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The Starting Line: Compaq preps for life after HP

As its future with Hewlett-Packard remains in flux, the PC maker appears to be positioning itself in case their proposed blockbuster merger unravels.

update As Compaq Computer's future with Hewlett-Packard remains in flux, the PC maker appears to be positioning itself in case the companies' merger unravels.

At Internet World in New York City Tuesday, Compaq CEO Michael Capellas spoke about where the company stands. "Let it be very clear, I absolutely support the merger." However, he added, "We have a business plan that's ongoing...we expect it to continue," with or without the merger.

Over the weekend, Capellas sent a memo about the HP-Compaq deal to employees telling them that the company supports the merger but would have "a pragmatic view of our business and a clear focus on the future."

That future, detailed by Compaq in June, centers on building its business around services, enterprise software and hardware, and innovative new access devices, he said.

"That strategy has not changed," Capellas said in the memo. "Whether we are part of the new HP or a standalone company--I am confident in our ability to achieve these objectives."

Capellas' memo capped a week in which Houston-based Compaq had been increasingly making its executives available to the press and analysts to counter the perception that it will founder if it doesn't merge with HP, and to trumpet its successes in storage, high-end servers and services, analysts said.

The public-relations push coincides with the ongoing saga between HP and its major shareholders, which have panned HP's plan to buy Compaq. It's hard to ignore the timing: The Compaq road show comes as the likelihood grows that the merger deal will fall apart.

Publicly, Compaq said it still supports the merger despite word that the David and Lucile Packard Foundation and Walter Hewlett oppose it.

But even before the Packard Foundation voiced its opposition last Friday, Compaq's actions indicated that the company could be hedging its bets, analysts said. Investors are also hedging: Compaq shares fell 14 percent on Monday to $9.70. HP shares held steady closing at $23.

"They are trying to remain visible because of the merger, but they are also making a statement that they are a survivor either way," said David Katz, chief investment officer for Matrix Asset Advisors, which holds shares of both Compaq and HP.

Compaq denies that it's straddling the fence.

"We are not trying to set ourselves up in case the deal doesn't go through," said Michael Winkler, executive vice president for Compaq's global business units. "But whether or not the deal goes through, we believe the stock is a great buy as we are fundamentally changing our business model."

Winkler was in New York last week meeting with various members of the press. Although he spent some time talking about why a merger with HP would work, much of the visit was used to talk about Compaq's business units and the information technology industry.

"The last couple months, Compaq executives have mostly talked about the HP merger, but now they're going back to talking about what Compaq is actually about," said A.G. Edwards analyst Brett Miller. "At this point, you'd have to hedge."

Miller noted that Compaq's effort to portray itself as something more than just a PC maker started in August when the company unveiled its services strategy to Wall Street.

But the HP merger put that PR effort on the back burner as Compaq head Capellas joined HP CEO Carly Fiorina to stump for their potential deal. Lately--as the HP deal has become dicier due to shareholder opposition--Compaq has made key executives available to highlight its business units and is even offering tours of its facilities; the latter hasn't typically happened in the past.

Campaign time
Last week, Compaq was on a barnstorming tour of sorts:

• Mary McDowell, senior vice president for the company's industry-standard server group, met with Merrill Lynch on Dec. 5 to talk about software tools for Compaq's Windows- and Intel-based servers.

After the meeting, Merrill Lynch analyst Steven Fortuna reiterated a "neutral" rating, but did note that "Compaq often excels in exploiting the more technologically advanced aspects of the open systems architecture for its industry-standard servers."

• Mark Lewis, vice president and general manager for Compaq's enterprise storage group, met with UBS Warburg analyst Don Young on Dec. 4. Young noted that Compaq can give EMC fits because it has a more efficient business model in storage. The analyst also "could not help but notice the clear advantages that (Compaq) has over Dell (Computer) in NT storage cost and technology."

• While McDowell and Lewis met with Wall Street, Winkler made the rounds with the press. Winkler said morale at Compaq remains strong even as the HP flap has unfolded, and he noted that Compaq has met its goals for October and November. He also discussed Compaq's efforts in supercomputing and the recent gains of new customers.

Miller said Compaq's efforts to tout its businesses and reposition the company are crucial to its success--especially if the HP merger does fall apart.

"It's tough in the industry right now, and they have to differentiate themselves," said Miller, noting that Compaq will likely face problems keeping executives and winning over customers who will be wondering whether the company will be up for sale shortly.

Luckily for Compaq, the company has strong management teams running its key divisions, Miller said. Though the top executives have lost ground on the strategic front because of the HP deal, division heads are still "blocking and tackling," he added.

Deal or no deal?
Some analysts expect Compaq shares to eventually rebound if the HP deal falls through. These analysts note that Compaq will continue to de-emphasize the PC business while continuing to invest in new technologies and services.

Last week, Sanford C. Bernstein analyst Vadim Zlotnikov said Compaq is positioned to top earnings estimates and show improvement in the fourth quarter. If the deal doesn't happen, Compaq will most likely have to restructure to cut costs, analysts said. If Compaq restructures, it should have at least enough growth to justify a stock price of $13, more than $3 above its closing price Monday.

George Elling, an analyst at Deutsche Banc Alex Brown, made a similar argument Monday. He said Compaq has "turnaround potential" and that its parts are worth more than the whole of the company's current value.

Matrix's Katz said he believes Compaq is worth much more as an independent company, which is why he was among the first to oppose the merger in October. "We think the company is worth 100 percent to 200 percent more than it is now," Katz said. "We can easily see Compaq at $20 in the next 12 to 18 months."

Other analysts aren't so sure about Compaq's prospects, noting management was willing to sell out when the company's shares were trading at a 52-week low. U.S. Bancorp Piper Jaffray analyst Ashok Kumar said Monday that Compaq's prospects as an independent company are "dubious." He said Compaq will have trouble convincing customers about its enterprise product plans.

While analysts may disagree over Compaq's future, they agree that the company's effort to position itself for a future without HP is the right move.

Joel Wagonfeld, an analyst at Banc of America Securities, said both Compaq and HP should end the campaign for the merger.

"Although we believe the merger could have been a viable long-term option at one point, we think both companies should now focus on mending customer relationships rather than risking further damage by fighting this uphill battle," Wagonfeld said.

Staff writer Jim Hu contributed to this report.