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Safe Money Report

September 11, 2000

Hewlett-Packard in Talks to Buy PwC Consulting Unit
By David Ward, Bloomberg

One More Merger Doomed to Fail ... Weiss comments

PALO ALTO, CALIFORNIA - Hewlett-Packard Co., the No. 2 computer maker, said it's in talks to buy PricewaterhouseCoopers LLP's management and information-technology consulting business for as much as $18 billion in cash and stock.

This would be Hewlett-Packard's first major acquisition since Chief Executive Carly Fiorina joined the company last year. She is seeking to drive growth by offering more consulting to potential buyers of the company's computer systems. International Business Machines Corp. and other rivals already offer such services.

"Among the leading systems and services companies, IBM and Compaq, HP's services and consulting revenue basis still has been relatively small," said Richard Chu, an analyst at SG Cowen Securities Corp. with a "strong buy" rating on Hewlett-Packard.

Consulting services account for $1.5 billion to $2 billion, or less than 5%, of Hewlett-Packard's annual sales, Chu said. New York-based Pricewaterhouse's management consulting business had $4.96 billion in revenue in fiscal 1999.

If completed, the transaction would "mildly" dilute cash earnings per share in fiscal 2001 and be neutral in 2002, Hewlett- Packard said. The company bought 32-employee computer test and measurement company Qosnetics last year for undisclosed terms.

"Gaining PwC would help (Hewlett-Packard) understand what the client wants," said Hugo Mills, an analyst at Donaldson, Lufkin & Jenrette in London. "It would also give them an army of people to help them integrate their product."

Shares of Palo Alto, California-based Hewlett-Packard fell 4.69 to 116.31 in early trading. PricewaterhouseCoopers will no longer be Hewlett-Packard's auditor because independence requirements bar accounting firms from doing certain business transactions with their clients.

SEC Pressure

PricewaterhouseCoopers, a closely held company with 2,000 partners and 30,000 consultants, said in February it planned to separate its auditing and consulting divisions, as the U.S. Securities and Exchange Commission increases pressure on accounting firms to split those businesses to avoid conflicts of interest.

Companies that sell computer networks and services have been seeking to offer more consulting and strategic advice to clients. Cap Gemini SA, Europe's largest computer services company, paid $6.8 billion this year for the consulting business of Ernst & Young, the world's fourth-largest accounting firm.

Hewlett-Packard is seeking to boost revenue in its computer server division, which sells powerful computers that run Web sites and corporate computer networks. The company relies currently on both internal and outside consultants.

In its fiscal year ended October 1999, Hewlett-Packard received $5.9 billion from information-technology services, which include consulting and customer support, according to the company's financial statements.


The talks with PricewaterhouseCoopers may not result in an agreement, Hewlett-Packard said. Any accord would have to be approved by partners at PricewaterhouseCoopers.

For PricewaterhouseCoopers, the sale would address concerns of the SEC, which in June proposed rules to expand restrictions on the ability of firms to design and install large information and computer systems while providing audits to a company.

"For investors to have confidence in the quality of the audit, the public must perceive the accountant as independent," SEC Chairman Arthur Levitt said in a speech last May.

DLJ's Mills said manufacturers such as Hewlett-Packard would be smarter to form alliances with consulting firms, rather than buy them, because their businesses are quite different. He cited a joint venture formed in March between Cap Gemini and Cisco Systems Inc. as an example.

"We would tend to be cautious towards these kinds of things because one is a product model, and one is a people-services model," he said. "If manufacturers need experience, the best way forward is to use joint ventures."

The current issue of Safe Money Report details the 10 mega-mergers most likely doomed to fail, or, at least, be a huge disappointment to shareholders. Too bad Hewlett-Packard made this announcement after our press date. Even before it is finalized, we can tell you that this merger is a disaster waiting to happen.

Putting aside the SEC scrutiny and regulatory hurdles that the proposed merger faces, the pricey $18-billion price tag makes it a bad deal at the start. Clearly HP got caught in a bidding war with PwC's other suitors. Now, because of some deluded ego trip, HP is set to pay much more than the company would be worth under normal conditions. And, HP is already warning that earnings will take a hit if the merger ever materializes. It's no wonder that HPs shares are taking a drubbing in the market today.

Moreover, similar deals, such as Ernst & Young's sale of its consulting arm to Cap Gemini, show just how unfortunate these mergers can be. According to CBS Marketwatch, shares of Cap Gemini have fallen 40% since that deal took place in February.

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