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Hewlett-Packard Co. Chairman and Chief Executive Carly Fiorina said Tuesday that the key to the success of its proposed $25 billion acquisition of Compaq Computer Corp. will lie in the integration of the two large computer companies.
There's "no denying the integration will be complex," Ms. Fiorina told analysts at a conference, which was also broadcast on the Web, to discuss the proposed merger of H-P with Compaq. Compaq and H-P are "sobered by the fact that the value lies in how well we do this," she said.
The companies are expecting $2.5 billion in annual cost savings within a few years. Both H-P and Compaq also said Tuesday that the new company will reduce headcount by 15,000, leaving the company, to be called Hewlett-Packard, with about 135,000 workers.
Officials declined to provide specific revenue targets for 2002 and 2003, other than to say they expect a loss in revenue in both years.
Regulatory Front
Ms. Fiorina said both companies intend to be "very cooperative" with regulators in both the U.S. and Europe. This industry is quite different from the one General Electric Co. and Honeywell International Inc. operated in, said Ms. Fiorina in response to a question about GE and Honeywell's failed merger. The computer industry has millions of customers, a low barrier to entry and intensive competition, she said.
Hewlett-Packard Agrees to Acquire Compaq Computer in Stock Swap (Sept. 4)
Still, the combined companies' market strength will likely provoke antitrust scrutiny. In PCs, for instance, the two control two-thirds of U.S. retail-store sales in the wake of the departures of IBM, Packard Bell Electronics and Acer America. Compaq also has been one of the largest customers of Lexmark International Inc., an H-P printer rival.
Even if the government doesn't block the deal outright, its investigation could take many months to complete and require divestitures of overlapping product lines.
Similar Organizations
According to Ms. Fiorina, the integration will be helped by the fact that both companies have similar organizations in place and also because both sales forces are structured "very much the same." She did concede that Compaq and H-P still have work to do in services, software and storage.
Under the terms of the deal, H-P would swap about 0.63 of its shares for each share of Compaq. In morning trading Tuesday, shares of Compaq were up 3.2%, or 40 cents, at $12.73, while H-P's stock fell 9%, or $2.15, to $21.06. Shares of Lexmark, H-P main printer rival, dropped $4.57, or 8.8%, to $47.60. All trade on the New York Stock Exchange.
Some analysts saw the deal as positive, despite investors' less-than-enthusiastic response.
"This move makes H-P look much more like IBM and, in our opinion, makes strategic sense," said Thomas Kraemer, analyst at Merrill Lynch. He noted that both Compaq and H-P have pursued similar strategies, including efforts to bulk up their services offerings.
However, H-P now faces a "Herculean integration task" as it combines two companies with more than 70,000 employees apiece and operations in more than 160 countries, Mr. Kraemer added.
Ms. Fiorina, 46 years old, will continue to be CEO of the combined company. Michael D. Capellas, Compaq's 46-year-old chief executive, will serve as president. Five representatives of Compaq are expected to join H-P's board.
H-P and Compaq's merger started off as a cross licensing deal, said a Compaq spokesman at the press event Tuesday. He said Ms. Fiorina called Mr. Capellas in mid-June to talk about a licensing deal and by late July both executive called bankers to construct a merge deal.
Among other executives, H-P Chief Financial Officer Robert Wayman will hold that post for the combined entity. The integration team will be led by Webb McKinney, currently president of H-P's Business Customer Organization, and Jeff Clarke, chief financial officer of Compaq.
Higher-Margin Offerings
Increasingly, the personal computer companies -- squeezed in their core low-margin business -- are trying to move onto the turf occupied by International Business Machines Corp. and Sun Microsystems Inc. by focusing on higher-margin computer services work, such as helping companies set up and maintain their computer networks. The combination would create a computer services giant. Both companies have been trying unsuccessfully to reach critical mass in their services operations for the last several years.
Amid relentless price-cutting in their computer operations, each has turned to acquisitions with varying degrees of success. For instance, H-P recently agreed to acquire Comdisco Corp.'s disaster-recovery operations but saw its talks to buy the consulting-services business of PricewaterhouseCoopers LLC fall apart last year. Compaq, which entered the services business with a splash when it acquired Digital Equipment Corp. in 1998, has made several small services buys since then but was outbid in its pursuit of Proxicom Inc.
Beyond their similar product lines, both H-P and Compaq have struggled to find a workable strategy after losing share in the computer markets that early on made each company successful. But with their stocks near lows, neither has the wherewithal to match IBM or the specialist services companies such as Electronic Data Systems Corp. In many ways, executives may have felt they had no alternative but to combine forces.
The two companies expect $2.5 billion in annual cost savings within a few years. Both Compaq and H-P are facing enormous profit pressures but have been reluctant to get out of the PC game entirely since that would be an admission of defeat. On paper, the deal would create the world's largest supplier of PCs and server computers. The combined company would hold a 19% share of the global PC business, leapfrogging current leader Dell, which has about a 13% world-wide share.
Deal to Boost Operating Earnings
Hewlett-Packard said it expects the transaction to "substantially" add to pro forma earnings per share in the first full year of combined operations. A Thomson Financial/First Call survey of 17 analysts yielded an earnings estimate of $1.05 a share for Hewlett-Packard.
What's more, the new company would hold 37% of the market for powerful server computers that run corporate computer rooms, a market which Compaq currently leads. That share would be more than double the current No. 2, Dell. Both H-P and Compaq have struggled to halt the inroads of Dell Computer in PC servers and of IBM in sales of large-computers running the Unix operating system. In the quarter ended June 30, Compaq's share of U.S. server shipments fell 26% and H-P's share fell 25%, while Dell and IBM were the sole big-company gainers, according to Gartner Inc., a Stamford, Conn., market research firm.
Hewlett-Packard is likely to get some tough questions from Wall Street. Its credibility is already shaky, and becoming the world's biggest maker of PCs at a time when the personal-computer market is suffering would probably prompt some analysts to scratch their heads. Integrating two giant companies would be a distraction for management and could leave rank-and-file employees wondering about surviving the inevitable cost cutting.
And with their businesses under attack from Dell, IBM and others, this may not be an ideal time to be focused internally. Indeed, some observers suggest that after Compaq acquired Digital Equipment three years ago its businesses suffered from a distracted management: market shares in PCs and workstations initially rose, then fell sharply. The Digital Equipment deal and others point to the computer industry's spotty track record of mergers and acquisitions and may create a show-me sentiment on Wall Street.
Weak PC Demand
The proposed deal comes at a time of weak demand for personal computers. Market researchers expect the U.S. PC shipments to shrink 10% this year and world-wide shipments to fall for the first time in 15 years. That contraction has forced Compaq and H-P to slash employment and costs in an effort to match Dell's cost efficiencies.
Yet the deal would leave the PC as critically important to the combination. Compaq gets nearly half its revenue from PCs, and H-P counts on PCs and PC servers for 25% of its sales. And PCs aren't a money-maker for either company. Last quarter, H-P lost an estimated $150 million on its PC business while Compaq lost $155 million. The companies had combined PC and PC-server sales of $32 billion last year.
Unlike Dell, both remain dependent on dealers and retailers for a sizable chunk of their PC sales. What's more, corporate and home PC buyers have been shunning major new purchases for nearly a year. Businesses are stretching out purchases, holding onto PCs for four years instead of the three-year replacement that had been the norm. At home, purchases of PCs have given way to digital cameras and other add-ons as buyer found that few programs demand the latest chips.
The move is a bold and risky bet for Ms. Fiorina, the former Lucent Technologies Inc. executive who was brought in to succeed veteran H-P executive Lew Platt in July 1999. The first outsider to run the venerable company, Ms. Fiorina is trying to transform it into a more wide-ranging purveyor of computers, software and services for its core corporate customers.
Ms. Fiorina was a star saleswoman at Lucent when she was tapped to run H-P. The company was splitting itself in two to spin off the test and measurement business, now called Agilent Technologies Inc., and Ms. Fiorina was seen as the fresh manager who was needed to help push H-P forward.
The deal shows how limited the options were for the two executives. Mr. Capellas, the Compaq CEO, has struggled to stem PC losses while searching for a strategy that encompasses the varied operations of the company, which had 2000 revenue of $42.4 billion. Since taking over in August 1999, he has restructured the company three times.
At H-P, Ms. Fiorina has struggled with delays in getting some products out, which has let rivals gain ground. The company has missed forecasts for several quarters in a row and has said it doesn't yet see an end to the slack demand for computers and consumer products.
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