ISS Backs HP-Compaq Merger

ISS advises about 700 funds on how to vote in proxy battles, and many of its clients are obligated to follow its advice due to the structure of their funds or potential conflicts of interest.

"We recommend that HP shareholders vote for the HP/Compaq-combination," said Patrick McGurn, a vice president at ISS, in a press conference Tuesday. "While [Walter Hewlett makes a credible case that the risks associated with the transaction are real and material, we believe that management's upside scenario is achievable."

Hewlett, son of a Hewlett-Packard co-founder, is behind an aggressive campaign to kill the merger.

"We strongly disagree with the ISS decision," he said in a statement. "We believe ISS has missed the point--we believe that the HP/Compaq merger will destroy shareholder value."

"We are pleased that ISS--a truly independent expert--recognized the strategic and economic logic of this combination as well as the thoroughness of the evaluation process undertaken by the directors of both HP and Compaq," said Carly Fiorina, HP chairman and CEO, in a statement. "ISS' conclusions confirm our long-held conviction that the merger offers the best value to HP shareowners."

Analysts expect 10 percent or more of HP shareholders to vote as ISS recommends and say many more fund managers could be influenced by ISS.

However, Hewlett believes differently.

"It has been widely reported and many clients of ISS have told us that they are independently evaluating the financial and strategic implications of the transaction, and we believe they will vote their HP shares against the merger based on the lack of merits of the proposed transaction."

ISS says it concluded management offers a reasonable prediction about what the future may hold.

"Specifically, we believe that: 1. the cost synergies projected by management are achievable (we are joined in this view by most analysts and even opponents of the merger); and 2. management's revenue predictions are reasonable," the ISS report says.

HP shareholders will vote on the merger March 19, while Compaq shareholders will vote March 20.

A recent survey of executives from the VARBusiness 500 (click here for survey results) seems to imply there is little optimism among solution providers that the two companies can be successfully integrated.

Almost three-quarters of those polled (71 percent) believe the merger, if completed, won't result in any benefit to their own organizations. But only about a quarter (29 percent) believe the combined entity would be a greater services threat to their own organizations than either company currently is alone.

Geoffrey Lilien, president of HP VAR Lilien Systems, says the merger would allow the companies to pursue technical innovation more competitively.

"The difference between HP/Compaq and Dell is that HP/Compaq invents," Lilien says. "Both companies spend a lot of money on R and D. Dell competes on price. To compete against Dell, you need to sell the customer on better technology and better service. Down the road, [HP/Compaq will likely come out with one type of PDA, for example, not both the iPAQ and the Jornada. That will cut down on some costs. But they'll not likely compete on price but instead funnel that money back into R and D to come out with more innovative products."

Another VAR concern is that the merging of the companies needs to be gradual so as not to alienate loyal customers of either company.

"I think the economies of scale would be that you could probably fire about 25,000 people and still have the same revenue once you've merged," says Rich Tear of Compaq VAR CSCI. "The bottom line is that the expense of these two companies is their labor. You don't need to have two sets of product people in desktops, for instance.

"I think it would benefit my company, because the resulting merged entity would be 'the number one company in the world to do business with,' and I think that it would facilitate a more comprehensive product line all called HP, servers through handhelds."

Additional reporting by Rich Cirillo and Jennifer D'Alessandro