Two of the 'big four' PC makers merge in one of the biggest deals in technology history, creating a company second in revenue only to IBM - but layoffs are inevitable

Hewlett-Packard will acquire Compaq Computer in a stock swap worth about $25bn (£17.5bn), the companies announced late on Monday.

The deal, one of the largest in technology history, would merge two of the biggest names in computers, printers and computer servers, and would have total revenue only slightly less than IBM, the largest computer company.

Carly Fiorina, chairman and chief executive of HP, will become the new company's chairman and chief executive, while Compaq chairman and chief executive Michael Capellas will become president of the new entity. Capellas and four other Compaq board members will join HP's board.

"This is a decisive move that accelerates our strategy and positions us to win by offering even greater value to our customers and partners," Fiorina said in a statement. "In addition to the clear strategic benefits of combining two highly complementary organisations and product families, we can create substantial shareowner value through significant cost-structure improvements and access to new growth opportunities."

Added Capellas: "With this move, we will change the basis of competition in the industry."

The deal was approved unanimously by both companies' boards of directors. Compaq shareholders will receive 0.6325 of newly issued HP shares for each share of Compaq. HP shareholders will own 64 percent and Compaq shareholders will own 36 percent of the combined company.

The combined entity will be based in Palo Alto, California, HP's hometown, and retain a "significant presence" in Houston, where Compaq is headquartered.

HP said the acquisition is expected to generate "cost synergies" totalling about $2.5bn annually. The combined companies will have operations in more than 160 countries and employ more than 145,000 workers.

But analysts speculated that layoffs were inevitable. They also suggested that the deal would be closely scrutinised by regulators, including the Justice Department.

The combined companies will be organised around four operating units. An imaging and printing group led by Vyomesh Joshi, now president of imaging and printing systems for HP; an access division business led by Duane Zitzner, now president of computing systems for HP; an information-technology infrastructure business led by Peter Blackmore, currently executive vice president of sales and services for Compaq; and a services business headed by Ann Livermore, now president of HP services.

The chief financial officer of the combined companies will be Robert Wayman, currently the chief financial officer of HP.

The acquisition will dwarf the last big merger between PC companies. In 1998, Compaq bought Digital Equipment, but for approximately $9.6bn. Through the acquisition, Compaq hoped to graduate from being a manufacturer of PCs and low cost servers to a full service computer provider with high-end hardware, an international services and consulting group, and chip technology.

HP's buyout of Compaq will be fraught with difficulty, according to Ashok Kumar, an analyst at US Bancorp. The two companies are very much alike. Roughly one-third of HP's revenue comes from PCs, notebooks and servers. Roughly half of Compaq's earnings come from the same sources. Their Unix services businesses are similar.

Layoffs were expected, Kumar added. Both companies are being squeezed financially in nearly all of their markets.

"There are so many overlapping units there is no complementary benefit," he said. "The problem with HP is that they have a lot to deal with and if they want to get Compaq, it is going to be really tough."

HP may be buying Compaq for its services business, Kumar speculated. Compaq currently gets 23 percent of its revenue from services, Kumar pointed out, but the revenue largely comes from basic support and maintenance. The margins for the services business come to only 14 percent.

Another issue that will likely come up is how to integrate the PC divisions. HP outsources 100 percent of its manufacturing. Compaq has been trying to move to a build-to-order manufacturing model for several years.

High-ranking executives from both HP and Compaq earlier this year said that mergers and acquisitions among PC companies were fraught with difficulty and rarely worked.

"It is hard to find a successful example of one PC company buying another," Webb McKinney, vice president of Hewlett-Packard's personal computing group, said in an April interview.

The aversion to acquisitions comes from the nature of PCs themselves. Computers made by one company are generally similar to PCs from another. By purchasing a smaller PC company, a larger company is mostly acquiring only the customer base.

"But are customers loyal? No. The reality is that you can't really buy a customer," McKinney said. "By and large, the consolidation should happen the old-fashioned way, by gaining market share."

Mike Winkler, executive vice president of the Global Business Unit at Compaq, echoed a similar sentiment, adding that the market would devolve into a big four.

"The big four (Compaq, Dell, IBM, HP) will continue to survive and grow," Mike Winkler, executive vice president of Compaq's global business unit, said in an interview this week. "The others are in question."

Though their backgrounds are vastly different, Fiorina and Capellas have been on similar tracks of late.

Capellas and Fiorina were both named to as chief executive of their respective companies in July 1999. First Fiorina, and, days later, Capellas.

In a vote of confidence, both Fiorina and Capellas were named to chair their company's boards in September of last year.

Although Capellas and Fiorina have been working independently to revamp their respective companies to get more revenue from services amid slowing hardware sales, the two have collaborated on occasion. In May 2000, Compaq, HP and other firms announced a project to establish an e-commerce parts procurement effort.

A slumping PC market and price pressure from Dell Computer has spurred talk of consolidation.

In January, Bear Stearns analyst Andrew Neff raised eyebrows when he issued a blunt report calling for massive consolidation. Among his recommendations was that HP should buy Compaq.

Neff also suggested Gateway should sell out to either a Japanese company or to Dell and that IBM should sell its PC business in exchange for more services business.

CNET News.com's Jeff Pelline and Steven Musil contributed to this report.

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