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Tough times ahead for HP

It is the closest vote since Bush versus Gore. But, before the chads were counted, Hewlett Packard claimed victory on 19 March 2002 as shareholders voted for the company’s acquisition of rival PC-shifter Compaq in a deal worth $22bn – the largest tech merger in history.

Ever since the deal was proposed in September 2001, political machinations between the ‘for’ and ‘against’ camps have gripped the IT industry. Carly Fiorino, HP CEO and the brains behind the merger went head-to-head with dissident HP director, William Hewlett, son of the company’s co-founder, and several institutional investors opposed to the deal. Meanwhile, Compaq, the silent partner, which can only gain from the merger, waited quietly on the sidelines. The troubled PC manufacturer has been having a torrid time of it lately because Dell is cleaning up in the PC price war.

Official certification of the vote result by independent inspectors is not expected for a few weeks, but latest estimates suggest the decision rested on just one or two institutional shareholders’ votes. If the deal is sealed then Hewlett will probably resign from the HP board, bringing to an end an era of family involvement born when Messrs Hewlett and Packard started the company in a Californian garage long before Silicon Valley existed.

Fiorino was jubilant in her press release of 19 March, and couldn’t resist one last dig at the Hewlett legacy. “We are gratified that HP share owners recognise the compelling strategic and economic benefits of the merger and that a decisive majority of shares not affiliated with the Hewlett and Packard families and foundations appear to have been voted in favour of this transaction.”

But “compelling” strategy apart, the deal is flawed from the outset.

Not because of the public mudslinging of the protagonists or accusations that Fiorino is motivated by personal greed (she stands to make $70m in bonuses over two years). The problem lies in the merged entity’s dire financial position and the costs and difficulty of integrating two very different companies.

Fiorino proposes that operational synergies, $2.5bn cost savings and added muscle provided by a tag-team relationship with Compaq will ensure the future of HP in an increasingly consolidated sector. To an extent you can see her point. Giant IBM has cleaned up over the past year in hardware and services, its business holding up well as the rest of the sector crashed. It even generated portly net profits of $2,333m in 2001.

But critical mass is not a sure-fire way to compete – the ability to make money helps. HP and Compaq’s combined profits for 2001 total minus-$377m, minus-$785m of that coming from Compaq. If the merger goes ahead, HP’s profit-making businesses such as printers and imaging will disappear into the Compaq black hole.

Under these circumstances, $22bn seems a ridiculous price for an underperforming company that brings little to the party. IBM was successful because it diversified into IT services and software. HP and Compaq have little diversified business, and forays into new markets will probably have to be put on hold while the workforce is rationalised and the two companies figure out how to integrate their IT systems and sales operations.

Fiorino estimates the physical costs of merging to be in the region of $1.4bn. Opponents of the deal claim $3bn is a more accurate estimate.

Ultimately, the cultural differences between the two companies may be the biggest problem. HP’s history of innovation and its non-proprietary stance in the server market don’t sit well with Compaq’s IBM-compatible, standards-driven strategy. Fiorino has had enough trouble persuading investors that a shift to Compaq’s volume-based, production-line approach is right. Getting staff to change their business methodology won’t be any easier.

There have already been calls for Fiorino’s head for what she has done to HP since she became CEO in 1999. The company’s share price has halved, costs have soared, revenues have fallen and 6,000 employees have been made redundant. And this last-ditch attempt to save her company by entering into a shotgun wedding with Compaq will only fuel the antipathy towards her.

For HP the move is a calculated gamble. If it survives the next five years, which will be fraught with integration woes and financial losses, it and IBM may just be the only two serious players left in the market.

But if it doesn’t make it, HP will end up as just a bigger box shifter in even bigger trouble. Of course, whatever happens, Fiorino will still have her millions.

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