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HP misunderstood in merger plan - Exec
( 2002-02-20 15:34 ) (7 )

Hewlett-Packard Co's technology services chief said on Tuesday that even though slower sales of computer hardware could crimp the unit's growth, maintenance and support would remain highly profitable -- a point neglected by opponents of HP's proposed merger with Compaq Computer Corp.

In an interview on one of the key disagreements over the proposed $21 billion deal, HP services chief Ann Livermore said maintenance and support -- nearly two-thirds of HP's services business -- was also the most profitable unit.

Founding family scion and dissident board member Walter Hewlett, the chief merger opponent, has said that HP needed to focus on the two other serviced areas, consulting and outsourcing, which constitute about a third of HP's services revenue, but generally are expected to grow faster.

"One of the things that I think Walter's argument hasn't really taken into account is how beautiful the support business really is. It is an annuity stream. Any time you have an annuity revenue stream, that is very attractive from a company's shareowner perspective and financial perspective," Livermore said.

The support business was the only services division with double-digit profit margins, she said.

Consulting tends to be seen by customers as a discretionary expenditure and has been hit hard throughout the technology sector downturn, she said.

"There is an oversupply of consulting in the market," Livermore said. "This is not the time to be going out and focusing just on that market."

Hewlett said in a presentation released on Tuesday that the company needed services that drove hardware sales, and pointed to HP's abandoned attempt in 2000 to buy consultant PricewaterhouseCoopers. "HP needs high-end consulting, integration and outsourcing skills, not more support," he said.

Both sides of the merger dispute agree that services are critical to Hewlett-Packard's future. HP services' profit swelled 31 percent and it recorded a 13 percent operating margin in the fiscal first quarter reported last week, making it the company's only profitable unit besides printing and imaging.

Livermore said the unit's operating profit margin would increase one to two percentage points once Compaq was integrated, largely thanks to increased scale and operating efficiencies.

In another sign of its relative strength, services was the only division to increase revenues compared with a year earlier, eking out a 2 percent rise and contributing 14 percent of HP's overall $11.4 billion in quarterly sales.

STEADY SERVICE SALES?

Whether HP can hold onto customers after the merger is a second major disagreement over the deal and bears on Hewlett's argument that sales will plunge as the integration falters, wiping out the projected gain from cost savings.

Hewlett argues falling product sales will mean a drop of up to 6 percent in services, which are often sold in deals with computers.

For its part, HP management has said that total revenue will drop no more than 5 percent, and services and printers would not fade as a result of the merger.

Livermore broadly stuck to that, but she said, "If our unit growth rates go down in the product business, clearly that will have some impact on our opportunity to sell support attached with it. That is a pretty basic point, so yes that's true."

Livermore said Compaq's product dominance in areas like Windows operating system servers and storage would help services, since the combined company would have expertise in a much wider range of products.

Hewlett has said that the deal, which roughly doubles HP's services, leaves it focused on support, without making HP a significant player in outsourcing and consulting markets, which together are multi-sided billion dollar markets.

Livermore said the merged companies would have $3.5 billion to $4 billion in consulting and outsourcing revenues, and be the third largest player in the total services sector, behind IBM Corp. and EDS Corp. HP now ranks as number seven or eight in the business, she said.

"There is a big difference in terms of being invited to the table to participate in proposals when you are number three," she said.

Hewlett-Packard shares fell 60 cents to $19.76 and Compaq dropped 39 cents to $10.56 in a falling market on the New York Stock Exchange.