HP’s acquisition of Compaq makes no sense

On paper, Hewlett-Packard Co.’s proposed acquisition of Compaq Computer Corp. makes sense. Combining the companies would create a powerhouse with a nicely rationalized portfolio of products, from high-end, fault-tolerant systems and data centre Unix boxes, down through PC-based servers and desktops. On Day One the company would be the top supplier of PCs and servers.

But the deal is eerily reminiscent of Compaq’s 1998 US$9.6 billion acquisition of Digital. That marriage was intended to help Compaq break into the increasingly important services business and create a soup to nuts system house – combining Digital’s vast VAX and Alpha resources with Compaq’s leading PC and server business and the fault-tolerant expertise Compaq had acquired in Tandem.

The failure of that deal is legend. Before the Digital acquisition, Compaq was a US$20 billion PC company with profits of US$1.3 billion, a seven per cent margin. In 2000, the company closed the year with twice the sales – US$42 billion – and half the profits – only US$569 million, a one per cent margin. And it has since done away with many of the Digital assets, including Digital’s prized Alpha architecture.

What’s worse, as Compaq was busy trying to stuff the US$10 billion Digital python into its pocket, Dell passed it by as the Number One PC supplier.

Big mergers don’t work. The rhetoric from HP’s Fiorina and Compaq’s Capellas is the exact same stuff trotted out by Eric Benhamou in 1997 when 3Com spent US$6.6 billion on modem maker U.S. Robotics (only to dump that business three years later). Essentially: “We’ve studied the other failures and saw what went wrong, and we can do it better.”

Fat chance.

But do HP and Compaq have a choice? After all, both companies are foundering. Based on the value of the deal, Compaq is in particular trouble. Not long after the announcement of the deal, HP’s stock had fallen so much in reaction to the news that the deal only valued Compaq at US$20.5 billion, less than half of Compaq’s revenue last year.

If they are lucky, execute flawlessly and realize the potential savings they have earmarked, this deal is one and one makes two – a bigger, more successful company doing what both companies have always done. But if they are to be risked at all, adding two companies in mergers such as this should add up to three – a combination that transforms the business.

This one doesn’t add up.