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Key hurdle for HP-Compaq merger looms this week

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CIOL Bureau
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Peter Henderson

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SAN FRANCISCO: Shareholders in Hewlett-Packard Co. have a few weeks remaining

to consider how they will vote on the company's controversial plan to buy Compaq

Computer Corp, but the fate of the $21 billion deal could effectively be sealed

this week, analysts say.

An estimated 10 per cent of HP shares -- a block that could determine whether

or not the largest-ever computer merger succeeds -- will be voted in accordance

with the opinion of Institutional Shareholder Services, which plans to disclose

its position on the deal by Tuesday.

ISS, as it is known, advises some 700 funds how to vote in proxy battles, and

many of its clients are obligated because of the structure of their funds or

potential conflicts of interest to follow ISS advice.

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Although some fund managers expect ISS to side with HP management and endorse

the merger, a surprise decision by the Bethesda, Maryland-based firm to oppose

it could sway enough votes to all but scuttle the deal, which has failed to

muster much enthusiasm on Wall Street, analysts say.

Noel Dedora, portfolio manager at San Francisco's Fremont Investment

Advisors, said his company would vote for the merger, preferring as usual to

vote with management. The uncertainty of scuttling the deal would be costly, he

said.

Even so, Dedora said he was interested to see the ISS decision. "If the

vote favors the merger then it certainly ups the odds considerably, but if the

ISS vote goes against it, it is probably a toss up. I don't think it will

destroy it," he said.

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Hewlett vs. Fiorina



The battle over the merger has grown nasty in recent days, pitting HP Chief
Executive Carly Fiorina, who says the merger would create a technology

powerhouse to rival IBM Corp., against dissident director Walter Hewlett, who

says the deal would saddle the company his father co-founded with a low-margin

personal computer maker.

Hewlett wants Fiorina fired if the deal is scrapped. Fiorina says Hewlett has

been deceptive by leaking details of discussed executive pay deals as well as by

floating talk of bringing back former HP CEO Lew Pratt to steer the company in

the interim.

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Both sides have buttressed their views with studies commissioned by outside

analysts.

"We will make our own decision," said Kar Ming Leong, a technology

analyst for Dreyfus Corp., an ISS client which held about 2.6 million shares of

HP on Dec. 31, 2001. "This time it is slightly different, because it is a

high-profile thing. I think the shareholders, other than the index funds, would

like to voice their own opinions."

ISS was expected to back management, Leong said.

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"When was the last time ... that you saw ISS oppose a deal? Not in

anybody's recent memory. On the other hand, if ISS said no, it is probably a

bigger factor," he said, but declined to say which way Dreyfus was leaning.

Index mutual funds, which build portfolios that match the composition of

stock indexes like the Standard & Poor's 500, represent around 9 or 10 per

cent of HP shares, according to several industry analysts. They will vote with

ISS as will Barclay's Global Investors, with 3 per cent of HP stock, since its

chief executive, Pattie Dunn, also sits on HP's board.

As a result, a negative ISS opinion would sway votes that combined with the

18 per cent stake of founding family interests opposed to the deal and a few per

cent held by anti-merger, outside investors could leave a third of HP shares

aligned against the deal.

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Institutional investors with a few per cent of HP shares have openly backed

the deal, but neither side has been able to rely on retail investors with around

25 per cent of shares, leading one opponent to conclude: "If ISS goes for

us, then it is a rout. If ISS goes for them, then it's a horse race."

Opponents outgunned, have head start



But outsiders have learned to never say never in the five-month-long HP
merger battle.

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Walter Hewlett's opposition in November had market players sure the deal was

dead -- for a few days. Similarly, the Packard Foundation's December decision to

vote "no" with its 10 per cent of shares appeared to kill the deal

again.

But that was before an aggressive campaign by management to sway outside

investors. HP shares, at $20.21 at Friday's close on the New York Stock

Exchange, were down 13 per cent since the deal was announced on Sept. 3,

compared to a 3 per cent rise for IBM over that period.

A number of analysts see management building a silent majority. Bear Stearns

analyst Andrew Neff thinks the deal is a bad move, but said HP management simply

has the stronger hand. "The odds are that management will prevail," he

said. "It is too hard to call right now, just because Walter has a head

start. I think he is outgunned, generally."

Sanford C. Bernstein analyst Toni Sacconaghi, who gives 2-to-1 odds that the

deal will be voted down, said he thought only about 20 per cent of institutional

shareholders who planned to make their own decisions were still waiting to do

so.

"But as in any voting situation, recency and momentum can definitely

sway lingering uncertain votes," he said.

Opponents of the deal outside the company have been much more vocal than

supporters, arguing that Compaq's PC business, No. 2 after losing the lead to

Dell Computer Corp last year, was commodity-oriented and would dilute the value

of HP's higher-margin printing franchise.

Many passionate retail investors posting on Internet message boards backed

that point of view, but HP management has beaten Wall Street financial

expectations for the past two quarters, after a year of profit disappointments.

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