Microsoft, IBM Are Both Potential Suitors for HP

Includes: HPQ, IBM, MSFT
by: EconMatters

The longer HP (NYSE:HPQ) languishes at the $41 a share level, the more likely the company will become a takeover target. Well, the fact that HP currently doesn't have a CEO, and the fact that its stock price is dirt cheap with regards to book value makes the company vulnerable.

After all, when HP is trading at $55 a share, and any takeover requires a hefty premium of at least 20% to actually get a non-hostile bid to be accepted by the board and shareholders, this becomes a huge roadblock to a M&A deal being completed successfully.

But if a firm's stock has fallen like HP's because of a non-material event to the business, like the firing of a CEO, this creates a once in a lifetime buying opportunity that might only have a short window before Wall Street investors wake up and realize that HP is too cheap relative to the company's underlying business fundamentals, and current financial performance. But if HP is trading at $41 a share, and Microsoft (NASDAQ:MSFT) or IBM pays a 20% premium over this price, this is doable.

Are there synergies that could be captured in a Microsoft and HP or IBM and HP merger? Actually, there are. Let's take Microsoft first.

Microsoft & HP

Microsoft wants to get into both the tablet and smart phone markets, which HP is already setting up the groundwork with its 2011 launch of the HP Slate and its recent acquisition of PALM. Microsoft desperately needs to branch out and get into the business services arena which HP already has a foothold in, similar to IBM. Otherwise, Microsoft risks other firms entrenching on its territory of office suite products through the backdoor of cloud computing, and other business services offerings.

Would there be a cultural clash between the two? Maybe 20 years ago, but odd as it seems, HP would actually add some much needed youthful element and growth zing to Microsoft's staid ways. Microsoft needs an infusion; it has been stuck in the same place for basically the last decade. It needs to either get off the pot and start paying a 5% dividend with all that cash it has been sitting on, or go out there and grow the top line through meaningful large scale acquisitions that really make a splash.

Next let's look at a IBM and HP merger.


The synergies between IBM and HP are quite striking in the business services arena, and actually could help augment each company's particular strengths in this area to attain more business by offering a more complete A-Z business solution in this high margin area. IBM could actually diversify its revenue stream by getting back into the consumer PC and hardware business, as IBM's latest quarter suggests it may have specialized itself into too fine a corner with its current business model approach.

Although IBM's current business model has high margins, it is very cyclical in nature, and almost exclusively reliant on the large corporate client, with little exposure that a large consumer base that HP offers. Acquiring HP would help IBM hedge and diversify its revenue stream. It’s the same reason why the major oil companies are still holding onto their downstream (refining and marketing) assets. The downstream operations offer more consistent earnings over a diverse set of economic conditions, and thus act as a revenue hedge for the more volatile upstream (E&P) operations. The same benefit could be attained by IBM through diversifying its revenue stream from the current overly specialized model.

Like Microsoft, IBM is sitting on a pile of cash, and even though it has changed their business model over the last five years dramatically, the stock price is the same place it was 10 years ago. So IBM is facing the same challenge of organic growth just like Microsoft. It will also either need to pony up and offer a 5% dividend, or start growing the top line through some bold moves such as an HP acquisition that would really invigorate Big Old Blue.

Takeout Put at $40

I think there is a natural put on the HP stock at the $40 a share level as the world was falling apart last week, and it held that level under some pretty serious selling pressure. This is the takeout put price. Will a deal likely happen similar to the BHP-Potash (POT) big time merger? We will see but one thing is for sure, whether we are talking about Exxon (NYSE:XOM) buying out XTO Energy or another merger in some other sector, we will experience major consolidations in all sectors including the Technology sector in the near future.

Corporations are sitting on too much cash and fortune 500 companies’ stock prices are too cheap given their financial performance in a tough economic environment. It is always easier and more cost efficient to grow through acquisition as opposed to an organic growth strategy, in most cases. In the current challenging economic environment and a low cost of capital for major corporations, acquisitions make for the most efficient use of capital allocation.

Disclosure: No Positions

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