A Stunning Reversal for HP's Marriage Plans

Now, the Hewletts say they'll vote no on the Compaq merger

In January, Walter B. Hewlett, the eldest son of Hewlett-Packard co-founder William R. Hewlett, was asked how he felt Chief Executive Carleton S. "Carly" Fiorina was doing after nearly two years on the job. Hewlett, an HP board member, praised Fiorina for paying attention to the 64-year-old computing giant's roots even as she worked to revitalize the stodgy company. "But only time will tell," he warned. "[Co-founder] Dave Packard was an old basketball player, and he always said `keep your eye on the ball, because when you start playing to the crowd, things can go wrong."'

Things couldn't be going more wrong for Fiorina now. Since her Labor Day announcement that HP (HWP ) would buy computer rival Compaq Computer Corp. (CPQ ), Fiorina has shuttled across the country trying to win over investors and analysts. But she has made only limited progress, and unhappy investors have sent HP shares tumbling 27% since September. Now, Hewlett may have dealt a death blow to her chances of pulling it off--not to mention her chances of keeping her job. Although Hewlett initially approved the bid, he said in a stunning turnaround on Nov. 6 that he, other family members, and the $3 billion foundation created by his father would vote their 5% stake against the merger. "With this transaction, we get what we don't want, we jeopardize what we already have, and we compromise our ability to get what we need," he griped.

SLIPPING SHARE. Harsh words, but these are harsh times for both HP and Compaq, and it's not just due to the economy. Hewlett now sees the deal as accentuating the negatives that HP already faces, in part because the combination would expose HP even more to the woes of a stagnating PC market, while diluting the profitability of HP's printing and imaging groups. Uncertainty over the future has weakened both companies and caused customers to look to competitors in droves. On the low end, Dell Computer Corp. (DELL ) keeps hitting them with low PC prices. In just three months, that's eroded the combined HP-Compaq worldwide market share from 19% to 17.7% for the quarter ended Sept. 30, according to researcher IDC. And the gloom looks no better for their high-end server markets, where IBM (IBM ) and Sun Microsystems Inc. (SUNW ) are overshadowing the two with the release of hot new products. Both companies suffered mightily last quarter and analysts expect HP's 2001 earnings to tumble 71%.

Now, even though both companies say they're committed to the wedding--and both boards reiterated their support on Nov. 7--its chances are dimming. Another relative of HP's founders, David Woodley Packard, followed Hewlett's criticisms with an announcement that he would not back the merger. The David and Lucille Packard Foundation, with about 10% of HP stock, says it will continue studying the deal. If the Packard family votes against it, the combined 17% voting block could be enough to scuttle Fiorina's ambitions, says Jerry I. Porras, a professor emiritus at Stanford University's Graduate School of Business. "This thing will snowball," he predicts.

Should that happen, the storm could well blow Fiorina from the executive suite as well. Her leadership style is increasingly under criticism. Worse, there were cracks in her support before she decided to buy Compaq. Sources say a headhunter representing at least one HP insider contacted former HP printer chief Antonio Perez this summer to sound him out about taking Fiorina's job. This followed a string of disappointing profits and her failed bid to buy PricewaterhouseCoopers' consulting wing for $18 billion. There were also bitter complaints last summer after she laid off thousands in a company not used to such tactics. "Her time appears to be up," says David A. Katz, chief investment officer of Matrix Asset Advisors, which owns 555,800 HP shares and 773,400 shares of Compaq.

The only ones happy? Rivals like Michael S. Dell. "I don't know what happens if they don't merge, but it certainly creates even more confusion and uncertainty," he says. "Got to love that!" HP shareholders won't, though, and that may force Fiorina to dig back into the play book if she wants to survive.

By Andrew Park in Dallas and Peter Burrows in San Mateo, with Robert D. Hof in San Mateo

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