HP: One year after the merger...

It's been a year since Hewlett-Packard finalised its acquisition of Compaq Computer, but analysts and others are still asking whether the whole is bigger than the sum of the parts.

On the positive side, HP has successfully welded two former arch-rivals into a single, functioning organisation, according to many in the industry. Although some European operations and the internal computer systems from the respective companies have yet to be fully integrated, HP has already realised many of the cost gains the company set out to achieve. The company has also landed high-profile accounts with companies such as the Bank of Ireland.

"Almost a year after we launched the merger of the two companies, we are at a point where we have met or exceeded I think every goal that we set associated with the merger," HP Services Chief Ann Livermore said in a recent interview. On the integration front, HP is winding down its effort with only 200 people working on merger-related issues, from some 2,000.

On the other hand, to echo Gertrude Stein, some wonder if there is enough "there" there to justify the merger. Analysts and critics say HP still has a long way to go to prove the strategic value of the deal, a question that has dogged the company since September 2001 when the merger was announced.

HP's share in key markets also continues to decline from the combined figures for the two companies from the year before. In the first quarter, Dell Computer overtook HP in shipments of PCs and Intel-based servers. Dell's shipments increased 24.4 per cent worldwide during the quarter, typical for Dell. By contrast, HP's shipments dropped 5.7 per cent and slipped 9.8 per cent the quarter before.

In servers, HP rocketed to number one with the Compaq acquisition, but it saw shipments decline slightly in 2002.

HP says it is encouraged by sequential gains in market share in several categories off the low-point established just after the merger. However, with Dell outgrowing HP in many areas, analysts say HP will have a tough time maintaining share against Dell in many key areas.

And Dell shows no signs of letting up.

"We don't believe our competitors are as prepared to be as cost aggressive as they need to," said Dell President Kevin Rollins at the Merrill Lynch Hardware Heaven conference this week. "We're stepping up cost aggression even more this year."

In evaluating how the merger stacks up thus far, a lot still depends on one's perspective.

Cost cutting is where HP has gotten its highest marks. The company originally set out to achieve $2.5bn in annual cost savings by the end of 2004. Now it said it plans to reach $3bn by the end of this fiscal year, which is in October.

However, there has been growing concern that HP might be reaching the threshold. Merrill Lynch made that argument recently in downgrading HP, saying that the company was already getting push back from some Taiwanese motherboard suppliers.

Not so, says Jeff Clarke, the former Compaq chief financial officer who now heads HP's supply-chain operations. "There is continued room (for improvement) across our supply base."

For further savings, the company is turning to new techniques, such as forcing suppliers to bid against each other in electronic auctions. For example, HP already buys about 85 per cent of its hard drives that way.

In all, HP bought $2bn worth of components through e-auctions last year, and Clarke promised the company will "do substantially more this year."

For its part, HP is still looking to cut costs amid a slow technology market, but any further savings won't be categorised as merger-related. Likewise, the company may cut more jobs than the 17,900 layoffs it announced, but if it does, HP won't attribute those to the merger either.

If cost cutting has been where HP has received its greatest praise, it's sharpest criticism has come over whether the deal will help the company to grow sales.

The company had projected the merger might lead to a five per cent decline in revenue, though sales are off far more than that. HP says that the economy is to blame, noting that competitors such as EMC, Sun Microsystems, Gateway and EDS are fairing far worse.

Analysts and critics, however, say that HP has not proven that it is in a better place strategically.

"That's where my concerns were," said Mark Lewis, the former head of Compaq's storage business who left HP for rival EMC last July, two months after the deal closed.

One of HP's key strategic goals of the merger was to return both its PC and enterprise computing businesses to profitability.

HP says it has made significant progress on both counts. Last quarter, for example, the company said it narrowed its loss significantly in the enterprise business, while returning its PC business to profitability.

However, some of that improvement is due to an accounting change that shifted costs from each of HP's business units to a general corporate ledger.

HP clearly lost some business during the uncertainty of the proxy fight, but the company says that it is gaining back momentum and will start to show year-over-year market share gains now that it has been a full year since the deal is done. Until now, HP has been urging people to look at sequential gains rather than looking at what the two companies had a year ago.

Many of those who defected did so because of uncertainty about how the company's products would line up once the deal was complete. That was the case with Virchow Krause, an American accounting firm based in Wisconsin that switched from buying Compaq servers last July and went with Dell, which already supplied the company's notebooks and desktops.

Allen Smith, the firm's chief information officer, said the company went with Dell over HP because it "didn't really have a clear understanding of where HP was going to go."

"I think that Dell really used that opportunity," Smith said. "If we hadn't had questions of what was going on with HP/Compaq, I'm not sure we would have talked to Dell."

That said, Smith said the firm will likely consider HP again as it looks to buy new gear this year. "We may even look at IBM," he said.

On the PC side, analysts say HP has done a good job cutting component costs, which in turn has prompted the company to be more price competitive while still paring losses. But analysts and insiders say there is more work to be done on the sales side to achieve the efficiency that Dell has. In particular, HP wants to sell more of its consumer PCs directly, as opposed to selling them through resellers and distributors.

"We're already seeing a big transition with direct sales to the enterprise, but the big challenge will be going direct in the consumer channel," said one source close to the company.

HP is also starting to show some momentum in its services business, which was another area heavily touted by HP CEO Carly Fiorina as she addressed investors about the deal.

For most of the year, outward signs of progress were limited, with the biggest deal announced being a buyout of its CIBC joint venture. In the past couple weeks, though, HP has announced a string of big deals, including contracts with Procter & Gamble, the Bank of Ireland and telecom gear maker Ericsson.

So what do investors make of the merger?

The most clear picture of how institutional investors feel comes from the company's share price. HP's stock is trading at a little above $16 a share, down from its close of $22.47 the trading day before the deal was announced in September 2001. It's also down from HP's $17 a share price when the transaction closed on May 3.

When asked, many investors say it is too soon to tell whether the deal will help or hurt the company long term.

"I do have a sense that they have done some things well to fight back in this difficult tech market in general," said John Serhant, investment committee chairman for State Street Global Advisor and one of HP's larger institutional investors. "The (merger) decision was the right one... the savings they claimed they have gotten would not have been available if the two companies had remained independent. And this is the time to be hunkered down in the tech world."

Roy Papp, founder and partner with HP investor L. Roy Papp Associates, also shared a similar view.

"We have not had a very good economy, and we're not seeing any net results from this merger that are conspicuous," he said. "The company has maintained its position in the industry and has been successful with its budget, but there is nothing booming with its business."

As for HP's largest shareholders, members of the Hewlett and Packard families, they have remained largely silent.

The man who led the fight for the deal, Walter Hewlett, has withdrawn from the spotlight since the deal closed and he was dropped from the company's board of directors. Through a representative, Hewlett declined to comment for this story. Other Hewlett and Packard family members declined to comment on how the merged company was fairing. One member said simply, "I have a lot of faith in HP employees. They are an important part of company and I'm sure they will do a good job."

Ian Fried writes for News.com. News.com's Dawn Kawamoto contributed to this report.