The Honeymoon's Over for Carly - HP's Carly Fiorina - Company Operations

HP's CEO apologizes for weak earnings and for losing the chance to buy PricewaterhouseCoopers. Her star is dimmed but not out.

CARLY FIORINA HAS BROUGHT SOME glamour and excitement to old-line computer-maker Hewlett-Packard. But last week the chief executive suffered her first humbling setback -- and it was a big one.

With the transformation of the company at stake, Hewlett-Packard badly missed Wall Street's earnings expectations for its fourth quarter. At the same time, HP lost the opportunity to buy the consulting arm of PricewaterhouseCoopers, a move that would have quickly given it the firepower of 31,000 consultants to take on e-business giant IBM.

For Fiorina, acquiring PricewaterhouseCoopers was an important step in an ambitious design to reinvent Hewlett-Packard for the Internet age. Like many of its hardware competitors, HP wants a larger piece of the lucrative services and consulting business. The company is recasting itself as a provider of strategic advice to major corporations, adding 500 consultants in its fourth quarter alone. But Wall Street was never sold on the benefits -- or the lofty $18 billion price tag.

HP's stock has fallen 36 percent in the two months since the company acknowledged it was in talks with PricewaterhouseCoopers, the nation's third-largest consultancy. The stock fall made the deal's price too high. "In hindsight, I let the PwC opportunity linger for too long," an apologetic Fiorina told investors.

The fall in HP'S stock meant the company would have had to issue about 500 million new shares to pay for the deal. Analysts complained this would reduce future earnings per share. In addition, the prospect of marrying a consultancy prized for its independence to a hardware maker presented its own challenges. The fear was that an alliance with a computer maker could bias PricewaterhouseCoopers' hardware recommendations to customers.

PricewaterhouseCoopers was, by every indication, eager to sell. Early this year the firm had talked about combining its consulting business (or the whole company) with IBM. As negotiations with HP advanced, top management sent optimistic e-mail messages to its employees, praising the merger.

Sources close to the company say the partners were happy with the proposed price, but became dismayed when HP suggested cutting the deal by several billion dollars. Hewlett-Packard executives, meanwhile, became alarmed by the increasing turnover of PricewaterhouseCoopers employees. In the past six weeks, a number of PricewaterhouseCoopers consultants left for jobs elsewhere.

Even with the deal's collapse, the industry trends are clear. IBM now gets a third of its revenue from its Global Services arm, and in 1998, Compaq Computer bought Digital Equipment for its services business. At HP, executives hope to double services revenue to 30 percent of sales inside four years. Adding PricewaterhouseCoopers would have nearly accomplished that goal.

In addition to addressing the unraveling of the PricewaterhouseCoopers deal, Fiorina had to explain the first earnings shortfall to mar her five-quarter tenure. The company reported 41 cents a share in operating profits instead of the expected 51 cents.

Hewlett-Packard blamed the miss on a combination of factors. Product sales were strong, but chiefly among lower-cost servers, printers and PCs. In combination with weak software sales, the company's gross margin suffered. Meanwhile, expenses were up. HP hired 2,100 people in the quarter, well ahead of expectations.

Outside the United States, the company felt the impact of the high yen -- HP buys components from Japan -- and the weak euro. The company also took a $48 million write-off against the financing it had extended to dot-com companies and posted a $48 million loss for its Verifone subsidiary, which HP has vowed to sell.

With Fiorina promising better revenue growth, most analysts had not expected HP's profitability to flag. Now "they are putting HP in the penalty box," says Richard Chu, an analyst at securities firm SG Cowen.

The earnings shortfall will probably force Fiorina to shelve plans for rapid expansion and pay more attention to day-to-day operations. That means controlling expenses and improving internal forecasting - and spending more time in the office.

Fiorina recently has been seeking a higher profile for the company by giving keynote speeches, making television commercials and visiting customers. After this week, employees may be seeing less of her on TV and more of her in the hallways.

Wall Street maybe ready to forgive Fiorina - but it certainly won't forget. "The honeymoon is over with respect to her aura of invincibility," says Shebly Seyrafi, an analyst at securities firm A.G. Edwards. "This was a major miss."

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