Merrill Lynch Calls for HP Breakup--Again

by Timothy Prickett Morgan

Hewlett-Packard did its Digital Experience Launch of 200 new products last week, and analysts at Merrill Lynch took the occasion to once again advise HP's upper management to hire a chief operating officer and to seriously consider splitting up the company into pieces. Steve Milunovich, the top IT analyst at the brokerage firm, has been saying for months that HP can be sensibly split into a consumer company and a commercial company, or can be divided into digital imaging and computing halves.

For the third year in a row, HP has launched a boatload of new products around the back-to-school and end-of-year IT budgets. And while Milunovich applauded the launch of the Vivera branding for HP's printer ink, which lasts 100 years, as opposed to 60 to 70 years with normal ink cartridges (and thereby justifies HP's premium prices and props up the profit margins of its Printing and Imaging unit), as well as new Photosmart printers, flat panel TVs, DVD home theaters, and other consumer products, he complained in a report released this week that the products seem a little late to market, with school soon to start.

Milunovich also believes that HP's need to emphasize functionality over low price with its imaging and printing products--and thereby to ensure continued profits that help to prop up its server and storage units--will give Lexmark leverage with customers. He makes a good point.

But the argument that all profitable divisions should be set free, while making financial sense in the short term, is not necessarily a good strategy in the long term. If IBM had believed the nay-sayers more than a decade ago, there would have been five Baby Blues that would be tearing one another to shreds today in a way that may not have yielded profits for these individual companies or decent products for consumers, because of the relentless cost cutting and competition.

Competition can go too far, and just as spinouts and mergers can. What IBM chairman and CEO Louis Gerstner correctly recognized was that IBM was far more valuable as a single entity than it was as a bunch of smaller companies. Upon taking over IBM, Gerstner must have also seen that it was in a much worse state than anyone had imagined and that it wasn't really possible to break up the company. Keeping IBM whole was his only real option, and he knew that the profits from one division could shore up other divisions as he cleaned house and got IBM into shape. It took four to five years for this to pan out, and Gerstner had the benefit of the ERP, Y2K, and dot-com booms to boost IBM's prospects.

While HP's current state is somewhat different, in that it is the result of a recent merger of two behemoths, whether Milunovich or the rest of Wall Street likes it or not, in the long run, HP needed Compaq as much as Compaq needed HP, and neither was going to profit without doing something radical, like the merger. Maybe HP should have bought Dell? Maybe HP should have done a lot of things. But it bought Compaq, and HP's management is committed to seeing this merger through, even without a boom to help tide it over. Wall Street had just better get used to this idea.