Investor skepticism about a proposed merger between Hewlett-Packard and Compaq Computer turned into concrete fallout on Wednesday as both companies' stocks continued to slide, and a major rating service downgraded Hewlett-Packard's creditworthiness.
Moody's Investors Service lowered the rating of H-P two notches to A2, still a relatively high rating shared by the likes of Texas Instruments, but nevertheless a symbolic vote about the challenges posed by the merger.
The merger would create the world's largest computer company. A hardware juggernaut under the Hewlett-Packard name with US$87 billion in revenue and a broad reach into the technology industry, it would be anchored by a an emphasis on sales of personal computer and printers.
But the challenges in integrating the companies, coupled with the struggles each has had individually in the PC market, have raised questions among investors. On Wednesday, shares of H-P fell US$0.66, to US$18.21. Compaq declined US$0.67 to US$10.41.
"This is the type of merger where just about everything needs to be going right to be successful," said Bill Shope, an enterprise hardware analyst with ABN Amro. "In this type of environment, it's hard to imagine that everything is going to go right."
Explaining the market's reaction to the proposed merger, Shope criticized H-P as failing to explain how the two companies would gain strategically. Carleton Fiorina, chairwoman and chief executive of H-P, and Michael Capellas, Compaq's chief executive who is to be president of the merged entity, emphasized cost savings when announcing the deal. But, Shope said, such savings are the easiest to achieve but much less important than "strategic synergies."
"I don't think there is any way, in the near term, to convince the majority of investors that this was a good idea," he said.
As for Moody's, it downgraded Hewlett-Packard from AA3, a rating that was among the highest held by any technology company. Along with a lower rating, Hewlett-Packard's creditworthiness was assigned a "negative outlook," meaning that it is possible the company could be downgraded further in the next six to 18 months. Compaq's rating remained at BAA2, which is several slots below Hewlett-Packard's current rating.
Dave Berman, a spokesman for Hewlett-Packard in Palo Alto, California, said the downgrade was "not unexpected." He said ratings services typically took a conservative position regarding large mergers, and he said the company still believed that it had an "outstanding" credit rating.
Richard Lane, an analyst at Moody's, said the reason for the downgrade was that the two companies would face "significant integration challenges." Lane said large technology mergers rarely worked smoothly, and he said H-P in particular was being downgraded because it was buying a company with a lower credit rating.
From a practical standpoint, Lane said the change in rating might have a slight effect, by increasing the cost to H-P of raising money. But he said that cost could be easily offset. Lane said one question was whether the newly merged company would be successful in expanding its services business.
Indeed, H-P and Compaq said that one reason for the merger was to try to combine their strengths to increase their presence in services, a growing and potentially profitable area that entails advising companies on how to build and manage technology networks.
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