3/12 Capellas Makes His Case
Compaq's CEO on why the Hewlett-Packard deal will work.
FORTUNE.COM
Tuesday, March 12, 2002
By David Kirkpatrick
Michael Capellas, in his New York hotel room, was explaining why a combined Hewlett-Packard and Compaq could cause trouble for PC market leader Dell. His cellphone began burping the cloying "Nokia song" and I wondered-"Does he know he can change the ring tone?" I never reached a conclusion, because a deputy answered and said "It's Carly," which certainly got my attention. Michael didn't miss a beat-he methodically finished his thought, then apologized for taking the call. It was less than four hours since shareholder advisory firm ISS had unequivocally endorsed the planned merger between the companies the two CEOs head.
What they said was unremarkable, at least so far as I could tell. The interesting thing was that they spent so little time celebrating-even though this was the best news they'd had in weeks. The call instead was serious strategy-how to further promote the deal and address the latest polemics of Walter Hewlett, the merger's
bitterest opponent.
Capellas has been this drama's man in the middle, and a generally quiet one at that. He has spoken little to the press, so I jumped at the invitation to dine with him on this fateful evening. He wanted to detail why he thinks the deal is so important to Compaq.
In Michael's view, the computer industry-if the merger goes through-will have consolidated down to just five major players: HP/Compaq, IBM, Dell, Sun, and EMC. "Two provide a complete portfolio of products and services, and three provide pieces of the portfolio," he explained. "Customers want to deal with fewer suppliers, so the portfolio play works. Customers are also no longer willing to pay for proprietary technology. They want industry-standard building blocks. The goal for HP/Compaq is to let Intel do microprocessor development, but to optimize it, and be the number one partner for Oracle and Microsoft. So we're creating a portfolio company around industry-standard components. And that's where the industry is going." Lou Gerstner over at IBM gets a lot of credit for the insights he brought as a former customer. Well, Capellas' background is as a CIO. He knows this stuff from the customer side, too.
"Microsoft clearly needs a partner that can help take them into the enterprise. It's not going to be Oracle, Sun, or IBM. And Dell is still on the low end-it doesn't really have the engineering and services support to make it happen. For major moves, Microsoft's traditional partner has been Compaq." He thinks it makes a lot more sense for HP and Compaq, which are the only two companies in the industry with essentially the same strategy, to combine forces rather than battle one another.
He points out that the Japanese PC industry is "just melting down," and that there remain no major European PC companies. In a rapidly globalizing market, he says Dell is seriously impaired by still being so dependent on the US market, with only 30% of revenues coming from other countries, a figure that has not grown in recent years. The comparable figure for Compaq is 62% of sales outside the U.S., and for HP, 58%.
"Some people seem to think the deal was done on the back of an envelope," says Capellas, looking pained. "But we did a huge amount of due diligence - comparing country lists, top account lists, buying patterns, product lines, and much more." He says that early on, HP hired McKinsey and Compaq hired Accenture to separately create earnings models and test various assumptions about synergies. "To actually simulate the P&Ls that way, before we brought in any investment bankers, is very unusual."
As for the deal's prospects now, Capellas remains cautiously optimistic. He believes the ISS decision "does swing the momentum towards the deal, no question." As for HP's institutional investors, who control 55% of its shares, "we see a huge amount of support...the ones I talk to are strongly in support. However, the great majority have a policy of remaining silent about how they will vote." Another reason he's optimistic is that almost 40% of HP shares are held by institutions that also own shares of Compaq. (Roughly 42% of Compaq is held by those institutions.) Compaq shareholders appear overwhelmingly in favor of the deal. There's no Walter Compaq out there with an axe to grind.
So does it all add up? For me it does. Like I said last week, I'll never count out Dell. That powerhouse will surely give the merged company a run for its money in every sense, and will probably eventually even become a force in services, Dell's greatest point of weakness today. But for HP and Compaq the option of not merging looks a lot more grim to me than doing it, especially after this bruising high-profile battle. If the merger fails, it will be a disaster for both companies and their shareholders.
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