Are You Synergized?

My eyeballs are aching from studying the ill-formatted proxy statement filed with the SEC for the HP / Compaq merger. I've never had cause to look so closely at such a proceeding, but this time it involves my employer of almost 19 years, and our interest as stockholders. The journal of the merger discussions is remarkable for how fast things progressed this summer, and for the number of people and firms involved. In particular, it's amazing that this was kept quiet from June through the September announcement. "During (the last week in July), representatives of Goldman Sachs, McKinsey & Co. and Wilson Sonsini Goodrich & Rosati also had numerous meetings with representatives of Salomon Smith Barney, Accenture and Skadden, Arps, Slate, Meagher & Flom LLP to discuss various financial and legal aspects of the business combination."

It sounds expensive. In addition to the generous compensation for the legal and financial advice, and the expenses of business travel, we can imagine that this must have demanded much (if not most) of the time and attention of upper management at both companies. We've heard lots and lots of marketing (internal and external are in congruence, as the "forward-looking statements" we've been getting internally have all been posted to the SEC) about how good the solution they came up with is for both companies, but by its nature, that's highly speculative. Who knows what the future's going to bring?

But how can we tell a good merger from a bad one? All those big consulting firms would be in a little trouble (at least) if they laid too many eggs, so they must have some inkling of what they're doing. But this is great work for them: companies worth billions of dollars dancing together leave fantastic tips. Thousands, tens of thousands, hundreds of thousands and ultimately millions of dollars flow out to all the helpers. This is very good work if you can get it.

The biggest rewards are reserved for the powerful leaders who dream it up and make it happen. At the highest level in the corporation, there is unanimity that "people are our greatest assets." The retention of "key employees" is considered essential for the success of the combined enterprise. The members of HP's compensation committee, "Messrs. Condit, Ginn and Hewlett discussed the fact that the success of the combined company following the merger would be determined in part by how effectively the combined company will be able to create a unified workforce drawn from the existing talent of both HP and Compaq, and the risk that uncertainty associated with the merger could lead some of HP's employees, including executives, to accept other employment opportunities." (This could, and perhaps should be read to include all the workers -- "unified workforce" after all -- but see the discussion of "synergies" following.)

How can we tell a good merger from a bad one?

They'll need more than just some assurance of their regular salary, we suppose, something substantial to make it worth their while. At that point, the treatise shifts to "reasons for the merger," which you may have heard. They sound like good reasons, but of course we wouldn't be reading such a document if they couldn't be made to sound good. Outside opinions vary. The stock market slammed the idea when it was announce on September 3rd. Investors thought it was a terrible idea, and discounted the value of the deal -- and the value of both companies -- by 30% or more. The insiders averred that those people just don't understand how good it'll be, they'll come around. The big nut is the "Synergies," valued in the public statements at $2.5 billion a year. Some form of the term appears no fewer than 57 times times in the document. Goldman Sachs estimates the net present value at $11 to $24+ billion, if they're 100% realized. Salomon Smith Barney figures the synergies are worth $28 to $31 billion to Compaq shareholders.

What are synergies, though? (You could look it up for what good that will do you.) The obfuscatory legal prose treats them rather specially: "The Synergies reflect the incremental benefits that the management of HP then expected to achieve as a result of the merger, including cost savings and operating synergies." In separate communications (such as the initial press releases), the execs were candid about reducing the combined workforce by some 15,000 employees. Eliminating redundancies, in the more precise British term. (I don't know if Brits talk about how redundancies are synergetic.)

Are you synergized?

I recall doing the "synergy arithmetic" at the time of the announcement: $2.5B/15k = $167k per employee per year. That's within the ballpark of "fully loaded" employee costs these days. Maybe a little high, and there's some other cost savings to realize; combining office supplies stocks, say.

Goldman Sachs looked at 3 scenarios of earnings estimates, with variables of whether or not the Synergies are realized, and whether or not revenue is lost due to the combination. The astute observer of mathematical combinations will note they're one short: the "no Synergy, lost revenue" scenario was not examined for some reason. Obviously, it wouldn't support the merger. Even without lost revenue, no Synergy makes it a bad deal, so perhaps GS figured everyone could assume that? At any rate, this is all forecasting, and who knows what will really happen? The statement disclaims that "none of HP, Compaq, Goldman Sachs or any other person assumes responsibility if future results are materially different from those forecast or are not achieved in the time periods contemplated."

On page 64 we get to the "Interests of HP and Compaq Directors and Executive Officers in the Merger." We find that Ms. Fiorina has declined the retention bonus the compensation committee came up with: two times her annual salary and target bonus, or $8 million. Capellas is turning down $14.4 million. Other HP and Compaq executives may receive up to three times their salary and target bonus, totalling $33 million and $22.4 million respectively. (Regarding "target bonuses," for the employees at large, the HP "Company Performance Bonus" amounted to a big fat zero for the last year. Nobody suggested paying us the target [which nobody tells us, either]. We did get a sop of a bonus of two days' salary just this month, though. Whether or not the merger goes through.)

Beyond that, there are a "substantial number of key employees" who stand to get a half-year's salary in two payments (at completion of the merger, and at its one year anniversary) for a retention incentive. We're not told what that adds up to. Finally, the execs get a soft landing for "qualifying terminations" within 2 years of the completion: 1.5 times then current salary and target bonus, stock options vest and remain vested for 3 years, etc. New employment agreements are to be expected, for the top brass, with higher salaries. They'll be managing a bigger company, after all.

On the Compaq side, the merger constitutes a "change in control" which triggers the top execs' severance agreements. Those agreements are rolled into new retention benefits, with a comfy package of benefits for qualifying terminations in the first year. I especially like "an additional payment to make the executive whole with respect to any golden parachute taxes imposed under the Internal Revenue Code." To make them whole. The $14.4 million figure comes up again: that's how much Capellas would get if he gets terminated in a qualifying way within a year of the merger. With no suggestion that he'd forgo that $14.4 million, we definitely want him to stick around, as a cost saving measure, if nothing else.

I confess, I can't parse the legalese of either the proxy statement summary or the actual agreement (annex A) to determine if a shareowner vote against the merger by itself triggers the $675 million mergus interruptus fee. I don't think it does, but I wouldn't want to bet my $675 million on that reading. Nevertheless, it isn't going to influence my vote on the issue. HP's a big company and if we need to shell out $675M for a big boo-boo by our board, we'll do it. We gave Pitney-Bowes $400 million earlier this year to settle a patent dispute, and no one batted an eye.


Which leaves us with the sixty-four billion dollar question: is this a good deal? HP's stock has tanked since the announcement (with a significant rebound when Walter Hewlett belatedly voiced his opposition, and then David Woodley Packard did too). Those of us in the rank and file have to weigh the management (and investment banker) forecasted upside against being part of an even larger corporation that sees 15,000 of us as "synergies" to liquidate. If the merger fails, the executives who spent their summer vacation on the joyride will probably all be looking for new jobs. Can Compaq and HP recover from the blow and make it on their own? (It seems as likely as the "flawless execution" scenario that makes the combined company a hands-down winner.)

It's hard to trust the Boards and executives when they stand to gain so much from the merger going through whether or not the combined company then succeeds or fails. Yeah, they'll do better if it's a winner, but they still can fund retirement for their extended families if it's a loser. It's hard to discount the opinions of the sons of the founders. I didn't see a signature section of the Compaq execs (just Capellas' on page A-47), but Walter's signature was conspicuously absent under the "Power of Attorney" on II-4. On Friday, Nov. 16th, Hewlett filed the analysis he'd received with the SEC; I haven't read through it yet, Edgar seems to be a day or two behind the news reports. (You can now find it on FreeEdgar, but be warned: it's most of 4MB. It's much more direct and readable than the corporate proxy statement, and it seems to me to make a stronger case.)

Many of us are still smarting from the first-ever layoffs at HP, mandated down the chain of command with minimal participation from lower management (another essay, still incubating), and even with the bad news and layoffs at Agilent (the "real" remnant from the spinoff, to some), the "Journey" Carly's taken us on seems to be a long way from home.

Tom von Alten      tva_∂t_fortboise_⋅_org

Wednesday, 28-Nov-2001 22:12:45 MST