Financial analysis of the 2006 Hewlett-Packard and Mercury Interactive merger

Merger

Financial Analysis of the 2006 Merger of Hewlett-Packard and Mercury Interactive: A Case Study

In July of 2006, Hewlett Packard announced it had signed a deal with Mercury Interactive to purchase the software manufacturer and distributer for approximately four-and-a-half billion dollars (Hewlett Packard 2006). The main strengths conferred upon both companies in this merger were found not in the financial benefits, though these were considerable, but rather in the strength of the new company's ability to provide products and services over the entire IT lifecycle (Boardman 2006; Coffee 2006). While Mercury Interactive became essentially a new division of Hewlett Packard, the deal was conducted as a merger and was considered such by most of the analysts covering the deal, as there was no aggressive takeover of Mercury Interactive by Hewlett Packard and neither company was struggling financially at the time that the merger took place (Harkiolakis & Mourad 2009). This paper will examine the financial benefits, impacts, and considerations of this merger utilizing pertinent literature and company documents.

Risk Management, Valuation, and Cost

Though the financial aspects of the HP and Mercury Interactive merger were of course quite large, the primary risks associated with the merger were more operational in nature (Knorr 2006). Specifically, the style of operation and the emphasis on testing and ensuring quality prior to delivery that had been a key part of Mercury Interactive's success was seen as somewhat lacking in HP's general modus operandi, and risk was identified by analysts and company officials on both sides of the deal in this area (Knorr 2006; Taft & Musich 2006). In order to mitigate and manage this risk, operational guidelines and values were a large part of pre-merger discussions, with agreements on such issues as product testing arrived at prior to the close of the deal (Knorr 2006).

Both companies were considered industry leaders at the time of the merger, and valuation for both was far into the black (Taft & Musich 2006; Coffee 2006). The precise valuations of both companies were achieved through a basic analysis of the cash solvency, profit margins, and debt loads carried by the two corporate entities; the agreed-upon price of fifty-two dollars per share of Mercury Interactive -- which worked out to approximately four-and-a-half billion dollars -- was the net result of Mercury's existing cash assets less its standing debts (Hewlett Packard 2006; Taft & Musich 2006). This purchase price also represents the major cost component for the merger; while there are also tax costs involved and some incidentals for the reworking of Mercury Interactive as a division of HP, operational costs remain largely unchanged from their pre-merger figures for both companies except for the shift of Merucry Interactive's costs to its new parent company (Hewlett Packard 2007; Hewlett Packard 2008; Mercury Interactive 2006).

Budgeting, Financing, and Capital Structure

Prior to the announcement of the HP-Mercury Interactive merger, Mercury had acquired a major competitor earlier in 2006 through a cash buyout, which was a definite asset to the company and made it even more attractive to Hewlett Packard, but which also left its cash assets in short supply (Taft & Musich 2006; Coffee 2006). As one of the largest corporations in the technology sector, indeed one of the larger corporations in the world, HP had significant cash supplies and strong credit rankings to utilize in budgeting for this merger (Harkiolakis & Mourad 2009; Knorr 2006). The budgeting for this merger was therefore entirely in the hands of Hewitt Packard's financial capabilities. The deal was thus financed as a cash transaction using Hewlett Packard's massive reserves and its ongoing cash flow, which is and was quite considerable even when compared to that of the hugely successful Mercury Interactive (Coffee 2006). This enabled the deal to move foreword relatively quickly despite some hindrance caused by investigations spearheaded by the Securities and Exchange Commission into Mercury Interactive's stock options deals and its delayed financial reporting to the SEC (Taft & Musich 2006).

With the completion of the merger all of Mercury Interactive's assets and liabilities were wholly transferred to Hewlett Packard, with the result that the new capital structure for the merged companies was essentially the same as the capital structure that existed at HP prior to the merger (Hewlett Packard 2007; Hewlett Packard 2008; Mercury Interactive 2005). The increased assets and profitability granted to HP as a result of this merger, as well as the far less significant added liabilities that came to the company along with its possession of Mercury Interactive, are clearly visible in Hewlett Packard's annual reports (Hewlett Packard 2007; Hewlett Packard 2008).

Merger Process, Stakeholder Communications and Reactions

The process of the merger between Hewlett Packard and Mercury Interactive was one of the more straightforward mergers to take place in the post-Enron era. Mercury Interactive was under investigation by a Special Committee and by the Securities and Exchange Commission at the time the merger was announced, but this did not really impede the merger process significantly if at all (Taft & Musich 2006). The offered price was announced in late July and the deal was completed in mid-November 2006 (Harkiolakis & Mourad 2009; Hewlett Packard 2006). While there were, of course, certain specific complexities involved in this merger and necessary authorizations from the Securities and Exchange Commission, the merger was essentially completed as a non-hostel cash buy out of Mercury Interactive by Hewlett Packard and was thus able to precede with relative ease and a great deal of speed once the specifics of the deal had been worked out by the leadership of both companies and their advisors (Hewlett Packard 2006; Coffee 2006).

Communication of the planned merger and its successful completion was accomplished through the usual channels, including media releases, letters to shareholders of both companies and updated information available on the websites of both companies and still viewable on Hewlett Packard's website (Hewlett Packard 2006a). Information regarding the internal notifications of the merger is not readily available to the wider public, but it is assumed that employees and all pertinent personnel were notified of relevant information as it became available. As there were not major operational changes at the ground level of the two merged companies employee reactions to the merger were not widely reported and thus it is assumed that they were not especially extreme or significant. The leadership personnel of the companies were far more affected by this merger, and there is no evidence that this merger was viewed as anything but a positive move for both companies by these individuals (Coffee 2006; Taft & Musich 2006; Knorr 2006). The cash premium that was paid to Mercury Interactive shareholders and the ongoing increase in price for Hewlett Packard stock following the merger makes it likely that shareholder response to the merger was equally positive (Google Finance 2010; Hewlett Packard 2006a).

Conclusion

Many mergers, especially in the past decade of increased scrutiny of accounting methods and financial reports, are quite complex and time consuming. The merger between Hewlett Packard and Mercury Interactive, however, was accomplished with a great deal of simplicity and efficiency. Though the primary benefits to both companies were found in the boosted assets, market share, and operational scope of the merged entity, the efficiency of the merger process was also a contributor to its success.