NEW YORK — Wall Street frowned Tuesday on the proposed merger of Hewlett-Packard and Compaq Computer, viewing the deal as an admission of weakness rather than strength and as an indication that a shakeout has begun in the brutally competitive computer business.
The chilly greeting means that Hewlett-Packard and Compaq executives will have to do a better job of selling the deal to their own shareholders even as they cope with possible antitrust issues.
The stock of the company being acquired, Compaq, normally would have been expected to rise on the news of a planned takeover. But it fell to a five-year low Tuesday. Hewlett-Packard, the acquirer, fell to its lowest level in nearly three years. Stocks of both companies continued to drop in mid-morning trading Wednesday.
Company officials said the combined company would have revenues nearly as large as those of IBM, the computer industry leader, and be able to compete with IBM in every market segment, from giant computers to laptops.
But shares of IBM, as well as Dell and Sun Microsystems, rose early Tuesday, indicating traders consider a bigger Hewlett-Packard to be a less fearsome competitor. Sun's stock fell back and ended the day with a loss, but the others held on to their gains.
"Two losers don't make a winner," said Bob Djurdjevic, the president of Annex Research, a Phoenix-based consulting firm, in one of the harsher reactions.
Carly Fiorina, the chief executive of Hewlett-Packard, conceded that there were questions about how well a merger could be accomplished and that challenges will be great.
"It all looks good on paper," Fiorina told a news conference, "but none of it will matter if we cannot integrate this effectively."
Wall Street appears to doubt that Fiorina, who was viewed as a wunderkind when she was named to head Hewlett-Packard two years ago at the age of 44, can do that. "There are many potential pitfalls in executing this strategy," said Ashok Kumar, an analyst at U.S. Bancorp Piper Jaffray, adding that "to realize the projected $2.5 billion in cost savings will require a large number of layoffs." He said Fiorina had handled previous layoffs poorly, damaging morale at Hewlett-Packard. The $25 billion deal, announced late Monday night, calls for Hewlett-Packard to exchange 0.6325 shares of its stock for each Compaq share. Based on Friday's share prices, Compaq shareholders would receive an 18.9 percent premium.
After merger news, the shares of the acquirer often slip, erasing some of the premium. The slippage can be attributed in part to normal merger arbitrage, in which some traders buy the target — Compaq — and sell short the acquirer — Hewlett-Packard. Such a trade would prove profitable if the merger is completed.
The first real indication that things were awry came when Compaq shares opened for trading on the New York Stock Exchange at 9:37 a.m. The opening block, of 2.7 million shares, including all the orders accumulated overnight, traded at $12, down 35 cents from Friday's close.
Compaq did soon rally, trading as high as $12.80 shortly after 10 a.m. But then the selling in Hewlett-Packard became more intense, and Compaq began to follow it down. At day's end, Compaq shares closed at $11.08, down 10.3 percent from Friday, as a promised premium turned into a large deficit. At the day's low of $10.75, Compaq shares sold for less than at any time since July 30, 1996.
There was a time when it was popular to paint what were really takeovers as being mergers of equals. But this deal seems, if anything, to present the reverse situation. To be sure, Hewlett-Packard is to get the majority of seats on the new board, and its boss, Fiorina, is to be the top officer of the merged company. But other aspects of the deal treat both companies in a surprisingly equal manner.
The merger agreement, filed with the Securities and Exchange Commission Tuesday, provides for a $675 million breakup fee to be paid by whichever company walks away from the deal, should that happen. And it gives each company's board the right to accept a superior offer, if one should come along.
It is unusual, to say the least, for a company that is doing the buying to provide for the contingency that it might get a superior offer. Formally, of course, there is no offer on the table for Hewlett-Packard.
In many all-stock mergers, the terms include what Wall Street calls a "collar" that protects the company being bought from a collapse in the share price of the acquiring company. It does that by agreeing to increase the number of shares being paid if the share price falls far enough.
But there is no collar in this merger agreement, and thus no protection for Compaq shareholders — other than the right to vote down the deal — if Hewlett-Packard shares continue to fall.
Tuesday, anyway, shares fell for most of the day. They opened at $20.90, a 10 percent decline from Friday's price, and then spent much of the day sliding. At the day's low, of $18.75, the price was the lowest since Oct. 9, 1998. The shares closed at $19, down 18.1 percent on the day.
Hewlett-Packard is down 72 percent from its peak, reached in the summer of 2000, while Compaq is down 78 percent from its high, reached in early 1999.
Shareholders seemed to doubt that the deal could help improve either companies' fortunes — if the transaction is completed at all. The deal will face scrutiny by antitrust regulators in the United States and in Europe. Lawyers for the companies are already preparing for a fight in Europe, and Fiorina is planning to fly to Brussels, Belgium, in several weeks to meet with Mario Monti, the antitrust commissioner for the European Commission.
But that trip may be unnecessary if she cannot convince shareholders of both companies that the proposed merger is in their interests, and that will be hard to do unless the share prices recover. While the companies say they will make more money together than they would apart, they also told investors Tuesday that they thought revenues would be 5 percent lower if they merged than if they remained separate.
With the stock prices suffering so much, speculation could begin that Hewlett-Packard itself could be a takeover target, although it is not clear who might want to be a buyer. Even at its depressed price, it has a market capitalization of $37 billion, a big bite for all but the largest companies — which would face antitrust questions if they were interested.
It appears that Hewlett-Packard may have anticipated that possibility. Its filing with the SEC disclosed that on Friday its board adopted a poison-pill, a standard takeover defense aimed at repelling, or at least delaying, an unwanted suitor.
On Monday night, Hewlett-Packard appeared to be a big company that was making a major acquisition that would vault it into the status of a giant. By Tuesday night, after investors reacted with scorn, it looked more like a potential victim than a victor.