Q&A: Making the Case for Combining

The proposed merger of Hewlett-Packard Co. and Compaq Computer Corp. was panned by a skeptical Wall Street after it was announced on Sept. 3. Now Carly Fiorina, chairman and chief executive of HP, and Michael Capellas, chairman and CEO of Compaq, have a big sales job ahead of them. On Sept. 5, they spoke with BusinessWeek Associate Editor Steve Hamm and Computer Department Editor Peter Burrows to make their case.

The stock market didn't greet this merger very well. You got beat up pretty badly. Is it possible that could kill the deal?

Fiorina: No. This is a very tight agreement. You don't make this kind of move and judge its success by the short-term stock price.

How are you trying to sell this merger to investors?

Fiorina: Initially people hear a cost- reduction story. And there's certainly a huge opportunity for value creation in the relatively short term. But we need to continue to accentuate that there's huge opportunity for stronger growth and more stable growth. This is a lot of news. It takes people time to digest it.

What's your vision for how the combined company will look? Will it be a growth company like Dell or an earnings company like IBM?

Capellas: With a company of this size, you won't have the growth rate of a smaller company, but you'll also have steady earnings growth with less variability.

Fiorina: Look at the revenue balance of the combined company. If all it does is grow at market, and you're talking about 10%, that's nothing to sneeze at for an $87 billion company. But you also get $1 billion a quarter of free cash flow. That's pretty impressive.

What do you see as the real growth engines of the company?

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.

After a merger, you'd still be up against companies that are more focused on doing one thing well. So how does this deal help you compete against them?

Capellas: Customers want simplification. They want fewer partners to deal with. And they want the partner to do more of the integration. We believe we can be brutally competitive in the individual product segments. But we can also integrate hardware and software into solutions.

Where are you taking services?

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. Also, consulting companies know they need a partner with the engineering capability to build the technical infrastructure. Who are they going to call? Are they going to call Dell? Hell no. There's one company they're going to call. It's this company.

Why are you staying in consumer PCs?

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.

Can you ever be as efficient as Dell in the PC business?

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. Look at handhelds. They generate incredible margins because there's innovation the customer is willing to pay for. A model that puts nothing into innovation is not sustainable over time.

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