Compaq/Digital

From: Compaq 1998 Annual Report

Source: http://www.compaq.com/corporate/1998ar/financials/notes/02_nf.html

On June 11, 1998, Compaq consummated its acquisition of Digital. Digital was an industry leader in implementing and supporting networked business solutions in multi-vendor environments based on high performance platforms and had an established global service and support team. The aggregate purchase price of $9.1 billion consisted of approximately $4.5 billion in cash, the issuance of approximately 141 million shares of Compaq common stock valued at approximately $4.3 billion and the issuance of approximately 25 million options to purchase Compaq common stock valued at approximately $249 million. The cash component of the purchase price was paid through the use of Compaq's general corporate funds. The results of operations of Digital and the estimated fair value of the assets acquired and liabilities assumed are included in Compaq's financial statements from the date of acquisition.

The purchase price was preliminarily allocated to the assets acquired and liabilities assumed based on Compaq's estimates of fair value at the acquisition date. In the fourth quarter of 1998, Compaq adjusted the fair values of certain assets acquired and liabilities assumed based on the receipt of additional information which was outstanding as of the date of the acquisition. These adjustments did not have a material impact on the initial purchase price allocation. The fair value assigned to intangible assets acquired was based on a valuation prepared by an independent third-party appraisal company of the purchased in-process technology, proven research and development, the installed customer base and trademarks of Digital. The amounts allocated to tangible and intangible assets acquired less liabilities assumed exceeded the purchase price by approximately $4.1 billion. This excess value over the purchase price was allocated to reduce the values assigned to long-term assets and purchased in-process technology in determining their ultimate fair values. As a result of the change in fair values of the long-term assets, the deferred tax liability associated with these assets was also adjusted.

The following table shows the fair value of the long-term assets acquired, the allocation of the excess value over the purchase price and the resulting assigned values for the long-term assets acquired through the acquisition of Digital:

 

 

Approximately $3.2 billion of the purchase price represents purchased in-process technology that had not yet reached technological feasibility and had no alternative future use. Accordingly, this amount was immediately expensed in the Consolidated Statement of Income upon consummation of the acquisition. The value assigned to purchased in-process technology, based on a valuation prepared by an independent third-party appraisal company, was determined by identifying research projects in areas for which technological feasibility had not been established, including UNIX/OpenVMS ($1.6 billion), NT Systems ($800 million), storage ($2.7 billion) and others ($600 million). The value was determined by estimating the costs to develop the purchased in-process technology into commercially viable products, estimating the resulting net cash flows from such projects, and discounting the net cash flows back to their present value. The discount rate included a factor that takes into account the uncertainty surrounding the successful development of the purchased in-process technology. If these projects are not successfully developed, future revenue and profitability of Compaq may be adversely affected. Additionally, the value of other intangible assets acquired may become impaired.

The following table represents unaudited consolidated pro forma information as if Compaq and Digital had been combined as of the beginning of the periods presented. The pro forma data is presented for illustrative purposes only and is not necessarily indicative of the combined results of operations of future periods or the results that actually would have occurred had Compaq and Digital been a combined company during the specified periods. The pro forma combined results include the effects of the purchase price allocation on depreciation of property, plant and equipment and amortization of intangible assets; adjustments to reflect the reversal of interest income resulting from the use of cash related to the acquisition of Digital, and preferred stock dividends paid. The pro forma combined results exclude acquisition-related charges for purchased in-process technology related to Digital.

 

 

 

 

 

 

 

 

 

 

 

 

Compaq, Digital Deal Creates Computer Giant
By Joe McGarvey , Interactive Week
February 2, 1998

Completing an improbable metamorphosis from PC clone maker to computer industry hardware, software and services colossus, Compaq Computer Corp. announced last week it will purchase Digital Equipment Corp. for $9.6 billion. The stock and cash proposal, which Compaq claims is the largest in the history of the computer industry, is expected to have a huge impact on the server market.

Found on the corporate networks and Web sites of business and financial institutions, servers are specialized computers that dole out applications and information and hold databases containing billions of entries.

Compaq, already the leading maker of servers for corporate networks, will gain control of Digital's high-powered server line, which run many large Web sites on the Internet. In addition, Compaq Chief Executive Officer Eckhard Pfeiffer last year engineered a deal to acquire Tandem Computers Inc. The $3 billion acquisition of the high-end server maker gave Compaq (www.compaq.com) a major presence in the retail and financial sectors.

The combination of Compaq's own server line and the equipment acquired from Tandem and Digital (www.dec.com) will make the company a more formidable challenger to other companies, such as Hewlett-Packard Co., IBM Corp. and Sun Microsystems Inc., that offer a wide range of server equipment, said Greg Garry, an analyst at Dataquest Inc.

"This is just what Compaq needed in order to move their stuff upscale into larger organizations and into more complex systems and networks," said Greg Blatnik, an analyst at Zona Research Inc.

Should the deal meet shareholder and regulatory approval, Compaq will acquire Digital's extensive sales force, 64-bit microprocessor technology, Unix operating system and its high-end servers and minicomputers, which are capable of processing thousands of business transactions every second, said Mary McDowell, vice president of marketing at Compaq.

Compaq's move into the high-end server market is good news for both Intel Corp. and Microsoft Corp., two of Compaq's biggest partners. Although Compaq will acquire Digital's Unix operating system as part of the deal, Blatnik said he expects Compaq to make Windows NT its operating system of choice, accelerating NT's ascent to power as a high-end server operating system.

Similarly, Intel will benefit since Compaq is likely to select its long-time partner's 64-bit microprocessor technology, due in 1999, to power its high-end servers, Blatnik added.

For Compaq, the brightest jewel of the proposed transaction, according to McDowell and industry analysts, is Digital's extensive and well-regarded services and support division.

Picking up the expertise to install, service and maintain a dizzying variety of hardware and software instantly will propel Compaq into the same weight class as services and systems giants HP and IBM, Blatnik said.

In fact, McDowell said, the Digital acquisition will raise Compaq's annual revenue to $37 billion, making it the second largest computer company in the world after IBM Corp. Much of that revenue is expected to come from Digital's service and support operations, which now account for 46 percent of the company's overall revenue. For the most recent quarter, revenue for services accounted for $1.5 billion of Digital's $3.32 billion in revenue.

If there is a downside to the deal, it would be the overlap between Digital's personal computers and Compaq's extensive line of PCs for both businesses and the home, said Cheryl Currid, president of Houston-based Currid & Co. But the big challenge of any acquisition the size of Compaq's proposed purchase of Digital -- expected to close midyear -- is making all the pieces fit together, she said.

Easy As 1-2-3

The acquisition of Digital Equipment Corp. will complete Compaq Computer Corp.'s three-phase transition from a PC maker to a comprehensive systems and services company.

Phase 1

Began building on its personal computer core in 1995 by introducing servers and networking equipment; acquired networking equipment makers NetWorth Inc. and Thomas-Conrad Inc.

Phase 2

Acquired Tandem Computers Inc. at the end of 1997 for $3 billion, providing the company with industrial-strength servers capable of completing thousands of transactions each second.

Phase 3

Last week's purchase of Digital extends Compaq's hardware arsenal to include minicomputers and provides the company with a service and support division that produced more than $1.5 billion in revenue in the most recent quarter.

 

Inside the Compaq-Digital deal

By Dawn Kawamoto
Staff Writer, CNET News.com
January 26, 1998, 1:25 p.m. PT

The computing industry's largest-ever merger deal was struck in the morning hours yesterday at the St. Regis Hotel in midtown Manhattan, capping two weeks of secret negotiations between the companies.

The weekend had been marked by haggling over the price of the deal but, in the end, Compaq (CPQ) and Digital Equipment (DEC) settled on a price of $9.6 billion in cash and stock.

By yesterday afternoon, the boards of both companies unanimously had signed off on the deal, which still awaits shareholder approval.

Discussions of a possible merger actually began more than two years ago in the summer of 1995, sources close to the deal said. Those talks lasted about four to six weeks before trailing off with no deal on the horizon.

A price tage between $9 billion and $10 billion had been discussed around that time, according to published reports.

Then in 1996, another round of talks were held at Compaq's prompting, but both sides walked away from the table after questions arose over management and the structure of the deal, according to a report in the Wall Street Journal.

Then, in early June of last year, Compaq and Digital again resumed talks--just before Compaq's acquisition of Tandem--a move aimed at giving the computer maker an edge in the enterprise market. Once again, the two parties weren't able to get it together.

"Compaq was a lot smaller company then, and didn't have the clear [potential ] in the enterprise market that it does now," said one source. "It was more of a desktop company, and Digital was [screwed] up."

In a conference call today, Eckhard Pfeiffer, Compaq's chief executive and president, described the previous discussions between the two companies as informative, even though they went nowhere for so long.

"As we mapped out our enterprise strategy, we were looking for the missing pieces--what else would be built, where else we would partner, where would we have to make acquisitions," Pfeiffer said, adding that the Tandem deal was the first move toward realizing that strategy, even if Tandem couldn't take care of all Compaq's needs.

"We were at the point to start looking and make the next move after the Tandem acquisition was integrated," Pfeiffer said.

It was at that point that the talks with Digital resumed. The things that changed in the course of the six-month hiatus of the talks ultimately clinched today's deal.

"Digital has settled with Intel, and exited networking by selling that business to Cabletron. They've restructured their operations to where they are profitable and have momentum," a source said. "The juxtaposition of those two events let the deal happen easier this time."

Compaq to buy Digital for $9.6 billion

By Michael Kanellos and Dawn Kawamoto
Staff Writers, CNET News.com
January 26, 1998, 2:25 p.m. PT

update Compaq (CPQ) took a major step toward its stated goal of becoming the No. 1 computer power in the world by announcing it would acquire Digital Equipment (DEC) for $9.6 billion.

The acquisition, which has been the subject of high-level, on-again, off-again negotiations for at least two years, essentially will provide Compaq with the high-end hardware technology and the worldwide corps of consulting engineers it has needed to act as a global technology provider.

"The reason for reaching this agreement was really very simple. Together, we are a much stronger competitor than we were as separate companies," Digital chairman Robert Palmer said in a conference call today.

Under terms of the deal, Digital shareholders will receive $30 in cash and an estimated 0.945 shares of Compaq stock for each Digital share. Compaq will issue about 150 million shares of its stock and pay $4.8 billion in cash for Digital.

The deal, which is expected to close sometime in the company's second quarter, comes at a time when Digital is moving away from its losses and into the black. In fiscal 1996 Digital reported a $111.8 million loss on $14.6 billion in revenues. But during fiscal 1997 the company has posted a profit of $140.9 million on revenues of $13 billion.

Compaq has performed strongly over the years, with 1997 revenues rising more than 30 percent, to $24.6 billion, and profits climbing more than 36 percent, to $1.9 billion.

Compaq has been the world leader in PCs for some time, but it has not had the high-end corporate "enterprise" technology necessary to take on hardware heavyweights IBM (IBM) and Hewlett Packard (HWP). Industry analysts also say the merger could affect rival Dell Computer (DELL), because Dell outsources much of its service work to Digital.

Through Digital, Compaq gains 1,600 certified Windows NT technicians and 3,000 Unix professionals, as well as a full line of Unix-based servers and workstations.

"The combined revenues of the two companies for 1997 was $37.5 billion. That makes us the No. 2 computing company," Compaq CEO Eckhard Pfeiffer said during a conference call that emphasized Digital's service capabilities. "Digital brings a world-class workforce to the Compaq family."

A Digital acquisition also brings Compaq a good deal of hardware technology it will not need. Once the merger is completed, expect Compaq to terminate Digital's PC and notebook business, though the company's workstation and midrange server lines should survive, analysts say.

Among some of the initial changes Compaq likely will make after the acquisition, the computer maker likely will begin to rid itself of Digital's PC line as well as its computer-manufacturing capabilities. Many of Digital's employees may be relocated to Texas, as well. In addition, upper management from Digital likely will leave the company within a short period of time, much as upper management at Tandem left the company shortly after it was acquired by Compaq. "It really is a huge system play," said Scott Miller, an analyst at Dataquest. "There is no leverage to the Digital name in PCs."

The deal is expected to close sometime in the company's second quarter. Roger Kay, an analyst at International Data Corporation, said initial changes likely will begin soon after. Other changes, Kay added, will take place gradually. Compaq likely will continue to sell Digital's Alpha and Intel-based workstations and only incrementally merge product lines.

Like many other analysts, Kay sees the Digital Multivendor Customer Service (MCS) division, Digital Equipment's consulting and support arm, as one of the crown jewels of the deal. The unit accounted for roughly $1.5 billion in sales last quarter. Moreover, much of the work performed by the unit lay in high-level consulting rather than in the more pedestrian--and less lucrative--area of maintenance. MCS's reputation ranks with those of IBM and HP, making its addition to Compaq's fold a coup for the company.

But Kay said that, while the Compaq-Digital deal looks good on paper, it has the potential to founder on cultural issues, a point Pfeiffer himself brought up during today's conference call.

"Digital tends to focus on technology. They will build a better technology and wonder why people never came," Kay said, noting that Compaq has the opposite emphasis, focusing more on practical application.

Interestingly, while cultural issues loom in the acquisition, analyst Chip Christiansen of IDC Research pointed out that many Compaq executives came from Digital. Tandem president Enrico Pesatori, senior vice president John Rose, and CFO Earl Mason all came from Digital's ranks.

Many pointed out also that the deal could spell the end of the Digital's Alpha technology, though not immediately. The 64-bit computing platform--which does not exist on Windows-Intel technology--accounts for a large portion of Digital's revenue.

Still, over time, commitment to Alpha may fade. Digital earlier this year said it would support Intel's upcoming Merced chip, which rivals Alpha.

"Sixty-four-bit NT [for Merced] is a way off. Compaq will need to turn [Alpha] into revenue growth,"

Ashok Kumar, an analyst for Loewenbaum & Company, said in reference to Microsoft's next-generation Windows NT operating system and Intel's next-generation processor. "Will they be able to grow revenues on [Alpha server lines]? Probably not. Momentum will shift to the Wintel camp with the appearance of Merced."

Kumar added further that the transfer of Digital's chip foundry to Intel in a recent legal settlement likely will not hold up the current deal. He said he had no doubt that Compaq did its due diligence surrounding the issue.

Pfeiffer, for his part, pledged commitment to Alpha. "We are committed to...investing in Digital's strategic assets, particularly its worldwide service organization, as well as its 64-bit leadership with Alpha microprocessors, OpenVMS, Digital Unix, and Windows NT enterprise systems, open storage, and software products," he said.

The deal, which Christiansen said has been discussed for two years, probably became a reality because of Digital's concerted effort to shed itself of business units over the past two years. Since 1996, Digital has been able to rid itself of its disk drive operations, printer business, networking unit and, more recently, its chip fabrication plant.

"Compaq did not want to be in the chip business and did not want to compete against its largest partner Intel," he said.