H-P's Controversial Compaq Purchase Comes Full Circle

SAN FRANCISCO (Dow Jones)--One of Silicon Valley's most controversial acquisitions is on the verge of coming full circle.

In 2001, Hewlett-Packard Co. (HPQ) stunned the technology world when it said it would buy one of its main rivals: Compaq Computer Corp. The deal faced skepticism from Wall Streeters and investors, who saw it as an expensive boondoggle. Even H-P's board of directors raised objections; the son of one of the company's founders called it a "$25 billion mistake."
Now, the deal that transformed Palo Alto, Calif.'s H-P into the world's largest computer maker looks likely to be undone. On Thursday, H-P said it was exploring strategic alternatives--code for a "sale"--for its computer business. In a press release, H-P said a divestiture could take the form of a spinoff, which would make the business a separate company.
A sale of the computer operations would mark yet another climactic moment for H-P, which has morphed over the years into a diversified technology giant from its roots as a standalone hardware firm. Under a succession of chief executives, the company has used acquisitions to expand the size of its hardware portfolio, bolt on business services and move into mobile communications. Now, a new chief executive, Leo Apotheker, is making the company both smaller and bigger at the same time: H-P said it was discussing an acquisition of software maker Autonomy Corp. (AU.L, AUTNY) as it announced the potential spinoff.
"He's jettisoning major businesses that are no longer profitable," said technology writer Michael S. Malone, the author of "Bill and Dave: How Hewlett and Packard Built the World's Greatest Company." "This is a very H-P kind of move."
An H-P spokesman declined to comment for this article.
From the start, H-P's acquisition of Houston's Compaq was fraught with contention. The two companies had overlapping computer lines, a mishmash of suppliers and contractors, and a sales team that was bloated when combined. One major worry: whether Compaq customers would stick with the company if the brand went away.
Carly Fiorina, the H-P CEO who led the deal, saw it as an opportunity for H-P to gain scale. At the time, H-P was the world's No. 2 computer maker, while Compaq was No. 4.
Fiorina also saw it as an opportunity to cut costs and add to H-P's profits. The company estimated earnings for the combined company would be 13% higher the year after the merger than they would be if H-P remained a standalone company, and it would save $2.5 billion in costs.
Others saw it as an expensive gamble.
Most notable among the dissenters: Walter Hewlett, the son of founder William Hewlett, who worried the deal would dilute H-P's profitable printer business and leave H-P dependent on low-margin PCs. He led family members of the founders who held 18% of the company's shares in a rebellion against the acquisition, turning the March 2002 vote on the deal into one of the bitterest proxy fights in American history.
Both H-P and Hewlett hired public-relations teams to push their views, set up websites and established legal teams to champion their positions. At one point, H-P called Hewlett a "musician and academic" in a letter to shareholders. Hewlett is a software developer. Later, H-P's board, of which Hewlett was a member, took out newspaper ads complaining about his "strident attacks on H-P and our CEO."
Hewlett didn't sit still. His camp launched an ad campaign filled with analysis of the deal and why it didn't make sense. His efforts, however, didn't derail the merger.
How much Compaq contributed to H-P is an open question. H-P became the world's largest computer maker through the deal, a position it still holds. The Compaq brand delivered much of that performance, giving H-P a low-end line that appealed to cost-conscious consumers, says Forrester Research analyst Sarah Rotman Epps.
H-P held a 17.6% share of the PC market in the second quarter, compared to 12.5% for Dell Inc. (DELL) and 12.1% for Lenovo, the China firm that purchased International Business Machines Corp.'s (IBM) PC business, according to data tracker Gartner.
Since the deal was completed, however, the PC industry has changed. Margins on hardware face pressure as most manufacturers compete on price. A weak global economy also has prompted both businesses and consumers to hold off on new purchases.
H-P's personal-systems group, which houses its PC business, had $40.7 billion in revenue for the fiscal year ended Oct. 31, about a third of the company's overall revenue. But the group's $2 billion in earnings from operations was just 13% of H-P's profits. Removing the PC business would improve H-P's operating margins to about 15% from the current 12%, according to investment bank Stifel Nicolaus. The bank says that will reward investors by justifying a higher stock price.
Another investment bank, Ticonderoga Securities, put it more simply. The deal, the bank says, "makes sense."