Key institutional advisor endorses HP/Compaq merger

Institutional investor advisory firm Institutional Shareholder Services is recommending a vote for Hewlett-Packard's planned acquisition of Compaq, a verdict that could swing the shareholder vote's outcome.

ISS' recommendation and report on the proposed deal will be sent to several hundred institutional clients, such as pension and mutual fund managers. Institutions own about 57% of HP's shares. With 18% of HP's shares controlled by the Hewlett and Packard families and their foundations, which have vocally opposed the acquisition, institutional support of the acquisition is critical if it is to pass.

Twenty-three percent of HP shareholders subscribe to ISS, according to HP Chief Financial Officer Bob Wayman. One of HP's largest shareholders, Barclays Bank, has said it will vote its 3.1% stake in accordance with ISS' recommendation. Barclays ceded the voting decision to avoid a conflict of interest. One of its top executives, Patricia Dunn, global chief executive of Barclays Global Investors, sits on HP's board.

The Compaq/HP deal is the first major proxy, or shareholder, matter on which institutional investors will have only one advisor. ISS merged with its chief rival, Proxy Monitor, in August. Proxy Monitor, the smaller of the two companies, bought ISS from its former parent company, Thomson Financial, with the help of outside investors. The merged company opted to retain ISS as its name.

Research firm Sanford C. Bernstein & Co. estimates that the acquisition's chances of approval by shareholders rises to "50% or more" with ISS' endorsement of the deal. Bernstein's own research suggests that 12% of HP's shares will be voted in accordance with ISS' recommendation, with another 7% of shares "influenced" by ISS' verdict.

"A yea vote could literally make the deal a horserace," Bernstein wrote in its report.

The issue of whether the acquisition will benefit HP financially and help the company realize its vision for future growth is the "fundamental, threshold question" about the deal, and one on which "reasonable people can (and do) disagree," ISS said in its report.

ISS concluded that HP's management team is offering reasonable projections about the acquisition's impact on the company. Both HP's anticipated cost synergies and revenue losses seem realistic, ISS said, citing HP's "generally strong performance" in its last fiscal quarter.

One of the most troubling points raised by the deal's critics is the dismal track record of major mergers within the IT industry.

"We share Mr. Hewlett's belief that integration is one of the most daunting problems facing a combined HP-Compaq," ISS wrote. "This is a task, however, that management by all appearances has tackled with relish."

ISS cited the detailed integration roadmap explained at meetings between itself and the top executives involved in the companies' integration planning.

"Management's integration plan makes clear that Ms. Fiorina and Mr. Capellas have taken the lessons of DEC and other failed tech acquisitions to heart," ISS said. "HP and Compaq also appear to have done pioneering work in thinking about and planning the 'cultural integration' of the two companies... It is hard to remain unimpressed in the face of such enthusiastic attention paid to the integration effort."

Digital Equipment Corp. (DEC) was acquired by Compaq in 1998. Compaq struggled to integrate the company's operations, and the Compaq-DEC union is widely regarded as a case study in how not to handle an IT merger.

ISS dismissed Walter Hewlett's charges that HP's board did not thoroughly consider alternatives to acquiring Compaq. Hewlett, a member of HP's board, is leading the fight to defeat the acquisition. ISS' discussions with other board members provide "ample evidence" that the process of corporate governance leading to the deal's approval was sound, the firm said.

ISS did chide HP for not disclosing what "clearly were very advanced discussions" about post-merger executive compensation. Last week, Hewlett released internal board documents about the compensation packages HP allegedly intended to adopt for HP CEO Carly Fiorina and Compaq CEO Michael Capellas, who will become HP's president if the company merges with Compaq. Hewlett charged that shareholders should have been informed of the sizable pay packages planned for Fiorina and Capellas.

While ISS found no "smoking gun" indicating that management intended to mislead shareholders, it cited the issue as a reason why Hewlett should be retained on HP's board, to continue "hold(ing) management's feet to the good governance fire."

"Whatever the result of the current contest, it is clear that Mr. Hewlett, contrary to some of management's rhetoric, has served an immensely productive role in stoking up an active debate about the merger's merits," ISS said. "If the merger closes, Mr. Hewlett's campaign will have generated enormous pressure for the combined company to perform -- and this can only be good for HP shareholders."

Hewlett's dissident group said it strongly disagrees with ISS' recommendation and believes the advisory group "has missed the point." The group stands by its belief that the acquisition will destroy shareholder value, it said in a prepared statement.

ISS' report issued Tuesday contains only its recommendation for HP shareholders. The company plans to issue its recommendation for Compaq shareholders within the next few days. With no vocal opposition to the merger on the Compaq side, ISS is unlikely to oppose management and reject the deal.

Compaq is pleased with ISS' recommendation for HP shareholders and eagerly awaits its recommendation for Compaq's shareholders, Capellas said in a prepared statement.

On the IT industry's last major proxy fight, Computer Associates International shareholder Sam Wyly's bid to replace CA's board of directors, ISS initially recommended that clients vote for CA's incumbent directors. The firm noted, however, that it would support a proxy bid for minority representation on CA's board, and several days after ISS issued its report, Wyly revised his proxy to seek replacement of only four of CA's 10 directors. Both ISS and Proxy Monitor then switched their recommendations and backed Wyly's slate of nominees. Wyly's bid nonetheless ended unsuccessfully, with more than 75% of CA's shareholders voting to retain the current board.

The IDG News Service is a Network World affiliate.