Thu, Jan 17, 2002 page19

• Compaq CEO hedges his bets

  On the one hand, Michael Capellas is touting a proposed merger with rival Hewlett-Packard. On the other, he's planning a survival strategy should the deal fall through

  • BLOOMBERG
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  Compaq Computer Corp Chief Executive Officer Michael Capellas is putting the second-biggest maker of personal computers in a better position to survive if a planned sale to Hewlett-Packard Co fails, investors said.

  Compaq last week said sales, which fell 33 percent in the third quarter, dropped about 31 percent in the period ended in December. The shares rose 17 percent in the quarter as Compaq landed new corporate accounts and Capellas pushed the sales force to focus on boosting market share in servers and storage devices.

  The pickup wasn't enough to convince investors that the US$25 billion stock sale will happen. Compaq shares now trade at 22 percent less than Hewlett-Packard's offer, compared with a 16 percent difference on Oct. 1. Still, Capellas's efforts have improved Compaq's prospects for recovery without Hewlett-Packard, investors said.

  

  Michael Capellas, CEO of Compaq Computer Corp, gives the keynote address at Internet World at New York's Javit's Center in December. Capellas is making sure that Compaq can survive on its own should a proposed merger with H-P falls apart.

  PHOTO: BLOOMBERG

  "They have the ability to survive alone," said Todd Ahlsten, a research analyst for Parnassus Investments, which owns 800,000 shares. Capellas is making sure that Compaq's server and data-storage businesses "will be extended if the deal doesn't happen," Ahlsten said.

  Compaq yesterday was scheduled to report a fourth-quarter profit, excluding some expenses, on revenue of about US$8 billion, the company said on Jan. 7. Analysts cited higher-than-expected demand from businesses and holiday shoppers as well as increased server and storage sales.

  The company on Oct. 24 had forecast a loss of US$0.03 a share and sales of US$7.6 billion to US$7.8 billion. A year ago, Houston-based Compaq had a profit from operations of US$515 million, or US$0.30, and sales of US$11.5 billion.

  The stock dropped 35 percent in 2001 and has declined 55 percent since Capellas was named CEO on July 22, 1999.

  Capellas, 47, declined a request for an interview, spokesman Arch Currid said. The CEO, who was paid US$29.7 million in cash and stock in 2000, has been talking to customers, shareholders and partners since the sale to Hewlett-Packard was announced Sept. 3.

  Capellas has worked to downplay statements from rivals such as Dell Computer Corp and analysts, who say Compaq is losing business because of the acquisition. He's visited customers and touted wins such as the US Postal Service and the American Express Co.

  "He's out on the road quite a bit, reassuring customers that either way, their interests are protected," said Bruce Garelick, an analyst for Loomis Sayles & Co, which owned 1.39 million Compaq shares as of September.

  Capellas, who would become president of the combined company, and Hewlett-Packard CEO Carly Fiorina will meet with officials at Institutional Shareholder Services, an advisory firm owned by Proxy Monitor Inc, in the next few weeks, said ISS Vice President Patrick McGurn. Some shareholders have said they will base their votes on the ISS recommendation.

  Opposition to the combination among Hewlett-Packard shareholders has derailed Capellas's lobbying efforts.

  Walter Hewlett, a Hewlett-Packard board member and son of co-founder William Hewlett, criticized the Compaq purchase on Nov. 6, saying it would make Palo Alto, California-based Hewlett-Packard too reliant on PC sales. Capellas and Fiorina said Hewlett ignored cost savings and relied on "faulty analyses." Capellas and Fiorina on Dec. 5 tried to persuade the David and Lucile Packard Foundation, Hewlett-Packard's biggest shareholder, to support the agreement. Two days later, the foundation said it would vote against the acquisition. Altogether, the family members of Hewlett-Packard founders control about 18 percent of the shares.

  Since taking the top job at Compaq, Capellas has restructured Compaq three times. He fired 8,500 employees last year and lost the title of largest PC maker to cross-Texas rival Dell.

  A self-described "geek," Capellas last month told Hewlett-Packard employees in a speech that the PC business is "rotten," though sales growth and profit margins will improve as communications and computer companies combine the PC with the Internet, music and video. PC sales made up 44 percent of Compaq's third-quarter revenue.

  Capellas hinted in December that Compaq is ready to go it alone when he wrote in an e-mail to employees that the company must keep a "pragmatic view" about the Hewlett-Packard agreement. He later said Compaq isn't preparing to abandon the acquisition and that there is no Plan B, although some investors think otherwise.

  "He has to be subtle," said Ahlsten. "He cannot come out and say, `Gee, this deal doesn't look like it will go through.' He's handcuffed in what he can say."

  Capellas has reduced expenses and inventory levels, and the company's shares are cheaper compared with Dell, investors said.

  Compaq's shares trade at about 28 times estimated earnings, less than Dell's price-to-earnings ratio of 44. Compaq has fought for market share in servers and storage while letting Dell take the lead in less-profitable PCs. Compaq has increased direct sales of computers in the US to increase competition with Dell in the US, analysts and investors said.

  Capellas did a "great job" last year, said Dan Niles, a Lehman Brothers analyst who raised his rating on Compaq shares to "buy" this month. Capellas's cost-cutting moves "have got them on an even footing [with Dell]. At least they're not getting blown out the door as they were before."

  David Katz, chief investment officer at Matrix Asset Advisors Inc, agreed.

  "The wheels didn't fall off and the numbers are coming in," he said. Matrix owns 711,000 shares of Compaq and 600,000 shares of Hewlett-Packard.
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