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Compaq Q3 shortfall beats up HP merger

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CIOL Bureau
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NEW YORK: Compaq Computer Corp.'s third-quarter shortfall gives shareholders

yet another reason to dislike its already unpopular plan to merge with

competitor Hewlett-Packard Co., investors said on Tuesday.

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Compaq, the No. 2 personal computer maker, said on Monday evening that it

would post an operating loss and a sales shortfall in the quarter ended Sept.

30. It blamed the weak economy, stiff pricing, and shipment issues related in

part to the Sept. 11 attacks on the World Trade Center.

The financial warning underscored the intense competition and weak demand in

the computer industry. It also may provide Wall Street with a new reason to

battle the merger between Houston, Texas-based Compaq and computer and printer

maker Hewlett-Packard, investors said.

Since Hewlett announced its plans to buy Compaq on Sept. 4, unhappy investors

have shed Hewlett shares, pushing the value of the deal down to $16.4 billion

from $25 billion. "Before anything happened on Sept. 11 the response to the

merger was not positive," said Alan Loewenstein, co-manager of the John

Hancock Technology Fund, pointing to the stock declines.

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"Now the business conditions have definitely gotten worse for the PC

market, most notably Compaq and Hewlett. You just wonder what's going to happen

as we go forward to make this merger work," he said.

Investors remain skeptical

Indeed, shareholders who have been against the deal from the beginning

continue to say that the merged entity will not be able to compete more

effectively against competitors Dell Computer Corp. and International Business

Machines Corp. than they can alone.

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"We don't like the merger. Our strong preference would be that the

companies reassess, take their cue from the market and the analysts who are

universally negative about it and both proceed independently," said David

Katz, chief investment officer at Matrix Asset Advisors, which manages $700

million in investments. Katz, who owns both Compaq and Hewlett shares, said that

he believes after a month of stock declines, the board of directors of both

companies are under pressure. "I think both boards have to be rethinking

the combination in light of the markets' fiercely negative reaction," Katz

said.

Compaq shares weakened on Tuesday, giving up about 3 per cent, or 24 cents,

to close at $8.09. Hewlett traded down 3.2 per cent, or 50 cents, at $15.10. The

deal's "spread" - or the difference between where Compaq's shares are

trading and where the deal values them at - closed Tuesday at 18.2 per cent, a

level most arbitrage traders consider dangerous. "Safe" spread

typically lie in the 9 per cent to 10 per cent range.

"The question in everyone's mind is, what kind of support does Carly

(Hewlett Chief Executive Carly Fiorina) have from the board right now,"

said one risk arbitrager, who asked not to be named. "There have to be some

doubts creeping into the board's minds."

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Capellas still selling the deal to investors

Fiorina and Compaq Chief Executive Michael Capellas have been selling the

deal to the boards of directors, employees and investors.

After an aggressive first week of September, investor communications were

interrupted as the attacks on the World Trade Center halted all flights the week

of Sept. 11 and then the following week as companies slowly got back to

business, Capellas said in a telephone interview with Reuters on Monday. They

have since resumed, he said, adding that the merger is going forward, despite

declines in the stocks. "This is a fixed price exchange. The merger was not

dependent on any particular stock price," Capellas said.

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"The long-term fundamentals have not changed. If anything the long-term

fundamentals have just moved to the point where all the basic rationale of the

deal is even stronger," he said. US Bancorp Piper Jaffray analyst Ashock

Kumar disagreed.

"A maturing and commoditized PC and enterprise market mandates

structural changes to the biz model, which will not manifest in the HWP/CPQ

merger," he wrote in a research note.

(C) Reuters Limited 2001.

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