What's in Store for This Happy Couple?

Despite the cheering, the new HP is facing steep odds

When Hewlett-Packard (HWP ) CEO Carleton S. Fiorina and then-Compaq CEO Michael D. Capellas met with investors last fall to sell their controversial merger, they were routinely greeted with stony silence and muttered jokes. But on May 7, at the launch of the newly merged company, the Carly and Mike Show received a far warmer reception: Before breezing through a painless press conference, the duo received a standing ovation from employees. Says HP human resources chief Susan Bowick: "It was like a rock concert, before the Rolling Stones come out on stage."

Call it the HP Honeymoon Tour--duration unknown. The new HP is even starting to get the benefit of the doubt on Wall Street: The stock has risen 18.6%, to $20, since Apr. 30, when dissident board member Walter Hewlett conceded a proxy fight against the deal.

In part, that's because HP shares had plunged 26% since the merger was announced, leaving little place to go but up. But investors and analysts were also impressed with the detailed integration plans the company offered up. Most also believe the company is keeping the right products. 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. "They've done more planning than anyone ever thought," says Gartner Group Inc. analyst Martin Reynolds.

Still, the star turn may not last long. Now, Fiorina and Capellas need to roll up their sleeves, because their merger faces huge challenges. One top problem may be morale. Despite the cheering throngs, many HPers still dislike the combination. Nearly 75% of the 34 million shares in one HP retirement plan were voted against the deal. And few of the company's 145,000 employees know if they're among 10,000-plus impending layoffs, which will be announced starting May 13.

HP hopes to partially address the problem by offering voluntary buyout packages, which should allow the disgruntled to leave. "It's time to get past this," says HR chief Bowick. But

HP will likely lose top performers, too. With the deal closed, some 6,000-plus key managers will get the first half of cushy retention bonuses. After months of tough work on a controversial deal, insiders say, some may soon depart.

Then there are financial hurdles. The company has said it can cut costs by at least $2.5 billion a year by 2004, while holding revenue losses to just 5%. That's supposed to lift earnings per share from 88 cents in 2001 to $1.51 next year.

But as AOL Time Warner and MCI WorldCom show, high-tech mergers rarely meet their goals. Indeed, some insiders worry that HP may come up short of its revenue and earnings targets. Fiorina, though, says those fears are unjustified. "The more we've looked at it, the more sound our assumptions have looked," she told reporters on May 7.

Key to meeting those targets will be strategy, and investors like what they see. When the merger was announced, analysts expected Fiorina to emulate IBM's push into consulting and other services. But for now, she wants to exploit HP's market-share lead in PCs, servers, and storage, which means working with IBM's services rivals such as Accenture. That's smart, since such partners might have directed customers to rivals like Dell Computer Corp. "HP scared [the big services companies], who don't want another IBM to compete with," says Humberto Andrade, an analyst with Technology Business Research Inc.

Still, Fiorina needs flawless execution and cost-cutting--especially with more-focused rivals such as Dell and Sun fighting for every deal in this down economy. "Right now, HP needs to focus on raw blocking and tackling rather than more glamorous long-term visions," says Morgan Stanley Dean Witter & Co. analyst Rebecca F. Runkle. If the company can't get the details right, the honeymoon could be painfully short.

By Peter Burrows in Cupertino, Calif.

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