Analysis & Commentary:

IDC ON HEWLETT-PACKARD AND COMPAQ -- LOOK TO THE FUTURE
by IDC Analysts: Del Prete, Melenovsky, and Doyle

IDC Opinion

What is the impact of the proposed merger between Hewlett-Packard and Compaq?

We regard the announcement by Hewlett-Packard and Compaq as indicative of both the short- and long-term trends in the global IT supplier marketplace. The announcement marks a formal recognition that the individual pieces of a technology solution are not enough, be that for a consumer or an entire enterprise. In recognition of this, two of the world's largest suppliers are joining forces with a long-term vision of providing more complete solutions, from access devices (mobile and tethered), to output devices (printers) and all of the "glue" servers, storage, and services to make it happen. In making this vision a reality, the new company will face a daunting task of rationalizing product lines as well as sales and services organizations. In our view, this is an aggressive move by both suppliers that will accelerate near-term pain for long-term benefit.

Announcement Highlights

On September 4, Hewlett-Packard and Compaq Computer announced plans to merge.

Details of the agreement include the following points:

• Hewlett-Packard and Compaq will merge to create an $87 billion global company.
• The merger is expected to generate cost savings of $2.5 billion annually by the middle of FY 2004. Pro forma assets of $56.4 billion, annual revenues of $87.4 billion, and annual operating earnings of $3.9 billion (based on both companies' last four reported fiscal quarters).
• Under the terms of the agreement Compaq shareholders will receive .6325 of a newly issued HP share for each share of Compaq, giving the merger a current value of approximately $25 billion. The transaction is expected to close in the first half of 2002.

Snapshot Analysis

Key Points:

#1 HP and Compaq -- Inevitable and Necessary

The proposed merger between HP and Compaq is indicative of both the current market conditions and the long-term structure of the information technology supplier marketplace. Both suppliers own large market share positions in their own right, and after the transaction is completed will be the share leader in nearly all of the segments in which it competes. In the hardware space, each of these segments has become increasingly competitive, with product differentiation harder and harder to achieve. In such cases, industry consolidation is a natural phenomenon. In many industries (e.g., memory, hard disk drives, mobile phones), consolidation has been a way to gain efficiency in terms of procurement, supply chain management, and design optimization. We expect that in this case HP will look for some of the same efficiencies. In fact, the company has already stated that in the case of Compaq today 18-20% of its product costs are related to logistics, an area that could certainly be rationalized post merger.

#2 A Combined Threat to IBM?

We believe the combined HP/Compaq will position itself as a strong competitor to IBM in terms of being able to provide leading-edge access and enterprise class technology and infrastructure support services. We note while the combined HP/Compaq services and product portfolio will certainly be stronger, the investment and associated revenue stream IBM derives from its technology group in OEMing non-IBM products will be approximately $14 billion this year. Therefore, while HP/Compaq is clearly a larger entity than before, we do not expect that the company will evolve to look much at all like IBM, rather like a new breed of industry standard-based open-solution provider.

#3 A More Attractive Partner

As an $87 billion entity, HP/Compaq will represent a huge customer for component suppliers and partner for downstream products and services. Today, while HP and Compaq are both committed to open industry standards, exactly which standards efforts are supported are sometimes understandably not the same. By speaking with a single voice, whether it's for the form factor of next-generation server blades, or the clustering technology for new operating system revisions, one large voice makes for a great partner. Expect the company to make use of this new-found status.

#4 Experience with Disparate Architectures

With this merger in place, HP/Compaq will represent the amalgamation of multiple architectures and environments. Apollo, Tandem, Digital, Compaq, and HP make up the experience set that will be drawn upon to solve customer problems. While there are obvious challenges associated with bringing together all of these skill sets, we believe the collective experience of bringing together different enterprise architectures will be invaluable to HP/Compaq over the long term. As industry standard technology can be deployed in increasingly sophisticated environments, the need to merge existing architectures (proprietary or not) with new open standards will be at a premium. Look for HP/Compaq to leverage this important skill set. IDC believes the services organization is in an excellent position to act as a "trusted advisor" to help businesses migrate to these new architectures.

#5 Stronger Player in the xSP Marketplace

The combined HP/Compaq will provide high-touch sales and services to a range of global service providers. The new HP/Compaq should be able to build upon each company's current moderate success in selling servers, storage, and management software to service providers. The combined company is likely to focus first on the xSP data center with additional opportunities available in 3G wireless, broadband, and next-generation voice markets. HP/Compaq's ability to execute and gain share in the xSP space is critical to future revenue growth.

Conclusion

We regard the announcement of the creation of a new $87 billion global technology and services supplier as significant as any in the evolution of the IT industry. In 1982, Rod Canion founded Compaq on the idea that customers were looking for an easier, more transportable way to use the PC. Over the ensuing 19 years, technology evolved to deliver performance levels far beyond the expectations of most people. In 2001, technology is beginning to fade to the background, being replaced by the need for more seamless solutions that solve the business problems of customers. This is not a transition that will happen overnight, but rather one that requires patience and a long-term vision. The first step is for suppliers to acknowledge the changing value proposition associated with providing more seamless solutions over point technologies. The announcement was a giant step in that direction.