62%

Divident Payout Ratio 10.19%

FINANCIAL STRENGTHS : HPQ

Quick Ratio 0.91

Current Ratio 1.22

Return on Equity Ratio (ROE) 19.49

Return on Assets (ROA) 7.14

Return on Invested Capital (ROIC) 14.27

Inventory Turnover 12.06

Particulars 2000 2001 2002 2003 2004 2009

Net Income $ 3697 408 -903 2539 3497 7660

Total Assets $ 34009 32584 70710 74708 76138 114799

Return on Assets % 10.87 1.25 -1.28 3.40 4.59 6.67



Return on assets (ROA) is basically used to compare the efficiency of the management,

as how best the firm’s assets are being used to generate what quantity of income. It

provide grounds for the top managers to evaluate the working and efficiency of their

management. HP and Compaq got merged in 2002 and the graphs replicates that HP has

shown its quality of work at 10.87% in 2000. This is because of their focused vision and

the changing trend in the market. During this time revenues were at the peak and

company is involved in specialization, thus resulted in making lot of money and showing

efficient use of the company assets. After that a declining trend has been viewed so much

so that in 2002 it has gone to losses. The trenches of decreased sale and decreased

revenues could not remain all the time. One reason quoted by the CEO is that HP has

gone for merger with Compaq, and concentrated majorly in expansion of their business.

This fact cannot be forgotten as the deal marked itself as one of the biggest in the telecom

sector making a transaction of $87 million. Before the sun rise of year 2003 HP suggested

new policies and changing the structure of the management. Fiorina’s primary focus in to

reduce the expenses and to reduce the purchasing cost of the raw material. According to

facts she was successful in doing so. The cost of raw material has been decreased by 4%

after the merger. After the merger employees costs has been reduced and company has

moved towards specialized people for specialized place. A sudden rise in efficiency has

been seen from the management and the ROA increased to 3.40% in 2003. This trend


2000 2001 2002 2003 2004 2009

10.87

1.25

-1.28

3.404.59

6.67

RETURN ON ASSETS(%)


showed growth in the subsequent years and now in 2009 it has been raised to 6.67%,

which shows the company’s advancement and positive attitude towards the changing

environment of market.

Particulars 2000 2001 2002 2003 2004 2009

Net Income $ 3697 408 -903 2539 3497 7660

Shares $ 1947 1939 3044 3043 3015 2440

Earning per $ 1.90 0.21 -0.30 0.83 1.16 3.14



Share

The contrast between the net revenue earned by the company and the number of shares

gives the total earnings per share. It is considered as one of the best tool used to formulate

the performance of the firm to the public. In the year 2000 the EPS of HP is at its hike as

compared with the past decade i.e $1.90. With the advent of acquisition with Compaq

there was less availability of income left with the company. Hp utilized almost all of its

revenue gathered from the past fiscal year 2001-2002 to make this acquisition successful.

In the year 2002 EPS decreased below the bottom line i.e. -0.30. This is because of; Hp is

expanding their business and paid whatever the value of Compaq be and the value of all

the assets, liabilities as well. As a result less money is available with the company. In the

consecutive years of 2003 and 2004 the management reduced their costs and worked

together for product differentiation. According to CEO of HP, after acquisition they have

16000 sales staff and around 65000 professional sales staff all over the world. Having a

big workforce and managing the work in a way to enable the company growth and stick

with the objectives enables HP to turn their EPS figures from negative to positive, with

remarkable increase i.e. 0.83 in 2003, 1.16 in 2004. During the period management

efficiency, employee motivation increases and HP’s expenses were cut short, eventually,

resulted in an increase upto $3.14 in 2009. During this period HP made revolutionary

changes to approach the market and face the competition with an attacking strategy and


2000 2001 2002 2003 2004 2009-0.50

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

1.90

0.21

-0.30

0.831.16

3.14EARNING PER SHARE ($)


proves himself successful in winning the public trust and maintain tranquility in the mind

of their shareholders.

Particulars 2000 2001 2002 2003 2004 2009

Net Income $ 3697 408 -903 2539 3497 7660

Total Equity $ 14209 13953 36262 37746 37564 40517

Return on Equity % 26.02 2.92 -2.49 6.73 9.31 18.91



ROE basically refers to as how much the income is generated out of the business from the

total shareholders equity as represented in the balance sheet. In the year 2000 the ROE

figures were 26.02% which was the best as compared with the previous decade. The

company is making good use of the wealth provided by the shareholders. Whereas in the

year 2001 there is a decrease in the equity and the net revenue, but the fluctuation is

greater this time as a result ROE decreased to 2.92%. The reason could be that the

company is planning for the acquisition as well as there is a converging trend in the

market. The sales figures all over the world dwindled during this era. After the period or

so; companies emphasized on “synergy” and testified the benefits rippled from it. In

2003 they first got the fruit of synergy with an overall increase in percentage to 6.73%.

With the passage of time technological, financial and R&D departments made drastic

improvements. Entering the market with innovative products and providing best quality

to the customers are the tools used by HP during these subsequent years, thus resulted in

an increase in ROE up to 18.91 till 2009. HP is doing well in this regard.

CONCLUSION:

It has been concluded that the merger of HP and Compaq resulted in financial

distress but later it has been proved that the merger was a great success. Combining the

company’s base in terms of profit, assets, and technology started showing its effects in

the market and towards its competitor’s i.e. DELL. After mergers the figures prove that


2000 2001 2002 2003 2004 2009-5.00

0.00

5.00

10.00

15.00

20.00

25.00

30.0026.02

2.92

-2.49

6.739.31

18.91

RETURN ON EQUITY (%)


the company is making efficient use from the synergy strategy. Moreover, above are the

strategies as how top management deals with the merger strategies as merger is not like a

magic stick that changes everything over night. As it has been complemented by the

CEO of HP:

“the challenges are great, and there are holes in the strategy”.

(Fiorina 2002)

With her this positive proposition seems that company is in a strong position and

benefitted a lot after this merger. They are planning for more if it suits to their objectives

and enhancing the customer base. It has also been observed that companies wanted to

avail the advantages of merger in order to increase their profitability, size, growth and

customer base. This would benefit the company as well as have greater impact in the

industry. Keeping the company’s base, values and most importantly financial conditions

Fiorina says:

"We can't bite off more than we can chew.”

(Peter Burrows et al, 2001)

---------------------------------------------------------------

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http://www.businessweek.com/magazine/content/01_38/b3749042.htm.

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APPENDIX

Exhibit-1

(Selling and General Expense Ratio of HP from 2001-2005)

Year 2005 2004 2003 2002 2001



Sales 86.696billion 79.905 billion 73.061 billion 56.588 billion 45.226 billion

Selling and general

expenses

14.559 billion

14.530 billion 14.664 billion 12.345 billion 9.674 billion

selling and general

expense ratio16.79316 18.18409 20.0709 21.81558 21.39035

(Selling and General Expense Ratio of HP from 2001-2005)

Exhibit-2

(Net Sales & Sales Growth Rate of HP from 2002-2004)

Year 2004 2003 2002

Net Sales Of HP 79,905(millions) 73,061(millions) 56,588(millions)

Sales Growth

Rate of HP

9.37% 29.11% -NA-

(Graphical representation of HP’s Sales from 2002 – 2004 )



Exhibit-3

(HP’s Long Term Debt to Capital and Profits from 2001-2007)

Years 2007 2006 2005 2004 2003 2002 2001L.T.D

to Capital 11.48 6.13 8.36 10.96 14.68 14.27 21.09Profits $7,271m $6,205m $2,398m $3,505m $2,539m ($923m) $640m

Exhibit-4

(Share Price of HP and DELL from the date of completion of merger to 31/12/07)

Share

Price

03/05/200

231/12/2002 30/12/2004 31/12/2004

30/12/200

529/12/2006 30/12/2007

HP $ 17.09 $ 17.27 $ 22.80 $ 21.13 $ 28.53 $ 41.36 $ 51.29

DELL $ 25.10 $ 26.85 $ 34.60 $ 42.04 $ 30.10 $ 25.12 $ 24.67

Exhibit-5



(Profit of HP and DELL from 2001 – 2007 in $ millions)

Profit 2001 2002 2003 2004 2005 2006 2007

HP $640m $(923)m $2,539m $3,505m $2,398m $6,205m $7,271m

DELL

$2,236

m $1,246m $2,122m $2,645m $3,043m $3,602m $2,583m

(Profit of HP and DELL from 2001 – 2007 in $millions)


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Merger and Acquisitions