It's been almost two years since Hewlett-Packard announced its $19-billion (U.S.) merger with Compaq, and more than a year since HP started the massive task of combining the two companies. This spring, a number of analysts were calling the merger a success, given the cost-cutting and other benefits CEO Carly Fiorina had produced in a short period of time, and the stock has almost doubled in a year. HP's latest results may make some of those fans think twice about their optimism, however.
Ms. Fiorina drew cheers this spring when she reported that HP had managed to cut its costs by more than $3-billion in the first year of the merger — beating her earlier target of $2.5-billion in cost cuts by 2004. Adding to the rosy picture was the fact that in the company's fourth quarter, net income beat consensus estimates by more than 9 per cent, rising to $309-million from a loss of $505-million in the same quarter of the previous year. Last month the stock price hit $23, a level not seen since 2001.
In its latest quarter, however, HP came in well below expectations on almost all its operating results. Revenue of $17.35-billion was lower than the consensus estimate from Wall Street analysts surveyed by Thomson Financial/First Call, and the company's profit of 23 cents a share (excluding one-time charges) was lower than the target of 26 cents most analysts had for the quarter. HP's PC unit saw its sales rise by just 4.5 per cent to $5-billion from $4.75-billion, and it turned in an operating loss of $56-million.
The imaging and printing unit — which includes HP's printer business, the core profit centre of the company, as well as its digital camera and optical scanner businesses — was a bright spot, with sales that rose 10 per cent to $5.24-billion. But HP's record-setting merger with Compaq was supposed to do more for the company than just create an even larger behemoth dependent on the same old printing business that has been paying HP's way for the past few years. So far, those benefits remain elusive at best.
In addition to all the other problems that come along with engineering the world's largest computer-company merger — combining two companies that were once fierce competitors — Ms. Fiorina has two main problems. On the one hand, HP is trying to compete with computing behemoth IBM in the field of consulting services (since that's traditionally where the big profit margins are), and on the other hand it is also trying to compete with Dell, the undisputed world leader when it comes to low-cost PC production.
The fact that the U.S. economy and the technology industry in general have been in the doldrums for some time now (although there are tentative signs of a recovery approaching) plays right into Dell's hands, which is why it has been growing like a weed even as other companies see little or no growth. Dell has virtually perfected the low-cost, just-in-time manufacturing model for PCs, and over the past two years it has been extending that model into the corporate world and other markets, such as printing.
When the economy is weak, the majority of the growth occurs at the low end, and that means Dell with a capital D. Higher-cost manufacturers have been watching the Texas-based company eat their lunch for the past several years — just as Compaq did, which is the main reason why it acceded to the merger with HP in the first place. Needham & Co. analyst Charles Wolf went so far as to say in a recent report that HP suffers from a "chronic competitive disadvantage" compared with Dell's direct model.
HP's results make for an interesting contrast with Dell's. The latest quarter saw the mail-order company's sales rise 16 per cent to $9.8-billion and net income climb 24 per cent to $620-million. Sales of corporate servers grew by 27 per cent, while external data storage sales climbed 46 per cent and desktop PC sales rose 25 per cent. In addition to the loss at HP's desktop and laptop computer unit, sales at the company's server and storage unit were essentially flat and it also reported a sizeable operating loss.
Ms. Fiorina admitted that the operating loss at the PC division was due to "overly aggressive pricing" on HP's part, an attempt to keep up with Dell. As if to drive home its advantage in that area and capitalize on its competitor's weakness, Dell announced a round of price cuts the day after HP released its results, dropping its prices on various products by anywhere from 3 per cent to 22 per cent. Dell recently overtook HP as the world's largest maker of PCs, with about 17.8 per cent of the market.
HP has just launched a suite of new printers, PCs and cameras, which some analysts hope will boost sales. But for now, Dell is winning the PC race, and forcing HP to suffer losses at the same time — and it is making inroads into both the corporate server and the printing market as well, HP's bread and butter. That could put pressure on both sales and profits in those areas too, and continue what Merrill Lynch analyst Steve Milunovich called the "squeeze play" that is crushing HP between IBM and Dell.
E-mail Mathew Ingram at mingram@globeandmail.ca
For past columns and a brief biography, click here
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