PAUL Thought you might be interested :The Wall Street Journal -- October 30, 1997
Alpha Male:
Digital's Palmer Faces
An Unsettled Future
After Intel Settlement
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CEO Bet Big on Fast Chip,
Now Needs New Strategy
To Restore Firm's Luster
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Benefits From a Bold Lawsuit
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By Jon G. Auerbach
Staff Reporter of The Wall Street Journal
Call it a $1.5 billion reprieve.
That is the amount Digital Equipment Corp. hopes to reap by settling its computer-chip patent-infringement lawsuit against Intel Corp. The sum includes $700 million for selling semiconductor-manufacturing facilities, plus product discounts and licensing fees worth perhaps $800 million over a decade.
The reprieve is for a corporation whose sales have languished as its superfast Alpha microprocessor failed to take off. But there is also a reprieve for Digital's chairman, chief executive and president, Robert Palmer, an Alpha enthusiast who defied skeptics by launching a seemingly foolhardy lawsuit against mighty Intel.
After Monday's settlement agreement, morale is sky high at Digital's Maynard, Mass., headquarters. The stock is up more than 40% since the suit was filed in May. Securities analysts are recommending Digital shares again.
But despite Intel's paradoxical agreement to build, for several years, the chip it had been accused of copying, Digital is essentially dropping its big bet on the Alpha. That bet had been the centerpiece of Mr. Palmer's strategy since he took over from founder Ken Olsen five years ago. Mr. Palmer agreed to sell the Alpha plant to Intel partly because of pressure from his directors, some of whom were convinced the chip was driving the company into the ground, insiders say.
Now, Mr. Palmer is on the hook to find another way to rejuvenate the old-line computer company. If he can't, investor and boardroom pressures are likely to increase, both on Mr. Palmer's autonomy and on the independence of the company itself.
Digital's second-largest shareholder, Prudential Investments, has urged directors to consider either selling the company or finding a CEO with more marketing experience while leaving Mr. Palmer in the chairman's job. Prudential Investments, an arm of Prudential Insurance Co. of America and holder of a 5.3% Digital stake, pressed those points in a letter to Digital's board this past summer, say people familiar with the letter's contents.
A spokesman for Prudential says it has no comment. The largest Digital shareholder, mutual-fund manager Dodge & Cox Inc., won't comment on its investment.
The board is restive as well. It has been criticized for complacency, but this may be a misconception. In fact, some board members have been pressing Mr. Palmer for the past year or so to give up some of his power, to get more involved in marketing and to deal with the financial drain of supporting the Alpha chip. Alpha, one director says, "was killing us."
But if the Intel deal clears regulatory hurdles, Digital will find itself not only with its Alpha cash drain ended, but also sitting on cash reserves totaling more than $3 billion. It also has tax-loss carry-forwards of $1.8 billion, plus businesses that industry analysts consider attractive to other computer companies, such as a world-wide service organization. As a result, the settlement, Mr. Palmer acknowledges, could make Digital appealing to the acquisitive.
"I believe it's attractive as a business," he says. "To the extent that somebody finds that interesting, that's the way the world is. I believe in capitalism. Whatever happens happens. We're focused on increasing shareholder value."
Frank P. Doyle, a director, says the board has discussed "in passing" the idea of Digital's being taken over. Improving financials, he adds, "amplify" the chance of interested parties emerging. "That's one of the risks of making it a better place," Mr. Doyle says.
Two years ago, Compaq Computer Corp. was prepared to offer as much as $10 billion for Digital before Mr. Palmer balked. People familiar with the matter say a "standstill agreement" now bars Compaq from making a bid on Digital, but it will expire in several months. Some Digital board members have been pushing to renew discussions with Compaq. The Houston PC maker declines to comment.
As for Mr. Palmer's own status, some directors have pressed the 57-year-old CEO to hand over part of his power to Bruce L. Claflin, sales and marketing chief. Mr. Claflin, 46, is a former International Business Machines Corp. executive who was credited with the success of the ThinkPad laptop.
At a spring board meeting, several directors said that Digital needed a clear No. 2 and that it should be Mr. Claflin, according to people familiar with the meeting. Mr. Palmer says that he has "never committed to promoting anyone" and that the board hasn't pressured him to elevate Mr. Claflin. Mr. Claflin won't comment.
Some directors also are said to have taken Mr. Palmer to task for not meeting with more customers, at a time when competitors often pull out all the stops to take away business. Digital's sales, at about $13 billion a year, have slumped under Mr. Palmer. Until recently, he rarely visited a customer unless a sale was in jeopardy, a person who has worked with him says.
In one case, Groupe Michelin, the French tire maker, wanted $40 million to $50 million of new equipment last year but was dissatisfied with the attention it was getting from Digital salespeople, says Robert Burnley, a member of the Michelin purchasing team. Mr. Burnley says Michelin couldn't get an appointment with Mr. Palmer until it threatened to go elsewhere, and even then, the meeting was in Massachusetts instead of France, where Michelin wanted it. Michelin executives left the meeting, which was last December, disappointed, Mr. Burnley says, adding that Michelin has decided to give most of its business to Hewlett-Packard Co.
Asked about the case, Digital said it isn't its policy to discuss customer affairs.
Mr. Doyle says that Mr. Palmer is "very effective with customers" but that all chief executives need to be reminded to make customer visits more often. Mr. Palmer says he spends about a quarter of his time on the road "talking to customers, giving speeches and visiting employees" and feels no board pressure to do more.
The Intel settlement would relieve some of the pressures Mr. Palmer has faced. The seed of the litigation was the belief, by some executives at Digital, that Intel was narrowing a speed gap between its chips and the lightning-fast Alpha by copying the Alpha. Years ago, Digital gave Intel the Alpha's blueprints, hoping in vain that Intel would adopt the chip as its next-generation processor.
In mid-1996, a Digital group headed by chief counsel Thomas Siekman began examining the extent of the company's patents, with the aid of engineers. In the early fall of 1996, Digital retained Herbert Schwartz, a New York litigator who had helped Polaroid Corp. win money in a patent suit against Eastman Kodak Co.
At about the same time, however, things began looking up for Alpha. During a 1996 visit with IBM Chairman Louis V. Gerstner Jr., Mr. Palmer proposed an Alpha partnership. IBM would get the Alpha to run its computers, and Digital would get cash from IBM plus guaranteed chip sales. But after several months of negotiations, Mr. Gerstner informed Mr. Palmer early last winter that a deal just wouldn't work, partly because IBM marketers felt adding yet another chip to the product line might alienate customers.
A disappointed Mr. Palmer took the news to his board. With such a deal no longer available to revive Digital's fortunes, the idea of suing Intel moved to the front burner. Mr. Palmer was convinced he could win a court ruling worth billions, say people who heard his views.
In February, he told directors that investigators had concluded that Intel did violate patents. He wanted to sue. The board wasn't sure. One director expressed concern that Intel would retaliate by cutting off chip supplies. Despite having the Alpha, Digital sells about $2 billion a year worth of computers with Intel chips.
Digital's legal and technical teams said that a suit would bring pressure on Intel from the Federal Trade Commission, which had investigated the Santa Clara, Calif., chip giant before. They figured regulators would take note because the suit would claim Intel had stolen technology from a competitor to tighten its market grip. In fact, last month the FTC did launch an Intel antitrust inquiry.
Colleagues of Mr. Palmer say he argued that he could use the suit to force Intel to pay Digital substantial royalties on future products. The strategy suggested engaging in settlement talks early on, insiders say. Mr. Palmer says he expected to resolve the case through litigation but acknowledges that a settlement was mentioned as a "possible outcome" before the suit ever was filed.
Months were spent figuring out how to surprise Intel, including analysis of anticipated responses. Digital also calculated that by filing suit in federal court in Worcester, Mass., not far from its headquarters, it might get a sympathetic jury as well as a court with a relatively small caseload. The board finally signed on, and the suit was filed May 12.
Intel executives were irate, denied patent infringement and filed a countersuit accusing Digital of the same sort of thing. Nonetheless, some in the Intel camp feared Digital's claims might have some merit, says one Intel insider involved with the case. Intel Chairman Andrew Grove sought help from David Yoffie, an Intel director who is a Harvard Business School professor, and Mr. Yoffie got in touch with a Harvard colleague's wife who sits on Digital's board, Kathleen F. Feldstein.
They agreed to a dinner meeting that included Digital director Mr. Doyle and an Intel director emeritus, Richard Hodgson. The Intel people stressed that even if Digital could win a big cash settlement, this couldn't happen without years in court -- during which time competitors would have a chance to steal Digital business by playing up the lawsuit's uncertainties. When Mr. Yoffie then asked what Digital was after, people familiar with the dinner say, Mr. Doyle suggested a deal might involve the Alpha chip.
With Alpha on the table, Intel's chief operating officer, Craig Barrett, told Mr. Palmer they should talk. They met in mid-June and discussed a possible sale of the Digital plant in Hudson, Mass., that makes the chip, Mr. Palmer says.
Digital directors had been pressing Mr. Palmer to move away from his Alpha strategy, partly because Digital's semiconductor operations lose about $100 million a year. In addition, according to people familiar with Digital's finances, the company has been spending $150 million to $250 million annually from its capital budget on the semiconductor plant.
Mr. Palmer, having led the development of Alpha and championed it for years, was by no means eager to give up on it. Believing that Intel patent infringement was the main reason for its commercial failure, he wanted to extract the maximum from his adversary -- cash, royalties on sales of Intel chips and some admission of infringement -- say people familiar with the matter. But Digital directors had a different emphasis. They pushed for a deal that would help their company while allowing Intel to save face.
Mr. Doyle and Intel's Mr. Hodgson were once again pulled into the discussions. They plus Messrs. Palmer and Barrett finally met in a Dallas hotel at the end of August and hammered out the outlines of Monday's settlement agreement.
Where does Digital go from here? Mr. Palmer now wants the company to move ahead as a provider of computer hardware, services and consultancy, similar to Electronic Data Systems Corp. Digital's service organization already has a big global presence. Both Compaq and Microsoft Corp. pay Digital to provide maintenance for computer systems running their hardware and software. Digital is responsible for keeping the Microsoft Network running.
Mr. Doyle says the expected discounts on Intel chips will enable Digital to sell systems at more competitive prices. Digital will continue to make its own computers -- using both the Alpha and Intel chips -- but it wants to be able to sell customers any "box" or software program. Although Mr. Palmer notes that the settlement would "sustain the [Alpha] architecture," a new Digital advertising campaign barely mentions the chip.
To Mr. Olsen, Digital's founder, "Alpha was a good chip, but they set about to destroy the rest of the company to build Alpha, and that wasn't smart." Mr. Olsen, who was forced out in favor of Mr. Palmer in 1992, adds, "I hope they're finally seeing the light."
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Digital's Board
ROBERT B. PALMER, age 57, chairman, president and CEO
VERNON R. ALDEN 74, ex-chairman of Boston Co.
COLBY H. CHANDLER, 72, ex-chairman of Eastman Kodak Co.
FRANK P. DOYLE, 66, former GE executive vice president
KATHLEEN F. FELDSTEIN, 56, president of Economics Studies Inc.
THOMAS P. GERRITY, 56, dean of the Wharton School
THOMAS L. PHILLIPS, 73, ex-chairman of Raytheon Co.
DELBERT C. STALEY, 73, ex-chairman of Nynex Corp.
ARNAUD DE VITRY, 71, an engineering consultant
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