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Regulators look at proposed H-P, Compaq merger

Hewlett-Packard Co may have to permit more competition among personal-computer makers in retail stores to satisfy antitrust regulators and win approval to purchase rival Compaq Computer Corp, lawyers and analysts said.

Hewlett-Packard's strategy will depend largely on whether regulators define the PC market to include Internet sales or just sales at retail stores. Together, the two companies account for 78 percent of the desktop PC market in US retail stores, according to NPD Intelect.

"Hewlett-Packard and Compaq will argue that the market goes beyond retail, but regulators typically view retail as a market in and of itself," said Hillard Sterling, an antitrust lawyer who helped defend Staples Inc's unsuccessful plan to buy Office Depot Inc in 1997.

While analysts don't expect regulators to block the US$23.8 billion stock acquisition, they may delay the purchase by asking for concessions from the companies. The prime targets for government officials are likely to be retail PC sales, because Hewlett-Packard and Compaq are the top two sellers in that market, and server computers, analysts said.

The proposed merger will be reviewed by the US Federal Trade Commission, the European Commission, the Canadian Competition Bureau and officials of other countries.

The companies expect to complete the purchase by May 31, with a possible three-month extension if needed. Further delays could harm the combined company's sales and profit, analysts say.

Spokespeople for Hewlett-Packard, Compaq and the FTC declined to comment.

The two companies say that by combining, they will be able to compete better in offering more profitable services, servers and storage devices, rather than narrow-margin PCs.

Investors, including the sons of Hewlett-Packard's co-founders, oppose the deal because it increases the company's exposure to the PC market. Since the acquisition was announced on Sept. 3, shares of Hewlett-Packard fell 5.3 percent through Friday's close, while Compaq's dropped 18 percent.

Compaq shares are trading about 27 percent below Hewlett-Packard's per-share offer, an indication that investors are doubtful the deal will be completed.

Antitrust regulators will examine the companies' dominance in the retail PC market, said Harvard Law School professor Einer Elhauge.

By comparison with Hewlett-Packard and Compaq's combined 78 percent, eMachines Inc. had 11.2 percent of the desktop PC market in US retail stores, and Sony Corp had 8.2 percent, NPD Intelect said. Retailers worry about relying on one company for too many products like PCs, handheld computers, printers and cameras, analysts said.

The question before the government is whether that matters anymore.

"Is that the right market, when consumers can buy over the Internet?" Elhauge said.

Dell Computer Corp, which sells only on the Internet and by telephone, is now the largest PC maker, with 14 percent of units shipped worldwide in the third quarter, according to Gartner Inc.

Compaq and Hewlett-Packard's shipments combined would have accounted for 17 percent.

That margin is small by comparison with software maker Microsoft Corp and chipmaker Intel Corp, which each control more than three-quarters of their markets. Many analysts say Dell eventually would reclaim the PC title from a combined H-P and Compaq.

"The burden is on H-P and Compaq to show that consumers readily substitute other types of purchases if retail isn't available," Sterling said. "That's a high hurdle to pass." If retail does matter, regulators might suggest remedies such as contracts that would allow retail stores to have more competition, lawyers said.

Houston-based Compaq has exclusive contracts to sell at stores of RadioShack Corp and Sears, Roebuck & Co, while Palo Alto, California-based Hewlett-Packard is prominent in Office Depot and Best Buy Co outlets.

"If they've got contracts that make stores carry so many of their computers or have to be exclusive, remedies could be you can't preclude competition in that way," Elhauge said.

If the companies reduce their presence in the retail side, some investors might actually cheer. Retail sales aren't as profitable as direct sales.

The concentration of power in the market for servers, the machines that run Web sites and networks, may also cause concern among regulators, analysts said. Together, the two companies had 37 percent of worldwide server shipments in the second quarter, according to Gartner. Along with Dell's 18 percent share and International Business Machines Corp's 17 percent, that would mean three companies would control 72 percent of the market.

"If they license some of the server technology to give other companies a chance, that might be satisfactory," said Dan Niles, an analyst at Lehman Brothers, who doesn't own shares of either company.

If the companies don't accept what regulators propose, that means litigation and delays, Sterling said.

The lawyers and analysts are split on whether Europe will be tougher on the merger than US regulators. Earlier this year, the EU blocked General Electric Co's US$47 billion acquisition of Honeywell International Inc, ruling that the purchase would have stifled competition and hurt consumers. Still, most say that in the end, the European regulators, like their US counterparts, will approve Hewlett-Packard's acquisition of Compaq.

"This deal will probably survive the government's scrutiny, but not without some modifications," Sterling said. "There's no reason for regulators or other companies to scuttle the deal."
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