What Price Victory at Hewlett-Packard?

Merger or no, the battle has been a costly one for HP, leaving CEO Fiorina with much to clean up

Well, the nail biting continues. After a high-drama shareholder meeting on Mar. 19, Hewlett-Packard Co. (HWP ) CEO Carleton S. "Carly" Fiorina claimed victory in the proxy fight over HP's merger with Compaq Computer Corp. (CPQ ) But board member Walter Hewlett isn't conceding. Hewlett backers figure that with just a quarter of a percentage point separating the two sides, it ain't over till it's over--and it will likely be weeks before all the votes are counted.

Even if Fiorina ultimately wins, this soap opera is hardly over. She still has to merge two struggling companies with divergent corporate cultures whose customers remain wary. And she has a long way to go to win over the many employees who opposed the deal. That was crystal clear at the shareholder meeting: Walter Hewlett got standing ovations, while Fiorina got boos.

Fiorina's mettle as a CEO will be tested in almost every dimension. She'll have to make peace with her critics inside the company while retaining the confidence of Wall Street investors who have lost billions. She also has to execute well enough to pull off her vision of a massive hardware giant, capable of delivering networking services to corporations as reliably as the phone company delivers dial tone today. To pull out a victory, HP spent $150 million in deal-related costs, according to company filings with the Securities & Exchange Commission. Now, Fiorina will have to focus on the tough tasks ahead.

Financial: The vote-counting limbo adds more risks to what is already a horizon littered with challenges. HP had a strong first fiscal quarter, ended Jan. 31, thanks to an unforeseen pickup in home-PC and printing gear. But revenues in corporate computing declined 4.4%, to $2 billion, amid mounting losses. A few more weeks of uncertainty won't help. If the vote count goes beyond a month, it could dent HP's second quarter, which closes Apr. 30, since tech companies book much of a quarter's sales in the final weeks. Already, says Don McDowell, a vice-president with server reseller Forsythe Solutions Group Inc.: "HP's customers are in pause mode right now, waiting to see what will happen."

To prevent further bumps in the road should the deal take place, HP's 900-person integration team has been working furiously. As soon as the vote is certified, the companies say they'll be able to tell all the top customers which products will be discontinued and who their sales and support liaisons will be. Indeed, the company says it is on track to achieve annual savings of $2.5 billion by 2004, while losing just 5% of revenues. "We feel comfortable, in all respects," says Harry W. (Webb) McKinney, co-leader of the integration team.

But sources inside the integration team say hitting those targets could be tough. Finding $2.5 billion in savings won't be hard in a $79 billion company. But limiting the revenue leakage to just 5% could be trickier, say two members of the integration team and others who have closely followed their efforts. One thinks combined revenues will slip 10% to 15%, rather than 5%. "I am very doubtful we'll be able to cut $2.5 billion in the right places without doing damage to revenues," says the team member.

Management: For decades, HP has been a management icon, thanks largely to an egalitarian corporate culture that forged a tight bond between employees and management. But dissatisfaction with Fiorina's strategy and management style have largely severed that unique bond. Almost 75% of the 34 million shares in one HP retirement plan were voted against the merger, for example. Part of the problem is layoffs. The merger alone will require 15,000 job cuts--a number that even drew angry employees from Compaq's French operations to the shareholder meeting.

HP contends that its own employee surveys show that more than 60% of staffers support the deal. And certainly, many do. But Fiorina faces an uphill climb in bringing the large group of unhappy employees back on board. One insider admits that he voted his personal shares for the deal, even though he didn't think it best. The reason: He's one of 6,000 HP employees getting hefty retention bonuses--$337 million in all--if he stays post-merger. "I'm giving up on the stock and taking the cash," he says. "The bribe worked."

Worse, with HP's new identity as an all-in-one tech shop, rivalries are brewing. Many employees within HP's lucrative $19 billion printer business worry that management will focus too much on money-losing computing businesses. And while insiders say the integration teams from Compaq and HP have worked together well, execs from the two computing units are more aggressively protecting their people and product lines as deadlines approach, say two integration team members and former HP execs. HPers worry that their Compaq counterparts, products of a tougher culture and years of layoffs, have sharper elbows. "It's going to be a reverse takeover," says one former HP manager. "The Compaq guys are ruthless."

Reputation: HP was always known for stodgy reliability and corporate integrity. But the nasty tactics of the proxy fight have left an entirely different impression. Fiorina admits that the fight resulted in unfortunate tactics. "I hope we can put the rancor of this campaign behind us and find common ground," she said at the shareholders meeting. Job One will be coming to an honorable peace with the Hewlett and Packard families, though that will be tough. So far, HP has steered clear of saying whether Walter Hewlett will be renominated for the board. And things could get even stormier: Sources close to Walter Hewlett believe HP persuaded shareholder Deutsche Asset Management to swing nearly half its 30 million votes to management, even as Fiorina was running the shareholder meeting. Talk is swirling about whether HP promised Deutsche Asset business in exchange for the support, allegations both Deutsche Asset and HP deny. Legal action is a possibility.

To be sure, Wall Street and others will have a short memory if Fiorina delivers. Last quarter's strong showing has already helped convince some she's up to the challenge. "Senior management was thoroughly ensconced in pushing this deal, but nonetheless they did mind the shop," says J.P. Morgan H&Q analyst Daniel Kunstler. Trouble is, that was just the warm-up.

By Peter Burrows in San Mateo, with Andrew Park in Dallas

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