CASE STUDY

HEWLETT-PACKARDCOMPAQ MERGER: SHAREHOLDERS LOSE,

CEOS GAIN
In February 2005, the board of Hewlett-Packard (HP) announced that it had
terminated the employment of its colorful CEO, Carly Fiorina. Fiorina, formerly of
AT&T and Lucent, had orchestrated the $25 billion stock-financed merger between
Compaq and HP in September 2001. This merger was strongly opposed by leading
shareholders such as Walter Hewlett, son of the companys founder. Fiorina barely
won shareholder approval of the deal. When we look back on the merger, we see
that the concerns of the market and opposing shareholders were well founded. The
gains that she projected when the operations of the rival computer makers were
combined never materialized. While revenues at HP rose steadily over her tenure,
profitability had been weak. Fiorina caused the company to move even more
deeply into the PC business, which it had not been able to manage profitably,
unlike its rival Dell.
She was not content to focus on HPs more successful business segments such
as printers. Instead she expanded into areas where it would command a larger
market sharebut not make a meaningful contribution to shareholder value. In
merging with Compaq, HP was adding a company that had similar troubles.
Compaq itself was the product of a prior merger between Compaq and Digital
Equipment. However, the PC business is very unusual in that it exists in a
deflationary market with industry competitors often having to reduce prices of their
products while their costs are rising. This is a very difficult environment in which
to be successful. It is noteworthy that the founder of the PC, IBM, sold its PC
business in 2005 to Chinese computer manufacturer Lenovo.
The acquisitive Fiorina was replaced by Mark Hurd, who immediately
changed the focus at HP from doing megadeals to being a lower-costs company
and emphasizing the companys strength in areas such as printers. It is too early to
tell how successful this very reasonable strategy is, but early results show promise.
Hurd separated the printer and PC businesses and focused on dealing with the PC
units problems. He has cut costs and managed to purchase components, such as

chips, cheaper by playing chipmakers AMD and Intel against each other. He has
also developed better relationships with retailers, while Dell has started to suffer
from its lack of a retail distribution system.
It is ironic that while shareholders suffered under Fiorinas reign, she profited
handsomely from her five-year stint at the company. At the time of her dismissal, it
was estimated that she would enjoy a severance package in excess of $20 million.
In addition, Michael Capellas, the former CEO of Compaq, who served as
president of the postmerger HP, received in excess of $15 million when he left,
even though he was only with the combined entity for a relatively short period. The
merger was the most significant action that Fiorina orchestrated at HP and it was a
clear failure. When CEOs receive great rewards for eroding shareholder value,
there are few incentives for them to pursue different strategies. One solution would
be to tie CEO compensation to the achievement of specific targets. If a CEO very
aggressively pushes a major merger in which the success is predicated on the
achievement of certain measurable performance targets, then let the board only
agree if the CEOs compensation and bonuses are also tied to the achievement of
those targets. This should be particularly true for deals that face strong opposition,
as this one did. If the CEO does not agree to performance-based compensation tied
to such major corporate gambles, then maybe the likelihood of these goals being
achieved is questionable.

QUESTIONS
Q1) What were the main reasons behind the merger Of HP and Compaq?

Q2) why the merger proved to be the failure one?