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“Fiorina’s Folly” at Hewlett Packard

By Hal Plotkin
CNBC.com Silicon Valley Correspondent

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One-year performance of HWP
One of the biggest questions swirling around Silicon Valley these days is whether Hewlett Packard Co.’s {HWP} charismatic chief executive Carly Fiorina is about to take her company to new heights — or right off a cliff.

Many analysts and investors, it would appear, seem to be betting on the cliff.

Fiorina, who was recruited from Lucent Technologies in July, 1999 to reinvigorate the grandaddy of Silicon Valley companies, was given a hero’s welcome. She set clear goals to make HP a big player in the Internet — and carried out the daring maneuver of spinning off the original HP test & measurement business into Agilent Technologies {A}, which was completed in June.

The new CEO had Wall Street eating out of her hand pretty much until August when analysts started picking apart the company’s third fiscal quarter numbers. And things have deteriorated since. The company is suffering from the same concerns over demand that overhang other makers of computer hardware, such as IBM {IBM} and Sun {SUNW}. It reports earnings for its fourth quarter on Nov. 15 and analysts are expecting 51 cents per share.

But it isn’t just a PC and capital spending slowdown that has turned investors off. Many are particularly alarmed about a proposed deal to buy PricewaterhouseCoopers LLP’s consulting business. Since news of the deal, initially valued somewhere between $17 billion to $18 billion, hit on Sept. 11, HP has lost a third of its value. Rival Sun Microsystems, by contrast, is only 12% off its 52 week high.

Even critics of the PWC deal agree that Hewlett Packard must beef up consulting and services to win the biggest, most lucrative corporate information technology accounts. That is particularly true when competing with IBM’s global services unit.

But this deal they don’t like. The biggest fear is that if the deal is consummated Hewlett Packard would immediately lose the most important thing it bought: PricewaterhouseCooper’s reputation for providing independent advice, rather than pushing one vendor’s products.

“Hewlett Packard could really damage the PWC brand by buying it,” says Julie Giera, vice president for information technology services outsourcing at the Giga Information Group. “Customers will always wonder if the advice they’re getting is biased. It’s going to be a nightmare for them.”

Giera is in the process of putting together a research report on the pending acquisition, which will be published shortly. The working title: “Fiorina’s Folly.”

Like many other analysts who have questioned the deal, Giera says Hewlett Packard might well be buying an organization whose most important assets could leave on the elevator and never come back. A takeover is likely to exacerbate the PWC’s turnover problem: the attrition rate has been 27% over the past year, she says. “Their best and brightest employees are already wandering out the door.”

Throw in vastly different employee compensation practices at PWC and HP, clashing organizational structures, and thousands of high-paying open jobs at independent consulting organizations, and you have what analysts say looks like a classic recipe for a totally indigestible acquisition.

“Historically, there have been problems with similar deals,” notes Christine Ferrusi Ross, an analyst with Forrester Research, based in Cambridge, Massachusetts. She cites Compaq Computer Corp.’s {CPQ} near disastrous 1998 acquisition of Digital Equipment Corp.. That deal was supposed to open up new markets for Compaq but instead created an entirely new set of headaches that the beleaguered PC maker is just now grappling with.

Fiorina is not, however, without her backers — although they are harder to find these days.

Some analysts say the pending deal could give Fiorina a chance to prove her legendary organizational and people skills. Fiorina is at her best, say longtime associates, when the chips are down. They say she thrives on challenges and particularly enjoys proving the experts wrong through a combination of hard work, careful planning, and reliance on an unusually inclusive management style. Making the PWC acquisition pay off would be right up her alley, they say.

Anna Danilenko, senior research analyst at International Data Corporation, based in Framingham, Massachusetts, for example, says the Street has probably overreacted to fears about the pending acquisition.

“I’m not 100 percent optimistic,” she says. “But I’m definitely not pessimistic.”

Danilenko says it all depends on exactly how the deal is structured. She says Fiorina is no dummy, and will likely find a workable structure to integrate the acquisition.

“To be successful, HP needs to keep PWC as a separate entity, although leveraging HP’s role as a solution provider,” she says.

“I’m confident that PWC would only agree to be acquired if they’re allowed to keep their objectivity. As far as I know, that is a condition for the merger.”

Assuming that happens, Danilenko says, HP would be able to add PWC’s profits to its bottom line and also take advantage of the firm’s global ranks of consultants as a kind of early-warning system regarding changing customer needs.

In addition, she says many of the two firm’s largest current customers would benefit greatly from the deal.

“There are many big companies that are already customers of both HP and PWC,” she says. “It’s going to be much cheaper for them if they don’t have to pay for two separate engagements. Certain customer segments would benefit enormously.”

George Elling, an analyst at Lehman Brothers, based in New York, says he’s concerned about the pending deal but still thinks HP is a sound investment, particularly for investors with at least a 12-month timeframe. He has a “buy” rating on the stock, without a current price target.

“I’m hoping HP is doing its due diligence,” he says. “But I think the company has been doing a lot of the right things, their printer business is going great, and they’re ready for the drive into digital photography printing which is going to be very popular.”

He also notes that HP was the fastest growing PC maker during the most recent quarter, in terms of total unit sales, posting year over year quarterly growth of 46 percent, as compared with 26.1 percent for Dell Computer Corp. {DELL} and 25.2 percent for Apple Computer Inc. {AAPL}, according to the Gartner Group’s Dataquest.

“Fiorina successfully reorganized the salesforce,” he says.

Daniel Kunstler, an analyst at J.P. Morgan, based in San Francisco, also has a “buy” rating on the stock.

“The Q3 numbers on the PC side made a lot of people less nervous about the stock,” he says.

But he admits he remains nervous about the pending PWC purchase, noting that precise terms and conditions, including the price, are yet to be worked out.

“There are so many open questions,” he says. “On the surface the synergies are highly conjectural and not based on any real history.”

He’s sure of one thing, though.

“If the deal falls through I think the stock goes up,” he says. “I know I’d feel better about it.”

Hewlett Packard is scheduled to report Q4 results on Friday, November 15.

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