By Caroline Humer
NEW YORK (Reuters) - Shares of Hewlett-Packard Co. (NYSE:HPQ - news) dropped more than 10 percent on Wednesday as investors questioned its purchase of Compaq Computer last year in light of new quarterly losses in its personal computer business.
With most of the benefits from the purchase -- such as eliminating duplicate jobs -- now in place, investors said they were focusing on whether HP could meet its financial and growth targets.
"The merger from our perspective was always about taking costs out of systems. I think it accomplished that. Its ability to grow (revenue) for the company remains to be seen," said Victory Capital analyst Marty Shagrin.
HP bought Compaq in May of 2002 for $19 billion, promising to make Compaq's big PC business profitable and setting strict profitability and revenue targets.
But it turned in a disappointing earnings and revenue report and fourth-quarter forecast on Tuesday, in part due to the PC business, creating more uncertainty about the company.
"There is this general question of whether it was a good idea in the first place and whether it's really possible to get much good out of a large scale merger," said IDC analyst Roger Kay.
PUTTING THE PC PIECES TOGETHER
The personal computer business is one of the areas that has been the most difficult for the two companies to mesh together, with myriad incompatible computer lines.
The different brands and number of computers are confusing to corporate buyers and costly, Kay said.
"What it implies is a cost structure issue. If you have to support all the lines, then it costs more to do that. You've got development costs and support costs and marketing costs," Kay said.
HP executives said the $56 million loss in the third quarter was due in part to having cut prices too low as it competed with Dell Inc.
Dell on Wednesday said it was cutting prices by up to 22 percent.
Unlike Dell, which sells directly to customers, HP sells most of its computers through distributors and was unable to adjust pricing quickly.
"HP can't adjust their prices as quickly because over 70 percent of their PC business is indirect," Lehman Brothers analyst Dan Niles said.
Compaq's PCs were losing money before the HP merger, but HP vowed to bring the PC business into the black and it reported profits in the business during the last two quarters. However, some of the profit was due to a change in the way it accounted for certain expenses associated with business lines.
HP has said that the business will be profitable in the fourth quarter.
"Seasonality plus those two execution issues led to the loss in Q3 being an anomaly," said Brian Humphries, an HP spokesman, adding that the PC business will be profitable for the entire fiscal year and that it continues to gain market share against Dell in the market for notebooks, the fastest-growing part of the PC market.
HP shares fell $2.31 to close at $19.80 on the New York Stock Exchange (news - web sites). Dell closed off 54 cents at $32.28 on the Nasdaq and the broader American Stock Exchange Computer Hardware Index (^HWI - news) was up less than 1 percent.
(additional reporting by Duncan Martell)