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Hewlett-Packard Agrees to Acquire Compaq Computer in Stock Swap
By NIKHIL DEOGUN, GARY MCWILLIAMS and MOLLY WILLIAMS
Staff Reporters of THE WALL STREET JOURNAL
The cutthroat computer price war may soon get tougher.
In a deal that would jolt the sputtering computer industry, Hewlett-Packard Co. has agreed to acquire Compaq Computer Corp. in a stock-swap transaction that values Compaq at about $25 billion, people familiar with the matter say. Both boards have approved the transaction, and an announcement is expected Tuesday. The deal would result in a combination of two of the biggest names in computers, printers and computer servers.
At its most basic, the deal would bring Compaq, the world's No. 2 maker of personal computers, under the umbrella of H-P, a distant No. 3, allowing the combined entity to be bigger than and better able to compete with leader Dell Computer Corp. But the deal would also have implications beyond the PC industry, which is witnessing one of its worst downturns in years. It threatens to bring the PC price war to the world of computer services and storage networks.
Under terms of the deal, Hewlett-Packard would swap about 0.63 of its shares for each share of Compaq. At 4 p.m. Friday in New York Stock Exchange composite trading, shares of Hewlett-Packard were down 19 cents at $23.21, while Compaq's stock was off 34 cents at $12.35. Both stocks hit 52-week lows on Friday, and Compaq shareholders would get only a modest premium of roughly 19% for their stock.
H-P Chief Executive Carleton "Carly" Fiorina, 46 years old, would continue to be CEO of the combined company, according to people familiar with the matter. Michael D. Capellas, Compaq's 46-year-old chief executive, would serve as president. Five representatives of Compaq are expected to join Hewlett-Packard's board.
A spokeswoman for Hewlett-Packard declined to comment. A spokesman for Compaq couldn't be reached for comment.
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.
Searching for a Strategy
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. The deal is expected to immediately add to H-P's earnings in large part because of the cost savings.
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.
The combined companies' market strength would 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 does not block the deal outright, its investigation could take many months to complete and require divestitures of overlapping product lines. Justice Department officials could not be reached for comment Monday night.
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.
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.
Ms. Fiorina has consolidated businesses, trimming the number of independent reporting units; she has also tried to shake up the company's sometimes slow-moving culture and make managers more accountable. Still, it has been a rough road, and the turmoil facing all computer makers has exacerbated her task of turning around the company, which had $49 billion in revenue in the fiscal year ended Oct. 31, 2000.
Today, the company is grappling with a slowing world-wide economy that has crimped spending by big customers. H-P has had to repeatedly warn of disappointing results, and it is cutting 6,000 jobs to cope with declining sales. Some analysts and industry watchers had speculated that Ms. Fiorina might be in danger of being replaced, though the H-P board has continued to support her openly. Others said she would have a few more years to prove her strategy was the right one.
H-P was late to the consumer PC business in the mid-1990s. It wasn't until 1995, after Compaq, IBM, Apple Computer Inc. and others had targeted the home PC market, that H-P followed suit with the Pavilion model. The company leveraged its strong brand name in printers and corporate PCs and racked up huge growth in the home market. H-P increased market share by 50% for many quarters and moved from almost nothing to being one of the top home PC makers.
Still, when prices started plummeting in the late 1990s, led by competition from Dell and Compaq, H-P scrambled to keep costs down and stay competitive. Recently, some analysts have been calling for H-P to get out of PCs altogether because it is a low-margin commodity business. IBM has already pulled out of the consumer PC business. H-P said last month, though, that it saw value in the PC business, even though it lost money in that unit in the most recent quarter.
Ms. Fiorina has continually looked for acquisitions in the services sector. Though it accounts for just 15% of Hewlett-Packard's annual sales, the services business is one of its few bright spots: It's the only unit that showed a rise in sales in the fiscal third quarter.
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.
His first year in office, he cut staff and combined the company's big-computer and services units to attack corporate markets for bundled software and services. He also launched a crusade to have Compaq considered a "cool" purveyor of consumer electronics. By 2000, he shifted gears and focused the company's units on taking advantage of the then-burgeoning Internet, killing off several marketing efforts to sell bundled applications.
This year, with a PC price war in full force, Mr. Capellas was forced to reorganize again, combining Compaq's business and home-PC units, pulling in its development efforts and curbing its Internet operations. In June, he announced a new corporate focus -- bundle services, hardware and software for big corporate customers.
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.
To compensate for the falling demand, H-P has been slashing costs, asking all its workers to volunteer for a temporary 10% pay cut and instituting an Internet-based procurement system to take $100 million out of next year's expenses. H-P is also trimming the number of contract manufacturers that it uses to four from 20. |
