Hewlett-Packard will acquire Compaq Computer in a stock swap worth about AU$47.5 billion, the companies have announced.

The deal 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.

Carleton Fiorina, the chairman and chief executive of HP, will become the new company's chairman and CEO, while Compaq's Chairman and CEO Michael D. 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 organizations 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, and retain a "significant presense" in Houston, where Compaq is headquartered.

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

The combined companies will be organized around four operating units. An imaging and printing group led by Vmomesh Joshi, now president of imaging and printing systems of 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; 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.

US Spokesmen for the two companies declined comment and a spokesperson for Compaq Australia said the company had just been informed of the decision and was therefore unable to comment. A spokesperson for HP has so far been unavailable for comment.

The acquisition, if it takes place, will dwarf the last big merger between PC companies. In 1998, Compaq bought Digital Equipment, but for approximately $9.6 billion dollars. 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.

Unfortunately for Compaq, the merger wasn't smooth. The service group was the crown jewel in the deal. Although picking up now, the services business was relatively flat for the first few years after the acquistion. Nearly all of the chip technology, including the intellectual property behind the StrongArm and Alpha chips, was transfered to Intel. Compaq has recently scored some supercomputer contracts for its Alpha based servers, but the market for high-end servers remains dominated by IBM, Sun and HP.

Roughly a year after the merger, Compaq CEO Eckhard Pfeiffer was fired.

A merger between the two 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 money comes from the same sources. Their Unix services businesses are similar. Layoffs would be inevitable. Both companies, he added, are also being squeezed finanicially 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."

Moreover, both companies are being squeezed financially.

HP may try to buy Compaq for its services business. 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 only come to 14 percent.

Another issue that will likely come up is how to intergrate 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.

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

Capellas and Fiorina were both named to as CEO 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. A Dell Australia spokesperson has also issued a resounding "no comment" about both the HP/Compaq announcement, and Dell's reaction to 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.

Copyright © 2009 CBS Interactive, a CBS Company. All Rights Reserved.
ZDNET is a registered service mark of CBS Interactive. ZDNET Logo is a service mark of CBS Interactive.