Case Study Hp

Introduction "Seldom is the inevitability of the strategic logic of large-scale corporate change immediately clear to internal and external constituencies and observers." (McKinney, 2005, p. 5) Two large technology companies both listed in the fortune 500 list before the merger surviving in a cut throat competition environment. The merger taking place at the time was one of its kind and is a recent example to discuss the way forward for big multinationals to gain market. This article is going to further analyse data based on the information available and to evaluate its post merger integration. Background Carly Fiorina is named CEO of Hewlett Packard (HP) in July 1999 by Lew Platt who was HPs CEO for almost 7 years. (Hewlett Packard Co) Fiorina being an outsider as compared to the other management begins her journey of transforming HP "into the hottest new company of the internet era without losing contact with the old times commitment to the quality and integrity that made HP name so trusted" (Robert M. Fulmer, 1999, p. 22). HP is stretchered upon four main operating units, Imaging and printing group (IPG) dominates its market, but due to the cut throat environment and sliming of profits Lexmark and Epson continuously challenge HP dominance. IBM referred to as the blue chip had realised at the time service was the new revenue engine with high profit margins. On the other hand, HP was unsuccessful in improving its service department it had tried to acquire services from Price water house Coopers but negotiations were stopped. Compaq was interested in HP's UNIX license that's how the conversation started between the two companies. Before the merger both companies had tried to grow without major success and were not ranked amongst the top three market leaders. Strategic logic After the merger the companies would complement each other's products benefiting from resource complementarities, the newly combined entity would turn out to be a dominant player and perhaps make its place amongst the market leaders if not at the top. Apart from HP's IPG it was struggling with its PC's market were Compaq adopted the approach from Dell in cutting the middle man out and was delivering direct to customers saving on cost. After the merger HP would benefit from the direct distribution system of Compaq while Compaq would benefit from positive operating margins through economies of scale from HP resulting in operational synergy. (Joint Proxy statement/ prospectus issued by HP and Compaq, 2002) "Compaq was a clear number 2 in the PC business and stronger on the commercial side than HP, but HP was stronger on the consumer side. Together they would be number 1 in market share in 2001" (McKinney, 2005, p. 10). Compaq was also a market leader in fault tolerant and industry standard serve in which HP had no presence in the market. HP was strong in UNIX servers which were a weakness for Compaq. The merger would also bring about service professional which would benefit HP to become market leader in the services department that was lead by IBM. As synergy is defined by Arnold as "?PV?_AB ?=PV?_A+?PV?_B+GAINS" (Arnold, 2002, p. 872) the gains here apply to the merged HP as the bigger entity having economies of scope, resulting in increased bargaining power with suppliers and profit margins. HP would be well positioned to price its products competitively and also creating opportunities to make further investments while reducing costs (McKinney, 2005). "The merger was expected to generate cost synergies of approximately $2.0 billion in fiscal 2003, the first full year of operations; fully realized synergies are expected to reach a run rate of approximately $2.5 billion by mid-fiscal 2004" (Hewlett Packard Co). Both companies are complimentary to each other and would benefit from the other in areas which they lacked dominance. There were certain demerits of the merger which were seen by Hewlett and some other stakeholders. Certain problems in their point of view that would not be solved by the merger and also worsen the current position of the firm destroying share holder wealth. The combined company would still be stuck below Dell in the low margin PC industry and also below IBM in the high end service department. Combined HP also was technically taking away a portion of the highly profitable IPG from its current shareholders. Technology industry at the time of the merger was on a down tern making sales volume low. Integration risk is high which results in an advantage for the competitors to take benefit of the confusion between the merging companies and its clients. Customers defecting to competition results in loss of market share. Consumers prefer to deal with a small number of suppliers especially in the IT services which HP would risk losing when the market thinks negative of the merger. Valuation The shareholders of Compaq were at an advantage when they were given 0.6325 shares of HP for every share they owned in Compaq. The valuation model of EPS was used to value the merger disadvantage of this method is sometimes the acquiring company ends up paying more for the company. If we apply the exchange ratio on 31/08/01 when HP share were trading at $23.21and Compaq $12.35 we can derive (23.21*0.6325)-12.35 = 2.33. The share holders are better off by $2.33 this price is taken just before the merger as the markets reacted negatively to the announcement of the merger. The closing price on the day of the announcement was HP $18.87 and Compaq $11.08 we can thus find out (18.87*0.6325)-11.08=0.855. The share holders had lost total gains per share of 2.33-0.855=$1.475. HP could have adopted the Cash flow method which uses forecast of the future cash flows, the results derived from this depend upon the quality of the forecast and the assumptions made. The method is refined enough to deal with complex structure and easy enough to be done in excel spread sheet. It also helps pinpoint were the debt part is as we calculate WACC of the firm. WACC is the minimum amount of return required from the projects to satisfy the lenders and the share holders. Discounted cash flow (DCF) is beneficial as it considers the time value of money when forecasting future cash flows. (Mckinsey & company, 2000) Value of the shares before and after On considering the past just before the merger was announced September 4 2001, it can be seen in fig 1 that stock prices were trading at less than half their 2001 highs. On analyses of the graph in further detail, a conclusion can be drawn why the prices had dropped to such an extent it comes to ones attention due to stock split 2 for 1 in September 2000. Fig1 (Hewlett Packard Co, 2007) The reaction of the market on the announcement of merger can also be seen in the middle of the year 2001 a sharp drop of 21.5% in hp's stock price (Gupta, 2002). Even after the merger took place investors did not see any small term arbitrage profit to benefit from in the stock market apart from long term investors who adopted long term value approach. It was also supported by the comments made by CEO Oracle "this will be the biggest hardware company in the world, and that gives them tremendous market power" (Lawrence J. Ellison, CEO, Oracle in 2001). Those investors in the options market who had bought put options which enabled them to sell at exercise price were in arbitrage. The market was further unstable due to September 9/11 a week after the announcement of the merger taking place. After the completion of the merger in 2002 the stock markets were still negative towards the company's performance as seen in the appendix, but after 2005 when Mark Hurd became CEO steady growth can be seen in the stock prices reaching the highs of 2000. It can also be seen in appendix when the share prices are compared to NYSE performance and also in another chart to the electronic industry the company's performance has been on track, this is also reflected by the market beta of 0.98 by digital look. Beta of near 1 share tends to underperform in bull market and slowly lose value in bear market. Another important factor to be considered is the liquidity of the stock traded in the volume part of the graph which shows there was a problem to find buyers of HP stocks when the share price dropped proving that investors lost faith in the company and success of the merger. Dividend policy of the company can be seen to have a stable approach, a dividend of 32¢ to be declared every year in total. The dividend history can be seen with details of dates in appendix. The important note here is that the dividend policy did not change after the merger and the same dividend has been declared every year. Post merger It might still take couple of years for it to be evident weather the merger of HP and Compaq would be a success or not. Although it can be seen, "the short-term synergy goal of $2.5 billion was exceeded by over $1 billion, equally importantly short term market share losses were lower than planned" (McKinney, 2005, p. 19). Overall revenue including US and international increased by 25% in fiscal year 2002 to $56.6 billion. This growth was due to the increase in IPG performance as increase in sales volume of printer occurred, giving credit to the expansion of the printer base after the merger. However some benefits were offset by the decline in PC and server business, not by the merger but the downturn of economy (HP annual report, 2002).From the available data it can be deduced that HP is moving towards what they had planned on the revenue basis as shown in fig2. Fig 2 (Digital look) Although increase in revenue is not the right measure to predict the future or achievements of a company. Some arguments would be competitive pressure harming revenue and reducing margins, 67% of HP revenue is generated from outside US in different currency mostly in the euro and yen. Foreign exchange risk plays a vital role in the profit margins of HP especially when operating in low margin industry as seen in the fiscal year 2001 revenues declined by 7% as the euro weakened (HP annual report, 2002). Fig 3 (Thomson one banker) Ms Fiorina and Mr Cappellas had said they would take over Dell computer, both companies' competitors in the personal computer sector (FRANCISCO, 2002). HP was named world's largest PC manufacturer for the year 2007 with 18.8% market share for PC units released by industry analyst firm IDC. Also HP became No 1 for storage systems taking over IBM with market share of 20.1% (Hewlett Packard Co). Although HP has achieved what was said by the directors at the time but this was supposed to have happened in years before and it has taken HP a long time to come on track for the targets promised. The move towards share holders' wealth has been on steady performance after 2002 as can be seen in fig3 showing the growth in EPS especially after the year 2005 when Ms Fiorina resigned as CEO and Mark Hurd was named CEO of HP. This increased confidence in market on HP performance, hence the markets reacting positively with share prices rising as seen in fig1 and also increasing earnings per share also seen in fig3. Conclusion From the analysis above it would not be wrong to state that both companies struggling in the market for further growth within an industry with sliming profit margins. Merger is the way ahead, in 2007 alone HP acquired 10 companies to grow further in the industry. Currently as market leader in technology and with steady growth HP is moving towards its objectives at the time of the merger as becoming the world's biggest and complete set of products and Services Company. The real benefits started to reap in the long term for HP, the short term cost saving were achieved instantly which was the initial assumption by the management and loss of markets share was controlled to less than expected.