The Hewlett Packard / Compaq Merger

On Sept. 3, 2001 Hewlett-Packard Company and Compaq Computer Corporation announced a

definitive agreement to merge, creating a new $87 billion global company. In announcing the
deal, executives from the two companies described the combined entity, which will retain the HP
name, as one that will offer the industry’s most complete set of IT products and services and will
carry forward both companies’ commitment to open systems and architectures. HP Chairman
and CEO Carly Fiorina, who became chairman and CEO of the combined company, described
the merger as a “decisive move that positions us to win by offering even more value to our
customers and partners.” Michael Capellas, Chairman and CEO of Compaq, who became
president of the new HP, commented that “we are creating a new kind of industry leader - one
founded on customer success, world-class engineering, and best of breed products and services.”
With operations in more than 160 countries, the new company will rank No. 1 worldwide in
revenue for servers, access devices (PCs and handheld devices), and imaging and printing.
Executives further described the merger as one that is expected to create substantial shareholder
value through cost structure synergies. These anticipated synergies, projected to reach $2.5
billion annually, will come from (i) product rationalization, (ii) efficiencies in administration,
procurement, manufacturing and marketing, and (iii) improved distribution of PCs and servers.

The HP-Compaq deal was finalized on May 3, 2002, when Hewlett-Packard acquired all of the
outstanding stock of Compaq Computer Corp. Excerpts from HP’s 2002 second quarter 10-Q
(ended April 30, 2002) are included in the supporting materials. These second quarter financial
statements do not yet reflect the impact of the pending acquisition of Compaq. Also included are
excerpts from Compaq’s 2002 first quarter 10-Q (ended March 31, 2002), Compaq’s last quarter
before being acquired. The supporting materials also include excerpts from HP’s 2002 third
quarter 10-Q (ended July 31, 2002), providing some details on the acquisition.

Based on the attached materials, please answer the following questions:

1. a. How much did Hewlett-Packard pay to acquire Compaq? How did they finance
the acquisition?

b. How much of the purchase price did HP immediately expense, and for what?

Copyright © 2014 by Professor Ron Kasznik, Stanford University. The case was prepared as the
basis for discussion rather than to illustrate either effective or ineffective handling of an
administrative situation.
 2. a. What is your best estimate of the fair value of all identifiable tangible assets (i.e.,
other than intangibles) net of liabilities acquired in the Compaq’s acquisition?

b. What is the carrying value of these identifiable tangible assets (other than
intangibles) net of liabilities on Compaq’s Balance Sheet before being acquired
by Hewlett-Packard?

c. What is your best estimate of the amount of Goodwill that Hewlett-Packard

recognized related to its acquisition of Compaq?

3. Using the worksheet below, prepare a summary consolidated Balance Sheet for Hewlett-
Packard at May 3, 2002, reflecting the acquisition of Compaq. You may assume that there
are no other changes between April 30, 2002 and May 3, 2002. You may also assume that
Compaq’s financial statements at May 3, 2002 are identical to those at March 31, 2002, and
that there are no material inter-company transactions between Hewlett-Packard and Compaq
before the merger date.

[Note that the empty space in the worksheet is provided for your convenience; you do not
need to use all columns/rows].

HP Consolidated
4/30/2002 HP-Compaq
Current assets 23,855
PPE, net 4,305
Investments and other assets 6,120

Total Assets 34,280

Current liabilities 13,832

Long-term liabilities 5,487

Total stockholders’ equity 14,961

Total liabilities and equity 34,280

4. HP’s announcement in September 2001 of the proposed merger with Compaq set
off a firestorm of controversy. Michael Dell, CEO of rival Dell Computer,
famously called it “the dumbest deal of the decade,” and board member Walter
Hewlett, the son of the company co-founder William Hewlett, mounted an
aggressive proxy fight to prevent the corporate merger from being consummated.
Stockholders and the media were fiercely divided as to the wisdom of the move.
Specifically, the day that HP and Compaq announced the proposed merger, HP’s
stock closed at $18.87, down sharply from $23.21 the previous trading day.

In the more than ten years subsequent to the acquisition of Compaq, analysts and
investors continue to debate the overall success of this contested mega-merger. In
the first few years following the 2002 merger, the new HP struggled to post
consistent profits in PCs and so-called enterprise hardware business -- selling
servers and storage products to large corporate customers -- where it faced stiff
competition from Dell, IBM, and others. These concerns have contributed to the
February 2005 ousting of CEO Carly Fiorina amid much investor displeasure
about the results of the Compaq deal. However, the surge in HP’s profitability
and stock price during the 2005-2007 period led some to argue that perhaps the
merger was indeed a good idea (see, e.g., “Compaq and HP: Urge to Merge Was
Right,” Stanford Business Magazine, November 2007.)

Over the years subsequent to the Compaq acquisition, there has been speculation
on Wall Street that HP would write-off any remaining goodwill related to the
Compaq acquisition. What would have been the effect on Total Assets, Total
Liabilities, and Total Stockholders’ Equity reported by HP at the end of 2013 had
they impaired all remaining Compaq-acquisition-related goodwill prior to October
31, 2013? [HP’s Annual Report for 2013 is posted on the program website].

5. As the world's leading PC supplier, HP generated about $32 billion in revenues in

fiscal year 2013 from its PC business (Personal Systems Group” segment; see
Note 18). Yet, on August 18, 2011, HP made a dramatic announcement that has
taken Wall Street by surprise. Specifically, HP revealed that is was exploring
strategic alternatives" for its PC business, which could lead to the division being
spun-off or sold. In statements to accompany this announcement, the then CEO
Léo Apotheker indicated this was part of a strategic shift to focus on higher
margin businesses such as cloud computing, software, and what he called “the
next-generation Information Platform.” However, Apotheker was fired a month
later, and the new CEO, Meg Whitman, has decided to continue selling PCs.

Suppose HP had sold its PC division at the beginning of 2013 for $10 billion (this
number is for illustration purposes). What would be the estimated effect of such
divestiture on HP’s Total Assets, Total Liabilities, and Stockholders’ Equity? For
simplicity, suppose the amount of liabilities associated with the PC segment is
proportionate to the amount of assets. [ignore tax effects.]
 Excerpts from
Hewlett-Packard
2002 Second Quarter 10-Q
(ended April 30, 2002)
Hewlett-Packard Company and Subsidiaries
Consolidated Condensed Balance Sheet
(In millions)

1pri1 30, October 31,

2002 2001
unaudited)

ASSETS

Current assets:
Cash and cash equivalents $ 8,741 4,197
Short-term in'restments 147 139
Accounts receivable, net 3,936 4,488
Financing receivables, net 2,216 2,183
Inventory 4,017 5,204
Other currei assets 4,798 5,094

Total current assets 23,855 21,305

Property, plant and equipment, net 4,305 4,397

Long-term investments and other assets 6,120 6,882

Total assets $ 34280 $ 32584

LIABILITIES AM) STOCKHOLDEPS' EQUITY

Current liabilities:
Notes payable and short-term borrouings 1,618 1,722
Accounts payable 3,584 3,791
Employee compensation and. benefits 1,665 1,477
Taxes on earnings 1,688 1,818
Deferred revenues 1,943 1,867
Other accrued liabilities 3,334 3,289

Total current liabilities 13,832 13,964

Long-term debt 4,442 3,729

Other liabilities 1,045 938

Stockholders' equity 14,961 13,953

Total liabilities and stockholders equity $ 34280 $ 32.584

Hewlett-Packard Company and Subsidiaries
Consolidated Condensed Statement of Earnings
(Unaudi ted)
(In millions except per share amounts)

Three months ended

April 30,
2002 2001(a)

Net revee 10,621 11,668

Cost of sales 7,583 8,738

Gross margin 3,038 2,930

Operating expenses:
1&esearch and development 742 706
Selling, general and administrative 1,864 1,881
ILestructuring charges 18 -
Total operating expenses 2,624 2,587

Earnings from operations 414 343

Interest and other net (45) 39

Net investment losses 16 -
Litigation settlement - 400

Earnings before extraordinary item and taxes 353 (18)

Provision (benefit) for taxes 115 (53)

Net earnings before extraordinary item 238 35

Extraordinary item - gain on early

extinguishment of debt, net of taxes 14 12

Net earnings $ 252 $ 47

Basic net earnings per share:

Net earnings before extraordinary item 012 0.02
Extraordinary item - gain on early
extinguishment of debt, net of taxes 0_UI -
Net earnings $ 013 $ 002

D3.lnted net earnings per share:

Net earnings before extraordinary item $ 0.12 0.02
Extraordinary item - gain on early
extinguishment of debt, net of taxes 0.01 -
Net earnings $ 0.13 $ 002

Cash dividends declared per share - -

Weighted-average shares used to compnte net

earnings per share:
Basic 1,955 1,935
Diluted' ' 1,973 1,987

NM - Not meaningful
 Excerpts from
Hewlett-Packard
2002 Third Quarter 1O-Q
(ended July 31, 2002)
 HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Third Quarter 1O-Q
Notes to Consolidated Condensed Financial Statements

Note 3: Business Combinations

In accordance with SEAS No. 141, HP allocates the purchase price of its
acquisitions to the tangible assets, liabilities and intangible assets acquired,
as well as in-process research and development, based on their estimated fair
values. The excess purchase price over those fair values is recorded as goodwill.
The fair value assigned to intangible assets acquired is based on valuations
prepared by independent third party appraisal firms using estimates and
assumptions provided by management. The goodwill recorded as a result of these
acquisitions is not expected to be deductible for tax purposes. The assignment of
goodwill to reporting units for these acquisitions has not yet been completed.

Compaq

On May 3, 2002, HP acquired all of the outstanding stock of Compaq, a leading

global provider of information technology products, services and solutions for
enterprise customers, in exchange for 0.6325 of a share of HP common stock for
each outstanding share of Compaq stock. The acquisition of Compaq is intended to
enhance HP's combined competitive position in key industries, while strengthening
its sales force and position in strategic markets. The merger is intended to
enable HP to focus on strategic product and customer bases, achieve significant
cost synergies and economies of scale and improve profitability of its combined
Enterprise Systems, Personal Systems and Services businesses. The exchange ratio
in the merger was derived from estimates of future revenue and earnings of the
combined company assuming completion of the merger, and by measuring each of HP's
and Compaq's relative contributions to achieving these forecasted results, in
addition to measuring the relative ownership of the combined company implied by
their contributions. This transaction resulted in the issuance of approximately
1.1 billion shares of HP common stock with a fair value of approximately $24.1
billion.
 HEWLETT-PACKARD COMPANY AND SUBSIDIARIES
Third Quarter 1O-Q
Notes to Consolidated Condensed Financial Statements
Note 3: Business Combinations (Continued)

Based on a preliminary independent valuation, which may change upon receipt of the
final valuation, the total purchase price of approximately $24.1 billion has been
allocated as follows (in millions)

Current assets $ 13,356

Property, plant and equipment 2,991
Long-term financing receivables and other assets 1,927
Intangible assets with definite lives:
Customer contracts and lists, distribution agreements 1,942
Developed and core technology, patents 1,589
Intangible assets with indefinite lives 1,422
Current liabilities (9,666)
Long-term liabilities (4,606)
In-process research and development 735

Intangible assets with definite lives

Of the total purchase price, approximately $3.5 billion has been allocated to
amortizable intangible assets including customer contracts and developed and core
technology.

Customer contracts represent existing contracts that relate primarily to

underlying customer relationships pertaining to the services provided by Compaq
Global Services. Customer lists and distribution agreements represent Compaq's
relationships within the Enterprise and Personal Systems segments installed base
and agreements with Enterprise value-added resellers. HP expects to amortize the
fair value of these assets on a straight-line basis over a weighted average
estimated useful life of approximately 9 years.

Developed technology, which consists of products that have reached technological

feasibility, includes products in most of Compaq's product lines. Core technology
and patents represent a combination of Compaq processes, patents and trade secrets
developed through years of experience in design and development. HP expects to
amortize the developed and core technology and patents on a straight-line basis
over a weighted average estimated useful life of approximately 6 years.

Intangible assets with indefinite lives

The estimated fair value of intangible assets with indefinite lives was $1.4
billion, consisting primarily of the estimated fair value allocated to the Compaq
trade name.

In-process research & development

Of the total purchase price, an estimate of $735 million has been allocated to in-
process research & development ("IPR&D") and will be expensed. Projects that
qualify as IPR&D represent those that have not yet reached technological
feasibility. Technological feasibility is defined as being equivalent to a beta-
phase working prototype in which there is no remaining risk relating to the
development.
 Excerpts from
Compaq Computer Corp.
2002 First Quarter 10-Q
(ended March 31, 2002)
 COMPAQ COMPUTER CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET

MARCH 31, DECEMBER 31,

(In millions, except par value) 2002 2001

(tJNAUDITED)
ASSETS

Current assets:
Cash and cash equivalents $ 3,702 $ 3,874
Trade accounts receivable, net 4,147 4,623
Leases and other accounts receivable 1,957 1,881
Inventories 1,419 1,402
Other assets 1,440 1,498

Total current assets 12,665 13,278

Property, plant and equipment, net 3,171 3,199

Other assets, net 6,935 7,212

Total assets $ 22,771 $ 23,689

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Borrowings $ 1,666 $ 1,692
Accounts payable 3,350 3,881
Deferred income 1,191 1,181
Other liabilities 3,984 4,379

Total current liabilities 10,191 11,133

Long-term debt 600 600

Postretirement and other postemployment benefits 844 839

Commitments and contingencies

Stockholders' equity:
Preferred stock, $.Ol par value
Shares authorized: 10 million; shares issued: none -- --
Common stock and capital in excess of $.01 par value
Shares authorized: 3 billion
Shares issued: March 31, 2002 - 1,774 million
December 31, 2001 - 1,766 million 8,375 8,307
Retained earnings 4,394 4,393
Accumulated other comprehensive loss (182) (132)
Treasury stock (shares: March 31, 2002 - 62 million
December 31, 2001 - 62 million) (1,451) (1,451)

Total stockholders' equity 11,136 11,117

Total liabilities and stockholders' equity $ 22,771 $ 23,689

See accompanying notes to interim condensed consolidated financial statements.

 COMPAQ COMPUTER CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME

THREE MONTHS ENDED MARCH 31,

(In millions, except per share amounts) 2002 2001

Revenue:
Products $ 6,109 $ 7,480
Services 1,619 1,701

Total revenue 7,728 9,181

Cost of sales:
Products 4, 969 5,893
Services 1,169 1,212

Total cost of sales 6, 138 7,105

Selling, general and administrative 1,157 1,438

Research and development 286 364
Restructuring and related charges 249
Merger-related costs 35
Other (income) expense, net 49 (106)

1,527 1,945

Income before income taxes 63 131

Provision for income taxes 19 40

Income before cumulative effect of accounting change 44 91

Cumulative effect of accounting change, net of tax (222)

Net income (loss) $ 44 $ (131)

Earnings (loss) per common share:

Basic:
Before cumulative effect of accounting change $ 0.03 $ 0.05
Cumulative effect of accounting change, net of tax (0. 13)

$ 0.03

Diluted:
Before cumulative effect of accounting change $ 0.03 $ 0.05
Cumulative effect of accounting change, net of tax (0. 13)

$ 0.03 $ (0.08)

Shares used in computing earnings (loss) per common share:

Basic 1,705 1,685

Diluted 1,718 1,685

See accompanying notes to interim condensed consolidated financial statements.