Knowledge@Wharton
The H-P Compaq Merger Two Years Out: Still Waiting for the
Upside
Its name is
synonymous with the evolution of Silicon Valley and technological
innovation. Its array of products and services is
the broadest in the tech sector. Its brand is known and respected by
consumers and corporations alike. And it pulled off the biggest-ever
tech merger more than two years ago.
So why are people
still asking some hard questions about the overall prospects for
Hewlett Packard? The reason, say experts at Wharton and elsewhere,
is that more than two years after its blockbuster acquisition of
Compaq Computer, the reconfigured H-P remains a work in progress.
Chairman and CEO Carleton (Carly) Fiorina has made strides in
integrating the operations and cultures of the two companies. But if
H-P's stock price is any indication of the company's prospects,
investors still harbor concerns about whether the merger will
ultimately strengthen the Palo Alto, Calif.-based company against
its two chief competitors, Dell and IBM.
Wall Street raised
eyebrows about the wisdom of the consolidation as soon as plans for
it were disclosed three years ago. On Sept. 4, 2001, the day that HP
and Compaq announced the merger, H-P's stock closed at $18.87, down
sharply from $23.21 the previous trading day. On May 3, 2002, when
the deal was officially consummated, the stock ended the day at
$17.44. As of Sept. 21, 2004, the shares stood at $18.70 -- down 19%
from the beginning of the year, according to a research report by
Goldman Sachs. In what may be another sign of the
times, Fortune magazine's just-released list of the 50 most
powerful women in American business gives the top slot to eBay CEO
Meg Whitman. Fiorina had won that honor every year since the list
was started in 1998.
"The question is,
'What is the value of the combined assets of these companies?'" asks
Harbir
Singh, a Wharton management professor who specializes in
studying mergers and acquisitions. "That's one reason the stock has
not done so well over the last two years. People haven't seen the
upside." Adds Megan Graham-Hackett, an analyst at Standard &
Poor's who follows the tech industry: "The jury is still out" on
whether the merger was worthwhile.
H-P is a sprawling,
global company. Its products and services range from handheld
devices, PCs, printers and digital cameras to servers and enterprise
solutions. It ranks 11th among Fortune 500 companies, has annual
revenues of more than $78 billion, employs 145,000, and ranks first
globally in printers; Windows, Linux, Unix and Blade servers; pocket
PCs; and total disk storage systems.
Singh and another
member of Wharton's management department, Saikat
Chaudhuri, give Fiorina and her colleagues high marks for
tackling the often difficult and tension-ridden job of merging two
large entities. "My sense is that they have been able to do a lot of
[positive] things, post-merger, in terms of the operational side,"
according to Singh. "It seems they have not had major battles after
the merger, which is typically the case with many large
transactions."
"The merger is on
track and is proceeding much better than expected," says Chaudhuri.
He views the acquisition of Compaq as just one "building block" in
Fiorina's attempt at a long-term transformation of HP. "It's not
just about HP buying Compaq; it's about a systematic renewal of
Hewlett-Packard." Referring to a bitter shareholder battle in 2002
with a member of the Hewlett family and others who opposed the
acquisition, he adds: "We know about the hostile context in which it
was pursued and how difficult it was to pull this thing off."
Chaudhuri says
Fiorina and senior H-P executives have done a "fabulous" job at
integration. Fiorina has retained H-P's traditional commitment to
innovation but has said that the new company would have to be more
results-oriented than it had been before and be able to move faster
to meet new challenges.
At the time the
merger was announced, people at Wharton and on Wall Street wondered
where the benefit was in acquiring a PC maker like Compaq at a time
when PCs were well on the road to becoming low-margin commodities.
To be sure, Fiorina's idea of achieving economies of scale in the PC
business was a sound one, giving H-P, already reaping hefty profits
from its printer and print-cartridge products, a shot at competing
with Dell, a low-cost, direct-marketer of PCs, according to Wharton
faculty members. But how was a merger going to allow H-P to go head
to head with IBM, which not only sells PCs but is a leader in the
high-margin server, consulting and service businesses, or EMC, a key
player in data storage?
'A Big Ungainly Place'
Chaudhuri believes
the decision to merge was sound. "H-P was caught in the middle and
so was Compaq," he recalls. "If you think about it, H-P at the time
was pretty strong on the consumer side but didn't have an adequate
presence on the corporate side. So when Carly Fiorina came in she
focused on why some areas weren't growing."
Rather than engage
in a series of acquisitions to strengthen the company in areas where
it could more readily compete with IBM, Fiorina opted to acquire
Compaq, which, while best known for its PCs, also had enterprise
businesses that it had built up through earlier acquisitions of its
own. "It's not that the acquisitions didn't go so well, but they
were underutilized because the critical mass was not there,"
according to Chaudhuri. "So, for [H-P and Compaq] it made sense to
merge because of these complementarities."
But management
professor George
Day, who was critical of the planned merger in 2001, continues
to have reservations about the decision today. "It's still a big,
ungainly place. What is their positioning in the market? I think
there's some ambiguity about that. People aren't sure what the brand
stands for and how all this stuff fits together."
There has been talk
that the sum of H-P's parts may be worth more than the whole, and
that the company should be broken up. But Day says such a decision
should not be talked about glibly since it would be irreversible. He
says Fiorina still has an opportunity to achieve her vision as did
-- irony of ironies -- another CEO (Louis Gerstner) at another tech
firm (IBM), which in the 1980s was deemed a lumbering dinosaur that
had seen better days and whose stock was a fallen star.
"Wall
Street may say, "Break the damn thing up,'" Day notes. "Analysts
[often] have good insights, but they made the same proposal in 1982
when Gerstner came on board. It's a nice parallel. Gerstner was
confronted, when he first arrived, with the idea of, 'Let's break up
IBM into six or seven different businesses.' Well, it would have
been the worst possible decision for IBM." Gerstner went on to
transform and resurrect IBM and is now considered a legendary figure
in corporate America.
Day says IBM's
experience offers both lessons and a cautionary tale for Fiorina.
"If Carly's going to make this thing work, she's going to have to do
something like Gerstner did: pull things together and create
solutions at the level of market segments. Each part of the
organization that reaches the customer should have the autonomy to
pull together whatever the customer wants, supported by product
groups. That's not a bad strategy. H-P is really a product-centric
company. If they can move to become a customer-focused company, with
the products feeding into those customer groups, then they may have
a chance. But the problem with that strategy is we have a player
[IBM] that's already done that. HP is trying to be cost competitive
with Dell and be the same kind of integrated-solutions provider that
IBM has become. If that doesn't work -- if it's clear IBM has too
big a lead -- then HP, which has this hugely profitable printer
business, has to think about breaking up."
Graham-Hackett of
S&P, who downgraded H-P shares to hold from accumulate in
August, says the company has been successful in several areas. It
has, for example, boosted sales of low-end servers and wrung costs
out of its PC business. In addition, the company has added to its
staff in its information technology consulting business. But H-P
will remain vulnerable until it beefs up its capabilities in
services even more. "The argument H-P makes is it can participate in
areas IBM focuses on, as well as Dell c But if you're looking out
several years, it's hard to ignore the fact that, with the
modernization of the hardware industry, you have to have a
differentiated strategy and a competitive advantage. H-P doesn't
have the services that IBM has."
Graham-Hackett adds
that H-P remains heavily dependent on imaging and printing systems.
These operations accounted for 31% of corporate revenue and 74% of
total operating profits in fiscal 2003, while services contributed
17% of total sales. "One reason you would want to buy H-P is because
of the lucrative cartridge business," she says, "but that wasn't one
of the reasons for the merger."
Another challenge:
ensuring that demand for its PCs stays high. The company has a huge
installed base of H-P and Compaq customers. Graham-Hacket says it
will be "interesting to see, as this equipment gets too old, if
customers stick with H-P or if they switch to another vendor."
H-P has a stellar
brand name that should help it battle any competitor, says Wharton
marketing professor Xavier
Dreze. "They're known as a technical company at the forefront of
technology, so that's something that can be seen as common among all
their segments."
Honing the Message
But Dreze and
Chaudhuri agree that H-P must better hone its message to business
customers. Says Chaudhuri: "H-P has to be more focused on its
marketing, not just saying, 'We provide everything,' but 'We can
cater to all your needs and this is how were going to do it.' The
beautiful part of IBM's e-Business strategy is everything else can
revolve around it. The challenge for H-P is to extend its brand.
High quality and innovation need to apply to servers, services and
storage systems as well as PCs."
Wharton's Singh
says he is uncertain whether the merger will eventually reap more
dividends than it has so far. But he thinks H-P could have tried to
obtain the same benefits through an alliance with Compaq rather than
embark on an acquisition. "A broad-based joint venture between H-P
and Compaq could have achieved many of the same goals without H-P
being involved in Compaq's lower-margin businesses. That may have
been a better bet. If the joint venture does well and there is the
potential for value creation, and getting to know one another
better, then maybe a merger is the next step."
Chaudhuri is more
optimistic about H-P's future. "We can expect H-P to much more
aggressively pursue the whole networked computing environment and
offer the whole gamut of services to clients. This is not a seamless
process yet for them, but if they carry on the momentum they have
had over the last two years, they definitely will be able to do this
in a reasonable time frame. In five years I
expect to see them competing head to head with IBM."
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