Can Fiorina sell it?

During the quiet moments in the run-up to next week's big vote, Hewlett-Packard CEO Carly Fiorina may well be reminded of the ancient Chinese warning to be careful what you wish for.

Not that she has a lot of downtime to reflect on much of anything these days besides the next stump speech before investors. With HP shareholders set to decide the proposed acquisition of Compaq on March 19, Fiorina is waging a battle against fellow board member Walter Hewlett, who has been equally dogged in mobilizing opposition to this mega-merger.

Both sides have picked up big endorsements, but as this race goes down to the wire it's getting too close to call. A little more than a week ago, Fiorina picked up the backing of the influential advisory group Institutional Shareholder Services. Only days later, the Hewlett forces made hay of the announcement by the California Public Employees' Retirement System, or CalPERS, that it would oppose the deal.

Appearing a little thinner and wearier around the eyes than when she sat down with CNET News.com last November, Fiorina remains publicly upbeat about the prospects of a vote in favor of the deal. At the same time, the shareholders' decision will be interpreted as a mandate on her leadership. If the nays carry the day, the Fiorina era at HP may well be over. And even if she wins, victory won't necessarily translate into a bowl of cherries. Management can't afford any missteps if it hopes to pull off a successful integration of these two multibillion-dollar companies.

With her own Super Tuesday fast approaching, Fiorina sat down with reporters and editors from CNET News.com, CNET Radio and ZDNet in her Palo Alto, Calif., offices.

Why has it been such a hard sell? Is there a credibility gap for the board and yourself?
I certainly don't think so, but I do think that first you have charitable foundations in the Hewlett and Packard family names whose investment interest may not mirror the investment interest of the 82 percent of the rest of our shareowners. I think, fundamentally, the board brought me in two-and-a-half years ago because this is a high-technology company that needed to change. It is a high-technology company that had fallen behind in a couple of key ways. And so, literally, I was brought in to bring about changes.

In two-and-a-half years, you probably over-promised a lot and, given the economic circumstances and everything else going on, under-delivered. So are you going to change your tune going forward?

"I think, fundamentally, the biggest risk in this merger is not strategy. The biggest risk is execution. And that is why we are planning the integration in such detail."

Well, as you might expect, I don't necessarily agree with the characterization. In the '99 and 2000 years, we delivered against the expectations we set, with the exception of fourth quarter 2000, where we absolutely (under-executed) and I stood up and took full accountability for that. I think if you look at our track record in 2001, what you'll find is--compared to a lot of technology companies--we performed quite well?Turning to the merger, however, we know that people are skeptical initially about a high-tech merger. Most of (the mergers) haven't worked. This one is different in important respects, not the least of which is that this is a merger of consolidation done at the bottom of a market, not a merger of diversification done at the top of a market. But what we are (putting) forward here for shareowners is a quite conservative, high-confidence-base case.

Assuming the merger goes through, would it make sense at some point to look at spinning off printing/imaging? That's come up in recent times; even the ISS report suggested it.
Actually the ISS rejected it, if you read their report. What they said is they looked at the possibility of spinning out imaging and printing and said they did not think it would create shareowner value. And that is clearly the conclusion the board has come to every time it has looked at this.

The board initially considered the spinout of imaging and printing when the board concluded we should spin out Agilent Technologies. The board has looked at it a couple of times since and it makes no sense because there are short-term costs in doing it. But more importantly, it makes no sense because the medium- and long-term growth of imaging and printing requires us to get into new categories. That new category creation requires the breadth of this portfolio.

The ISS report made clear that there are strategic risks that are attached to the merger.
They also made clear they accept the underlying strategic logic and believe it is absolutely the best way to create shareowner value that's sustainable over time. So I think their endorsement was actually fairly loud and clear on the subject of strategic logic, economic logic and on the quality of our integration planning. There are risks in any course. There are risks of standing still; there are risks of doing nothing; there are clear risks in going slow. And some of those risks we experienced over the past five years when this company missed some key trends in the industry, including--but not limited to--the Internet. I think, fundamentally, the biggest risk in this merger is not strategy. The biggest risk is execution. And that is why we are planning the integration in such detail.

Whether you look at HP's internal polling, or the polls done by David Packard, there is a significant number of employees who aren't supportive of this deal.
I would characterize our employees in three basic mindsets. There are people who are wildly enthusiastic about this deal and who have been (enthusiastic) from the day we announced it. There are people who have legitimate concerns and questions: "I need to understand more." "I need to understand what this means to me personally." "I need to understand how you're going to go about selecting people for the positions." All of those are very legitimate and understandable concerns and we must continue--and have been for six months--spending a lot of time with our employees at all levels of the organization, giving people facts and helping them understand how this process will roll out over time.

And then I think there are employees who have difficulty with change. There are employees who have had difficulty with change both before and after this merger. That is not unique to HP, but certainly it is an ongoing aspect of change. You know, change is necessary and resistance to change is inevitable. I think it was (former General Electric Chairman) Jack Welch who said in his book that for the first several years he was at G.E., he had 30 percent of his employees with him. Fortunately, we have the vast majority of employees who understand change is necessary, but resistance to change is real.

But it's more than just resistance to change. In some respects there is a percentage of the work force actually going even further in saying, "What you're planning to do is to destroy the HP Way." Do you feel that you're going to need to do some fence mending with the disaffected?
If you ask people who have been around here for a long time, what they'll tell you is that there were task forces back in the early 1980s about whether the HP Way was being destroyed or not. I think it is a legitimate conversation to have always, but I don't necessarily think it is always tied to this merger?But once the shareowners have made their decision...it is our job inside HP--all of our jobs inside HP--to execute. And so, of course, we need to put the fight behind us. We need to heal the wounds and build the bridges so that we together, as a team, can execute the will of our shareowners and we, as a team, can go serve customers and beat competitors, which is what this is all about. But ultimately we have to get on with it.

Would you support Walter Hewlett's re-election to the board?
Everyone is sort of fascinated by the drama of it, which is unfortunate...because I think it distracts from the choice shareowners are being asked to make. I will answer you the same way I answer everyone who asks this question: This is a decision for the Nominating Committee of the board and the Nominating Committee of the board hasn't taken the subject up yet. When they do, they'll make a decision.

As CEO, do you think it's important for the foreseeable future that someone representing the families be on the board, whether it's Walter Hewlett or someone else?
There really are two subjects that I'm not going to speculate on. One is the future of management and the board if this deal is voted down, and the other is what the composition of the board will be going forward. I just think that kind of speculation isn't particularly useful at this point. It may be sort of interesting, but it's not useful. The choice for shareowners right now is very clear and we think it's important that shareowners focus on the choice they're being asked to make. We have a process at HP which elects board members annually. And so, there's an opportunity every year to consider that question and we will do so in a timely way.

Leaving the board question aside, what role for you as CEO does the family play? What role would you like to see them play in terms of your leadership--not necessarily in terms of formal roles, but in terms of the influence that they should rightly have on your decision-making?
Well this is a company that will always bear the Hewlett-Packard name and we will always be proud to bear that name, and we hope that we will always make the families proud of the company that we built.

That doesn't necessarily mean that they should be directly involved. Is that what I'm gathering?
I think the families at some level will always be involved in this company because we bear their name and because a great deal of what I have been doing since I arrived at HP is to build upon the legacy that Bill Hewlett and Dave Packard left for us. I believe that is a legacy of constant innovation and willingness to embrace change, not resist change.

In terms of the public battle, are there things you might have done differently or that you might recommend to other people in similar positions?
This is a merger that the board of directors--a board that brought me in because they knew substantial change was necessary for the ongoing health of this company--very carefully considered. They very carefully considered it against a whole set of alternatives that they have evaluated over the last two-and-a-half-plus years. And they have concluded after that very careful process that this represents our best alternative--one that improves our market position, one that improves our profitability and cash flow, one that we can execute. And having made that very carefully considered decision, they feel strongly that we must put the facts in front of our shareowners.

And unfortunately, when we believe that our opposition has misrepresented the facts about the company, about the merger, about the numbers...the process this board has gone through and its deliberation, then this board feels it must set the record straight. I find this episode difficult and regrettable in many cases, but I also know that this merger is of crucial importance to the future of this company. This is a decision that is very significant for our shareowners and they must have the facts.

Have you been able to talk to your customers and at least provide them with product or technology plans post-integration?
Well as I said, our product-line road maps are now completed for every product for the next three years and we will be rolling those out to our customers...as soon as we go operational and get shareowner approval. So, absolutely, we will do that.

"If you ask people who have been around here for a long time, what they'll tell you is that there were task forces back in the early 1980s about whether the 'HP Way' was being destroyed or not."

On the services side, previously you had attempted to buy PricewaterhouseCoopers, which everybody thought was a great deal.
(Laughing) You know, peoples' memories are interesting...I walked away from that deal because I couldn't get it structured in a way to create shareowner value. Read that to mean I couldn't get enough assets at the right price. When we announced that deal, our stock was hit by eight bucks. So at the time, people didn't like the deal. In retrospect, people now say, "Gee, that was a good deal. It's this one that's not so good."

Right. But the services business, it gets you from No. 8 to No. 3 with this merger, and that's a distant No. 3 compared to IBM, let's say. Do you have any other ideas about how you can get ahead?
No, so let me correct (about) the facts here, OK? You're right in terms of it being a distant No. 3 in terms of overall size. But if you look at the composition of our businesses...IBM is the largest principally because of consulting services. The consulting-services business, if you've looked at it over the last 18 months, what you'll see is its growth has slowed dramatically, as has its profitability. The bulk of our services business is in support and outsourcing. Support, contrary to popular myth, is extremely high-margin business; it is low-20s operating-margin business. We want more of it. Why? Because it's like supplies--it comes in month-in, month-out, quarter-in, quarter-out. We book it with long-term contracts with our customers. So, we're doubling the size of our support-services business?If I can have a bigger business that earns low-20s operating margin, I want it.

One thing that I know has been a hot-button topic with you is the executive compensation plan or lack of a plan. What is the bottom line on what's being designed and has been designed in board meetings about executive compensation for you and (Compaq CEO) Michael Capellas?
First of all, nothing has been designed and no contracts are in place...There were...conversations early on in the process. Those terms grew out of the fact that Compaq had change-of-control provisions that needed to be dealt with when this merger agreement was signed. Those terms (were) explicitly...rejected by the Compensation Committee way back in September. By the way, our opposition knows this because he is a member of the Compensation Committee.

There are two very important reasons why this is an important question to be considered by the new board. One is new market data needs to be collected. The market data around executive compensation in '99 and 2000 is not the same as the market data in 2001 and 2002, so you have to go back and reset?What I can assure shareowners of, however, is that whatever the new compensation plan is, it will absolutely be aligned so that it is HP's executive performance to exceed our shareowners expectations that our pay is tied to. And the second thing that I can assure our shareowners is that we will be targeted to achieve numbers that are above the case we have presented to shareowners today.

If this deal doesn't go through, are you still with HP? Are you still a CEO of the company?
Well...that's one that I have refused to speculate on actually...because I don't think it's useful. I think what I will say though is this is a board of directors and a management team that is dedicated to the success of this company. And this is also an independent board and a management team that absolutely believes that this is the right course of action for this company, and we have committed an enormous amount of energy to getting this deal done and to making sure that we can execute it when we get it done.