HP’s Fierce Face-Off

It is hard to remember, standing in Enron’s long shadow, that a company in a growth crisis can be as fascinating as one that’s just plain in crisis. But Hewlett-Packard is doing its best to remind us. The personalities driving HP’s long-running and very public merger debate are larger than life, and the whole of Silicon Valley is riveted by the story. Which, if you haven’t been paying attention, goes like this: CEO Carly Fiorina wants a $25 billion marriage with Compaq–the largest tech merger ever–to avoid being squeezed between Dell (the personal-computer giant) and IBM (a leader in tech services and server computers). But certain key shareholders–including the children of HP’s garage-dwelling founders and geek-world deities Bill Hewlett and Dave Packard–think the proposed merger is the equivalent of two stumbling drunks trying to prop each other up.

As the merger debate rushes toward a March 19 shareholder vote, both sides have engaged in a nasty nationwide campaign of name calling. Last week Walter Hewlett, Bill Hewlett’s son and the HP board member leading the fight against the Compaq merger, released a report on what the company should really be doing. Its main proposal: dump Fiorina. “She’s burned a lot of bridges,” Hewlett told TIME. “It’s hard to see how she would survive.” This came after the rest of the board, which backs Fiorina, drafted a blistering open letter to Hewlett: “You have insulted our personal commitment and fiduciary responsibility.” Them’s fighting words.

You don’t see public backbiting like this at every company. Then again, not every company has a legacy like HP’s. Both Hewlett and Fiorina have staked their claim to what the founders dubbed “the HP way,” a phrase that at first embodied the ideals of innovation and good corporate citizenship but has come to mean many things to many people over the past 60 years. Now two polar-opposite visions of the company’s destiny–indeed, of how best to survive in today’s rough-and-tumble tech economy–have taken shape. When the smoke clears, there will be only one HP way.

In Fiorina’s future, HP follows the mantras of the dotcom era: get big fast and diversify, keeping your fingers in as many pies as possible (in this case, the PC business, the server business, the consultancy business, and printing and imaging). Hewlett’s vision is more classic and conservative: avoid spreading your resources too widely, and focus on what you do best–and what you’re known for. In HP’s case, that’s printing and imaging. Hewlett would have HP ditch most of its low-margin PC business. Until recently, Wall Street seemed to be in lockstep with Hewlett. Shares plunged 19% when the proposed merger was announced, then soared 17% late last year when Hewlett came out in opposition to it.

Amid the acrimony, the challenge for investors is to keep an eye on the bottom line. “Personalities make this contest more sexy for public consumption,” says Ram Kumar, senior analyst for Institutional Shareholder Services, who has heard the stump speeches of both sides. “We try to confine ourselves to logic.” Kumar’s rationale counts more than most. Next week the influential ISS will mail a widely awaited report to pension funds and other big holders of HP stock. Because the family foundations opposing the merger control 19% of HP shares, Fiorina needs around two-thirds of institutional investors on her side.

So which way is Kumar’s logic leaning? He won’t say, but the wind may have started to turn in Fiorina’s favor. In HP’s latest earnings announcement, quarterly profit was a whopping three times last year’s level, thanks largely to strong Christmas sales of cameras and printers. Hewlett seized upon that, saying it showed how well HP can do on its own, but others were pleasantly surprised–and more inclined to give Fiorina the benefit of the doubt.

“I wouldn’t say she’s got the Big Mo, but there’s clearly a change in investors’ willingness to view the merits of the deal,” says Joel Wagon-feld, research analyst at Banc of America Securities, which had previously been skeptical of the merger. Indeed, the gap between what HP wants to pay for Compaq shares and how the market values them–a key measure of merger confidence, called the arbitrage spread–has narrowed from a toxic $4.35 in November to $1.70. In another tacit sign of support, the company’s top five shareholders have been quietly adding to their stake.

Hewlett certainly can’t rely on regulators to scuttle the deal. The European Union rubber-stamped the merger without attaching conditions. The FTC will likely do the same. Support for the merger within HP has climbed to 65% from its 55% low, according to internal polling. (That HP has taken internal polls shows just how dicey things were.) And Hewlett’s fellow board members have been increasingly eager to point out that Fiorina is not riding roughshod over them. “It’s unfair to say this is Carly’s deal,” says Bob Knowling, a former CEO of Covad. “Compaq just makes a tremendous amount of sense. Two plus two can equal five.”

To find out how that equation works, you have to get inside the Carly Fiorina mindset. Enter her well-appointed corner cubicle, and she will tell you about how successful companies have to accelerate change and embrace risk–something she says she learned as a sales manager at the once great and now battered Lucent. “If two years from now we want 10% growth,” she says, “we have to keep moving into new categories.”

The one category Fiorina keeps hammering away at is services, a catchall name for the lucrative fixing-up, installing and consulting contracts that midsize businesses across America, overwhelmed by the demands of new technologies, are increasingly willing to pay for. One way to get more service business is to buy a consulting firm like PricewaterhouseCoopers, which Fiorina tried but failed to acquire in 2000. But there is another way. Call it the Gillette strategy. Just as that company virtually gives away razors to make a killing on blades, HP could opt to gather more strength in the PC and low-end server businesses in order to sell more service contracts as part of the package. “I certainly don’t see PCs as white elephants,” she says. “Getting on the desktop brings you a lot of opportunity.”

Hewlett, on the other hand, has his elephant gun aimed squarely at those big beige bundles of Intel chips and Microsoft software. It doesn’t make sense to him–or to some industry analysts–to spend so much money on other people’s technology, especially now that Dell seems to have the PC direct-sales market sewn up. “Strapping together boxes and selling them is not an area where HP is doing well,” Hewlett points out. “Why get further into that business?”

A far brighter path, Hewlett says, would be to spend a few billion growing HP’s most profitable division, the one that makes printers and digital cameras. There’s an alternative Gillette strategy: seed the exploding digital-camera market now; cash in on lucrative printing services later. Think of all those PowerPoint presentations and full-color reports that companies across the country are sending to Kinko’s right now. That, argues Hewlett, should be HP’s turf. “Our printing business alone is worth more than our current stock price,” he says.

Printing and imaging have long been the jewels in HP’s crown, and Fiorina bristles at the suggestion that HP doesn’t innovate enough (indeed, the company recently introduced the first photo printer that prints directly from a digital camera’s storage card). She slams Hewlett’s alternative as a waste of opportunity. Roughly 25% of the profit a combined HP-Compaq would make, in the best-case scenario, would come from printing and imaging. “It would be an easy course if we were focused on the short term,” she says. “We’re looking 10 years ahead.”

Of course, that sidesteps the question of whether HP and Compaq can successfully merge without leaving the floor slick with blood. Most large-scale tech-firm mergers have been hideous disasters. Compaq’s last acquisition, the Digital Equipment Corp., was a textbook example of how not to do it. Good products died, top talent fled and resentment lingered for years after management cut 15,000 jobs. Now HP plans, upon the merger, to lay off 15,000; it also hopes for cost savings of $2.5 billion. A team of 500 is working full time on integrating the companies, though most of what they have done so far is talk about culture clash–how HP’s engineers try to solve a problem by discussing it while Compaq managers prefer to impose a solution from above. “We’re the cultural astronauts,” says Webb McKinney, head of the integration team. He had better hope they are not brought back to Earth too quickly.

Is this the HP way? Certainly Bill and Dave would have balked at laying off 15,000. In 1970 they chose cutting work hours 10% over firing 10% of the company. On the other hand, Fiorina’s gamble on greater growth is about as gutsy as their decision to build an oscillator in their garage back in 1939. “I respect her for being aggressive,” says Craig Barrett, CEO of Intel, HP’s largest vendor. “And I’d label her a work in progress.” This is what the HP story has that Enron’s doesn’t: a heroine in transition and a $25 billion cliffhanger.