The HP-COMPAQ Merger

A hi-tech giant or another merger fiasco

Executive Summary. The worlds largest corporate Information Technology merger began in September 2001 when HP announced that they would acquire Compaq in an all stock purchase valued at $25 billion. Over an 8 month period ending in May 2002, the merger passed shareholder and regulatory approval with the end result being one company. The new HP has annual sales of approximately $90 billion which is comparable to IBM, and an operating incom e of almost $4 billion. The merger was led by Carly Fiorina, the chairwoman and CEO of HP. The president of the new HP was Michael Capellas who was the former chairman and CEO of the old HP and who has recently resigned and is now the CEO of World Com. Overall, many analysts were critical of the merger from the beginning since both Compaq and HP were struggling companies before the merger. The common question that has been raised by analysts is: Do two struggling companies make a better merged company? Some analysts have indicated that the merger is a gamble and that it is difficult to see any focussed logic behind the merge considering that most I.T acquisitions are not successful. Prior to the merger, Compaq has been unable to grow despite previously buying Digital, while HP was trying to grow internally, without much success. Both companies were still adjusting to acquisitions they have made in the past and both were adjusting to new leadership (Fiorina and Capellas). The merger deal also means that there are many overlaps in products, technologies, distribution channels, services, facilities and jobs. Employee morale is a threat to a successful merger as there has been numerous layoffs -15,000 employees. The claimed annual cost savings of about $2.5 billion dollars by the year 2004 amounts to only 3 % of the combined costs of both companies. Gartner Group research has indicated that the merged company has failed to do a good enough job of presenting the benefits of an acquisition of this scale to justify the deals risk as it is generally known that technology mergers rarely work. In addition, both companies in the past have struggled to resolve conflicts between direct and indirect sales channels. The cultural background of both companies is quite different and integration will take a long time. The culture at HP is based on consensus, Compaqs culture on the other hand is based on rapid decision making. From a positive perspective, most botched tech mergers involved companies that were trying to buy their way into new businesses they knew little about, this is not the case with the HP/Compaq merger. Apart from servers and PCs, they have several areas where their products overla p. e.g: they are both are involved in making data -storage equipment and both make hand held computing devices. In addition, both companies also bring different strengths to the table. Compaq has done a better job in regard to engineering an entire line and HP has been strong in consumer products. The justification provided by HP senior management suggests that a merger will enable them to com pete with two of their biggest competitors, IBM and Dell. In conclusion, it is viewed by many analysts that there will be at least 2 more years of bitter infighting which will cause the new HP to lose direction and good personnel. This is great news for competitors such as IBM and Sun as both of them will be able to pick off the market while the new HP is distracted by the merger. The new HP may be a threat to IBM but not anytime soon. It could take several years to determine if the largest merger in I.T history will be a success or a complete flop.

Presentation Outline
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PRE MERGE
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HP Compaq HP+COMPAQ NEW HP

Presented by: Leo B. Hugo P. Hongqi H.

MERGE
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POST MERGE
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Pre-merge Compaq: in The Life Cycle

Intro Growth

Maturity

Decline

Branding competition : Compaq was a reference and standard leader. Market maintenance and development of new markets (2000: 58% revenues outside U.S. Large Market Share. Product/service emphasis (strategic partnerships with Microsoft, Oracle). Client base stable. Distributing dividends (1998). In 2000, emphasis on cost reduction and increase in gross margin. Competitor pressure Scope scale sales (ie, pocket computers)
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Pre-merge Compaq: Products

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PC, (desktop and portable) Manufacturing and selling Servers Manufacturing, selling plus services Pocket Computer (handheld computer) Manufacturing and selling Storage manufacturing, selling, services and on-line storage
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Pre-merge Compaq: BCG Matrix

Pocket Computers

On-line storage and IT services

Storage PC s :
Laptops Desktop

Servers

Pre-merge Compaq: Competitors

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IBM
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Servers, PCs, storage and IT services. Servers PCs PCs, IT services and pocket computers Pocket computers
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Sun Microystems
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Dell
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HP
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Palm
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Pre-merge Hewlett-Packard
Known as a box vendor, a one-stop shop for business applications: n Unix servers n E-commerce application software n Hosted services n Network management n Integration services n PCs, printers, ink cartridges
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Pre-merge HP : Competitors
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IBM - Servers, PCs, storage and IT services Dell - PCs Canon - Printers, fax, copiers, optical equipment Compaq - Pcs, Servers, Pocket computers
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Pre-merge HP : Organization Life Cycle

Intro Growth

Maturity

Decline

HP known as a brand name for printers and ink Held number 1 position in a number of areas, i.e Storage Area Network (SAN), RAID and disk storage systems Stable client base Competitor pressure

Pre-merge HP : BCG Matrix

Pocket Computer

Servers PCs Computer repair

Printer supplies - ink cartridges - photo paper

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Pre-merge HP : Leadership - Fiorina

Categories STRATEGY EXECUTION CULTURE INNOVATION DEAL-MAKING Grade B C C+ B+ D
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ORGANIZATION D

Business Week Magazine

STRATEGY For decades, HP was a collection of independent businesses, each selling a particular kind of product. Fiorina was hired to execute an "e-services" strategy that would meld these pieces into one powerful, profitable whole. HP could sell everything from handheld gizmos to back-office servers, with the high- margin software and consulting to make it all work. Grade: B The "e-services" plan looks good on paper and may be the right long-term path for the company. But so far, HP is as dependent as ever on its last remaining gold mine: the $20 billion printing business, which has subsidized losses at the rest of the $48 billion company for the past three quarters, say analysts.

EXECUTION When Fiorina arrived, HP was two companies: a world-class maker of printers and imaging gear and a mediocre computer company. She set out to pump up sales and profits in the ailing computer business by becoming stronger in software, storage, and consulting. Grade: C HP is still the same two companies. While it remains the king of printers, the economic downturn has hurt efforts to improve profits in the computer business. It has gained market share in Unix servers, but there has been negligible progress in storage and software. Also, consulting remains small compared with rivals.

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Merger

HP and Compaq
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Merge champion (Fiorina) Horizontal merge Initiated Sept 2001, Completed May 2002 8 month process Biggest merger in IT history 25B$ all stock purchase 1 million working hours spent on merger integration
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Merger HPQ : Pros and Cons

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The Positives:
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COST SAVINGS FINANCIAL BULK CROSS-SELLING & TECHNOLOGY BUYING POWER INCREASING EXECUTION CHALLENGES PCs BUSINESS OVERLAPING COMPETITIVE POSITION MORALE
Business Week Magazine
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The Negatives:
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HPQ is the new stock symbol for the new HP. The merger alone will require 15,000 job cuts. HPQ has to merge two struggling companies with divergent corporate cultures and the CEO has a long way to go to win over the many employees who opposed the deal. The merger will double the size of HP's maintenance-and-support business. But it does little to help HP in other service sectors, such as consulting and outsourcing. These businesses would make up less than 20% of the company's service revenue. Since they are key to landing big contracts with corporations and governments, analysts say HP may still need to do an acquisition, which is unlikely in the wake of the Compaq deal. Armed with the market-share lead in PCs, back-office servers, and printers, the new HP would have the sheer bulk and reach to turn these two troubled companies into one far healthier one This will enable HP to leverage Compaq's strong market share and brand recognition in the commercial PC market. 13

Merger HPQ : Objectives

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Increase competition with major competitors. i.e. IBM, Dell. Cut costs by $3 billion annually by 2004 Increase earnings for shareholders Face the challenge of a shrinking market

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HP wants to emulate IBM's push into consulting and other services The accelerated cost savings come from leveraging HP's new bulk to renegotiate contracts for supplies such as memory chips and hard drives. A big chunk of the savings--$1.5 billion annually--will come from trimming the payroll. And investors could benefit big time from huge cost savings. By eliminating redundant administrative functions, HP cost savings would reach $3 billion a year by 2004. The company would likely write off most of the more than $1 billion cost of the merger in 2002. The new HP will exploit its market power for everything from better deals with suppliers to pressuring software developers such as Oracle Corp.and SAP to push HP gear. Then, over time, it will develop the consulting and software smarts to help customers deliver whizzy new offerings. The accelerated cost savings come from leveraging HP's new bulk to renegotiate contracts for supplies such as memory chips and hard drives. A big chunk of the savings--$1.5 billion annually--will come from trimming the payroll 14

Post-merger HPQ : SWOT Analysis

Threats
Competitive environment Economic downturn Organizational Culture conflict

Employee morale

Opportunities

Confront Exploit
Innovation Integration Customer loyalty market share cost savings Stable growth

Avoid Search
Overlapping management Overlapping product lines

Strengths

Weaknesses
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SWOT stands for Strengths, Weaknesses, Opportunities and Threats. It's a four-part approach to analyzing a company's overall strategy or the strategy of its business units. All four aspects must be considered to implement a longrange plan of action. In order to swat the competition you need to understand SWOT. SWOT stands for Strengths, Weaknesses, Opportunities and Threats. It's a way to analyze a company's or a department's position in the market in relation to its competitors. The goal is to identify all the major factors affecting competitiveness before crafting a business strategy.

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Post-merger
HPQ : PRODUCT LINES & COMPETITORS PRODUCTS
PCs (-) PRINTERS (+) LOW-END SERVERS HIGH-END SERVERS (-) LOW LEVEL SERVICES STORAGE (+) SOFTWARE (-)
MAIN MARKET COMPETITORS SHARE (%)

19% 15% 37% LAG 62% LEAD LAG

DELL ( + )
CANON, LEXMARK

IBM (+) IBM (+), SUN IBM (HIGH LEVEL) EMC, SONY MS, CA, IBM

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The new HP will feature Compaq's corporate PCs, low-end servers, and its iPAQ handhelds, along with HP printers and UNIX servers. Consumer PCs from both sides will also remain, though HP's business PCs and Jornada handhelds will not. Fiorina: We'll continue to organically grow, particularly the outsourcing and consulting ends of the business. We'll be looking for strategic opportunities for acquisition. Capellas: We believe we can be brutally competitive in the individual product segments. But we can also integrate hardware and software into solutions. The company must cut costs to the bone to beat Dell in PCs while pouring money into research and development and consulting to take on IBM and others on the high end Although HP enjoys the biggest share of the PC market now, the combined company's share is expected to remain flat, while Dell grows 30% a year. Sensing a possible vulnerability as HP merges with Compaq, Dell recently reached an agreement with Lexmark International to have printers and ink cartridges manufactured under the Dell name. 16

Post-merger HPQ : PRODUCTS GROWTH

45 40 35 30 25 20 15 10 5 0 PRINTERS PCS SERVERS STORAGE SERVICES INDUSTRYWIDE ANNUAL GROWTH RATE INDUSTRYWIDE GROSS PROFIT MARGINS HP/COMPAQ MARKET SHARE / RANK

* Data: Gartner Inc., IDC, Credit Suisse First Boston

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Post-merger HPQ: Product Life Cycle

pcs Printers

Storage s erver

Service
software Notebook

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FOR PCs: HP needs flawless execution and cost-cutting--especially with more- focused rivals such as Dell and Sun fighting for every deal in this down economy cost leadership Capellas: First and foremost you've got services growth, the fastest-growing segment of the whole IT market. Managed services and outsourcing is growing fastest. The customer service side is growing slower but is very profitable. A more focused HP might also make more of its franchise printer operation. HP has built a thriving business in photo printers and all- in-one printer-copierfax gizmos. These categories brought in 32% of HP's $5 billion in printer sales in its most recent quarter. Since photos require more ink than plain documents, the photo printers drive sales of highly profitable ink cartridges. And while PC sales help the top line, profits from the printer-supplies unit held up the bottom line. HP develops and markets products in a broad range of printing and imaging categories. We lead the market in inkjet printers, all- in-one devices, laser printers, wide- format plotters, scanners, print servers and ink.

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Post-merger HPQ : BCG Matrix

Service Industry growth rate
High

Software

Notebook Servers Storage Image printer

Low

PCs

Low

High
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Relative market share ( Cash generation )

Today, a third of HP's server business-- its powerful Unix machines--has healthy profit margins and is tied with Sun Microsystems (SUNW ) for top market share. But most analysts expect Sun and IBM (IBM ) to outpace HP in this sector when tech spending recovers because rivals are offering newer Unix models. At the same time, HP's $1.6 billion Intel-based server business continues to bleed red ink. While higher-end Unix systems now bring in most of the industry's profits, over time, less expensive machines based on Intel Corp.'s (INTC ) new Itanium chip and either Windows or the Linux software will take over many jobs. While the Unix market is expected to grow around 6%, Fiorina says the market for Windows and Linux models will grow 20% a year as these systems prove their mettle at tougher computing jobs. Indeed, market researcher International Data Corp. estimates that worldwide revenue from sales of Windows and Linux servers will outpace Unix machines by 2005. The company says the printer business will grow by 10% in 2003 and 2004. By contrast, personal computer sales will fall this year and grow less than 2% next year.

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Post-merger HPQ : Directional Policy Matrix

Diversification Market Segmentation Market leadership innovation

High
Capability
Phased withdrawal; Position; merger Server Market penetration

PCs Maintenance of

printer
Expansion, Productt Differentiation

Storage
Divest

Notebook
Imitation; Service phased withdrawal

Cash Generation

Low
Unattractive

Average

Attractive
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Matrix obtained from page 257 of Strategic Management Book

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Post-merger HPQ : Financial Ratio Profile

Profitability
Low Industry standard High

Liquidity
Very tight Industry standard Too much slack

Leverage
High Debts Industry standard No Debt

Activity
Too slow Industry standard Too fast

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HPQ Industry Average Profitability: Gross Margin: Gross Margin 5 yr. Avg. EBITD 5 yr.Avg. Operating Margin 5 Yr. Avg. Pre-Tax Margin 5 yr. Avg. Net Profit Margin 5Yr. Avg. Effective Tax Rate 5 yr. Avg. Liquidity: Quick Ratio: Current Ratio: 1.33 Leverage: LT Debt to Equity: Total Debt to Equity: Activity: Receivable Turnover: Inventory Turnover: Asset Turnover: 1.43 Data Source: Yahoo Finance 0.18 0.23 7.39 7.36 1.32 7.07 32.84 5.98 23.42 0.91 7.04 29.49 1.01 1.46 7.73 8.07 10.13 28.82 31.33 10.73 9.14 13.12 26.36 29.87

0.45 0.63

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Post-merger HPQ : SPACE CHART

Company Financial Strength

Conservative in storage market

Aggressive in printer market Aggressive

Company Competitive Advantage

HPQ

Industry Strength

Defensive in PCs market

Environmental Stability

New HP competitive in server market

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Competitive advantage: ( 3.8 / 5 ) Market share: 5 Product quality: 5 Product life cycle: 3 Customer loyalty: 4 Know how: 5 Vertical integration: 1 Financial strength:( 2.8 / 5 ) ROI: 2 Leverage: 1 Liquidity: 3 Easy of exit from market: 2 Inventory turnover: 5 Economies of scale and experience: 4 Environmental stability: ( 3.2 / 5 ) Technological changes: 4 Rate of inflation: 1 Demand variability: 3 Price range of competing products: 2 Barriers to entry into market: 4 Competitive pressure/rivalry: 5 Industry strength:( 2.5 / 5 ) Growth potential: 2 Profit potential: 3 Financial stability: 1 Technological know-how: 4 Capital intensity: 3 Ease of entry into market: 2

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Post-merger HPQ: Organization Life Cycle

Performance Maturity

Decline

HP
Development

Introduction

Effort & Time

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Even though both HP and Compaq were mature companies before the merge, it can be considered that the merged company is under redevelopment/restructuring, as a result the company has lost some ground as a Mature company.

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Post-merger HP: CHALLENGES

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CHOOSING PRODUCTS
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Fix the PC business Optimize the server business Enhance the service & consulting

CUT COSTS WHILE MONITORING REVENUES

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Cut $3b Keep revenues from shrinking more than 5%

INCREASE MORALE & AVOIDING CULTURE CLASHES

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Workers from HP and Compaq have spent more than 1 million hours planning their merger. Here's how they're doing. Their merger faces huge challenges. One top problem may be morale. The new HP will feature Compaq's corporate PCs, low-end servers, and its iPAQ handhelds, along with HP printers and UNIX servers. Consumer PCs from both sides will also remain, though HP's business PCs and Jornada handhelds will not. Most of the $2.5 billion in reduced costs will come from eliminating overlapping corporate functions, from legal and marketing to human resources and sales management.

The team's biggest task: finding financial synergies. It has been dispatched to hit two targets: $2.5 billion in cost savings by 2004 and keeping revenues from shrinking more than 5%, as rivals swoop in to grab customers.

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Post-merger HPQ : ETOP Profile

Factors Impact Importance Threat Economic 8 9 72 Political 6 4 24 Social 8 8 96 Tech. 10 9 90 Competitive 9 9 81 Geographic 2 2 4 Total 367
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Enviromental Threat and Opportunity profile (ETOP) for the new HP/Compaq identifies a very high score of 367. This scoring is based on of the 3 individuals drafting this case study. The Threat value is based on the product of Impact X Importance. The high score is due primarily to the merger of both companies. There are political issues arising due to the agressiveness of the merger. The Social threat is rated high due to an employee morale issue within the company due to the number of layoffs that have occurred. The Competitive nature of the hi-tech industry and technological changes also strongly impact the new HP. As indicated in this ETOP, the new HP is critically vunerable due to Economic, Social, Technological and Competitive threats.

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Post-merger
HPQ : Strategic Profile Design Factors
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Sustainability The new HP must retain and grab additional market share Uniqueness Largest I.T company in the world Value added Merger must demonstrate success Enhancement Increased product line Flexibilty Adaptation to market forces Stability Retention of customer/client base

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These design factors were obtained from slide 5-28

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Post-merger
HPQ : Strategic Profile Design Factors cont

Fit Was the merger of HP/Compaq a good strategic move? Only time will tell!!!! Performance Results of merger to be monitored over a long period of time, i.e: 12 24 months and continuously benchmarked against competitors Consistency HP must demonstrate in new corporate structure Stretch CEO and Chairman Fiorina to lead merged company aggressively

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Post-merger

Conclusion - HP Strategy
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Balance between the innovation/being first to the market and pure, raw, low cost. Maintaining both company brands and strength. Adjust and optimize product line. Enhance high-end Service.

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Capellas: There is very clearly a balance between innovation and being first to market on one hand, and pure, raw, low cost on the other hand. If you don't spend any money in R&D you will by definition have a couple of points on the bottom line, but you'll also never lead in any new product categories, so you won't get the margins there.-Fiorina: People are declaring the PC business dead because it has had a couple of rough quarters. That's incredibly shortsighted. It's clear that this is a critical part of the ability for consumers to do interesting things in their homes. But the reason for buying isn't going to be to get the hottest box at the lowest price. You've got things like digital imaging, digital music. It's something that does something for a consumer. This is what the industry is missing. It's innovation. That's what Dell can't do. Compaq has compelling offerings for home/wireless networking and HP has strength in digital imaging solutions. Maintaining both brands will enable HP to leverage existing brand awareness and preferences and give customers the opportunity to continue to buy the brand and products that best meet their needs.

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