SONNY -- THIS ARTICLE MAKES ME UNDERSTAND THE PRICE PAID BY CPQ -- LOKING FOR LAYOFF'S OF 15000 - MY GUESS - AFTER YOU GET A CHANCE TO READ WE CAN DISCUSS - NOT LOOKING AS BAD
The Wall Street Journal -- January 27, 1998
Tech Takeover:
Compaq Buys Digital,
An Unthinkable Event
Just a Few Years Ago
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The PC Maker Grew Rapidly
While Big Competitors
Shunned Risks and Lost
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Gambling on the 386 Chip
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By Evan Ramstad and Jon G. Auerbach
Staff Reporters of The Wall Street Journal
In 1985, Digital Equipment Corp. was a behemoth. It sold speedy corporate computers that were seen as the future of high technology. Only IBM could outmuscle it. Sales that year: $6.69 billion.
In 1985, Compaq Computer Corp. was in its third year of a new business. The idea: Clone other people's best-selling computers. Sales that year: $504 million.
Yesterday, highflying Compaq, now the world's biggest seller of personal computers, agreed to buy struggling Digital for $8.55 billion in cash and stock, or $57.40 a share. Digital shares closed yesterday at $55.44.
What happened between 1985 and yesterday is, in many ways, the story of modern computing.
For Compaq, the purchase of Digital puts it in position to compete directly with giants International Business Machines Corp. and Hewlett-Packard Co. In a ruthlessly competitive market, the move gives Compaq the ability to move beyond PCs into a whole new realm: high-end computing -- Digital makes powerful workstations and Internet servers -- and servicing computer operations for big companies, which alone is estimated to bring in about $6 billion a year for Digital.
"We have now all the major pieces in place," says Eckhard Pfeiffer, Compaq's chief executive officer.
But while a boon for Houston-based Compaq, the folding of Digital into the younger computer maker is a sad commentary on a company that helped pioneer the computer era. More than any other, Digital, based in Maynard, Mass., symbolized the high-tech boom that came to be known as the Massachusetts miracle. Digital's success spawned numerous imitators along the Route 128 highway that arcs around Boston.
Founded in 1957 at a time when IBM owned the industry, Digital introduced its first computer, called the PDP-1, in 1960, bringing computers out of back offices and into the hands of the general public. Unlike previous machines -- hulking mainframes that could cost millions -- the PDP-1 fit on a desk. At $120,000, it was cheaper than anything on the market. It was an instant hit.
Digital went on to become the leader of the burgeoning minicomputer market. By the mid-1980s, Digital was the No. 2 computer maker in the world, second only to IBM. In 1988, sales topped $11.4 billion, with profits at an all-time high of $1.3 billion.
Compaq was then a mere pipsqueak. Founded in 1982 with help from venture capitalists, the company set out to make a modified version of IBM's nascent personal computer. Compaq's version was a 20-pound machine that could be carted around.
When IBM launched a portable PC of its own in 1984, Compaq went after IBM's core PC business: desktops. With cheaper prices and specialized features, Compaq and other clone makers gradually ate into IBM's PC market share, increasing the significance of chip maker Intel Corp. and software maker Microsoft Corp.
In the fall of 1986, Compaq upset the industry's balance of power. IBM didn't want to use Intel's latest chip just yet, enjoying sales from the current version. So Compaq beat Big Blue to it, rolling out a computer using the new 386 microprocessor. Sales in 1987 doubled to $1.2 billion.
At Digital, however, founder Kenneth Olsen was insisting that terminals attached to minicomputers were all most people needed. He also criticized Digital customers' desire to move to standard, open computer systems from machines that had proprietary operating systems.
In 1992, with the company's other businesses slumping, Digital directors forced Mr. Olsen to resign. The directors, many of whom were close friends of Mr. Olsen, chose Robert B. Palmer, his polar opposite. While Mr. Olsen drove a minivan and wore flannel shirts, Mr. Palmer, who is 57 years old, fancied Italian suits, drove a Porsche and took grueling runs to clear his mind.
A Texan who left home at 15 and put himself through college to become a sought-after chip engineer, Mr. Palmer took over a company that had reported $4 billion in losses, was saddled with a work force topping 130,000 and was hemorrhaging money. He slashed more than 60,000 jobs, which made him unpopular with employees. He became insular, infrequently seeing colleagues outside the office, say people who have worked with him.
With his semiconductor expertise, Mr. Palmer helped develop a blazingly fast microprocessor called Alpha that remains the fastest in the market. He invested heavily in it, and even sued Intel for patent violations in hopes of making it Digital's core business.
Digital was plagued by sales-force problems that Mr. Palmer proved unable to repair. In an industry of cutthroat sales competition, Digital gained a reputation as unresponsive and arrogant. Mr. Palmer himself was reluctant to make customer calls. He began traveling more, to meet prospective buyers, only after his board begged him to press the flesh more often, say directors. Business was lost to Hewlett-Packard and IBM.
Though Digital remains the nation's No. 4 computer maker, the company's numerous missteps turned the former powerhouse into a second-tier player.
Compaq, by contrast, hardly hesitated to push the personal computer into more advanced uses. In 1989, it introduced the PC server, which is at the center of computer networks. That same year, it led nine other PC makers in refusing to go along with an IBM proprietary design for moving data inside a PC. From then on, Rod Canion, Compaq's founder, said, "It's been fairly clear that what we had developing here was a steamroller."
However, it would be his top lieutenant, Mr. Pfeiffer, who paved the way for Compaq's fastest growth. With Compaq struggling to compete with a raft of cheap computers in the early 1990s, the board ousted Mr. Canion and promoted Mr. Pfeiffer, a German-born sales and marketing executive who had argued for cutting the bells and whistles and lowering PC prices.
Mr. Pfeiffer, who is 56, was promoted in October 1991, just after Compaq suffered its first quarterly loss. Noting the strides of its lower-cost competitor, Dell Computer Corp., Mr. Pfeiffer shocked the industry and caused a bloody price war by deciding to cut gross profit margins almost in half, to about 22%. By the end of 1994, Compaq had passed IBM to lead the world in PC sales. The next year, its total passed Digital's.
Since then, Compaq has been racing to match Dell's production efficiencies -- which are achieved largely by waiting to build computers until an order comes in -- while continuing to grow quickly through a multitude of sales avenues, including dealers, retailers and, most recently, the Internet. The company missed Mr. Pfeiffer's goal to be producing, by the end of 1996, all of its PCs on a build-to-order basis. Knowing by mid-1996 that the company wouldn't make it, Mr. Pfeiffer urged his top 200 managers to redouble their efforts. "This is the last thing," he implored them at a meeting. "This one is going to stick." Compaq at last began changing production last July and aims to finish this summer.
To be sure, Compaq has had its share of goofs. Its notebook business is a distant third to Toshiba and IBM. It failed in a foray into producing printers. And it has had trouble in Japan. None of those problems, however, has dented its financial performance.
Now Compaq is the world's leader in PC servers, a high-margin and fast-growing part of the business. It turned the home-computer business upside down by leading the push to offer PCs priced below $1,000. And the recent acquisition of Tandem Computer Inc. gave it a new line in specialized systems and a seasoned sales force of 6,000 to go with the 2,000 sales people it hired last year. Digital will add 7,000 more salespeople to that mix.
Digital has never been able to make major inroads in PCs, dropping out of the consumer market a couple of years ago. Accounting for just over $2 billion in sales, the PCs it makes now are used for the broader systems it installs.
To make the deal with Digital work, Compaq will need to boost efficiency and profits at Digital, which lags behind most of the computer industry. Digital's sales in fiscal 1997, ended in June, fell to just above $13 billion, the lowest this decade, and it was just barely profitable, with net income of $140.9 million.
Compaq is considering further layoffs. One person familiar with Compaq's thinking says eventual cuts could reach 10,000 of Digital's current 55,000 jobs, although the magnitude hasn't been decided. Earl Mason, Compaq's chief financial officer, declined to comment on layoffs, except to say that any plans will be disclosed when the transaction closes, which is expected in the second quarter.
People who have been following the negotiations don't expect Mr. Palmer to stick around long. That wouldn't be surprising, given Compaq's recent history. The company acquired Tandem last summer for $3 billion, and Tandem's well-regarded chief executive officer, Roel Pieper, stayed only to help with the integration; he left the company two weeks ago.
Mr. Palmer says he will remain at Digital to "make sure . . . the integration goes smoothly," but he wouldn't comment on whether he will remain beyond a transition period.
Under the terms of the deal, Compaq will pay $30 in cash and about 0.945 shares of its common stock for each of Digital's approximately 149 million shares. Although the deal was initially valued at $9.6 billion, it was worth $8.55 billion after Compaq's shares yesterday fell nearly 9%, or $2.75, to $29 in composite trading on the New York Stock Exchange.
Both companies have said a combination has made sense for some time, and the two courted off and on since 1995, when Compaq first approached Digital. Then, the two generally agreed on a purchase price of between $9 billion and $10 billionabout the same as the current deal, based on Compaq's closing share price Friday. But Digital's board balked, convinced that sales of computer systems built around the Alpha chip were about to take off, insiders say.
They didn't. Worse, a sales-force reorganization left important customers uncovered, and Digital was forced to acknowledge that a glut of its personal computers were backlogged in retail channels.
The companies talked again in summer 1996, but Compaq made it clear it was interested mainly in Digital's service business and was put off by Alpha's problems, say people close the matter. But Digital agreed to sell Alpha and its manufacturing facility for $700 million to Intel in October, settling the nasty patent dispute. Though the deal still needs regulatory approval, it changed the landscape, and Compaq decided to make a move last month.
After face-to-face meetings and a slew of telephone calls, Mr. Palmer and Mr. Pfeiffer met in New York last Friday to begin final negotiations at the St. Regis Hotel. Mr. Pfeiffer was joined by chief financial officer Earl Mason, while Mr. Palmer was joined by director Frank P. Doyle, a retired GE executive who played a crucial role in negotiating the Intel settlement.
Again, the companies reached fairly quick agreement on price, which some saw as low, despite its premium of about 25% over Digital's closing price Friday. Digital has cash reserves of about $2 billion that could swell closer to $3 billion if pending asset sales and the deal with Intel get a green light from federal regulators. Plus, Digital has tax-loss carry-forwards estimated at about $3 billion that can shield some of Compaq's net income from taxes.
"It looks pretty cheap," says Tom Jackson, a portfolio manager with Prudential Investments, which owns more than six million Digital shares. Mr. Jackson, who has been pressing Digital to consider selling, was disappointed that the purchase price wasn't any better than what was discussed two years ago.
Mr. Olsen, the Digital founder who now runs a closely held company that makes high-end computers, says that he was "saddened" by the Compaq purchase, but that "it's probably a good thing" because Digital was losing market share to more nimble competitors. "They needed something to save them," he says.
Compaq Chairman Benjamin Rosen says Compaq recognized early on that the PC was becoming a commodity, meaning it needed to pay less attention to technology. "It took Digital longer to make this change," he says. Though the company has been responding recently, he notes, "It was a much more difficult job moving down than up."
Ever aggressive, Mr. Pfeiffer said late last year that he wants Compaq to reach $50 billion in sales by 2000. Now, he says he intends to raise that goal when the dust settles a little later this year and challenge IBM, which has annual sales of $78 billion. "This is a major step in that direction," Mr. Pfeiffer says.
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