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Boston Capital: Investor activist on DEC
By Steve Bailey & Steven Syre, 05/22/97
[Image]Struggling Digital Equipment Corp.
is starting to attract the kind of
attention no management wants.
Herbert Denton, a shareholder activist who
has been taking aim at a series of
underperforming companies, plans to meet
with some of Digital's largest shareholders
in New York on June 18. He predicts holders
of 40 percent of the stock will be
represented at that meeting.
Denton, who has a tiny stake in Digital,
says the meeting at his Fifth Avenue office
will offer institutional investors opinions
from analysts, pro and con, on the Maynard
company's outlook. He says it is early in
the process and it is unclear where the
meeting will lead, but adds: ``The stock is
down from 75 to 32. What else do you need
to know?''
Digital shareholders have every right to be
disappointed. Since Robert Palmer took
control of the big computer maker in 1992,
Digital's stock has lost 12.5 percent while
shares in rival International Business
Machines Corp. - another big computer maker
undergoing reconstruction - have rocketed
ahead 140 percent. The Palmer Years have
seen flat revenues, more than $2 billion in
losses, and 50,000 jobs axed.
Palmer has bet the ranch on reshaping his
company around its Alpha microprocessor,
and so far it has been one bad bet. The
company has spent an estimated $2.5 billion
to build the world's fastest chip - twice
the speed of Intel's popular Pentium chip -
yet after five years, it has less than 1
percent of the $18 billion microprocessor
market. Intel has 92 percent. Digital sued
Intel this month, charging key elements of
Pentium were pirated from Alpha.
The problems have lead to speculation about
Digital's future as an independent company.
Earlier this month, the Wall Street Journal
reported that Digital talked with Compaq
Computer Corp. in 1995 and 1996 about
selling out. The companies agreed on a
price of $9 billion to $10 billion in late
1995 before Digital backed way, the
newspaper reported. That has to be painful
for Digital shareholders: Today the company
is valued at just $5.3 billion. Shares
closed yesterday at 34 3/4, up 2, on the
New York Stock Exchange.
Denton thinks all this smells of
opportunity.
He modestly calls his Providence Capital
Inc. a broker-dealer that ``represents the
interests of institutional investors.'' But
with only four full-time employees and a
tiny amount of money under management, he
has been making life uncomfortable for a
number of big, underperforming companies.
His current fight with Comsat Corp., the
Maryland-based global satellite
communications company, is a good example
of what Denton targets can expect.
Providence Capital holds a mere two-tenths
of 1 percent of the stock, but it has
teamed with a bigger Comsat holder,
Wyser-Pratte & Co., which holds 1.45
million shares, or about 3 percent of the
company. Things have turned nasty fast.
In March Denton met with Comsat's senior
management to talk about the lagging stock
price. That month the company announced a
restructuring that would sell the company's
dish manufacturing business and would
concentrate on satellite and communications
networks services.
By April, Providence and Wyser-Pratte had
launched a proxy fight, seeking to replace
the directors and take control of the
company. Comsat has fired back by suing its
former chief executive, whom it charged
with leaking inside information to
Providence and Wyser-Pratte. The lawsuit
seeks $20 million in damages.
Comsat is just the latest of Denton's
interests.
Last December Denton withdrew his attempt
to replace three board members at
Kentucky-based Ashland Inc. after the
company announced a plan to consider
selling its exploration business and buy
back stock. It also paid Providence $75,000
to cover its expenses.
At about the same time, Denton and Clover
Capital Management Inc. took on management
at California Microwave Inc., a San
Francisco wireless communications company.
They managed to elect two members to the
board, and the company's chief executive
quit a short time later. The stock,
however, has gone nowhere.
Denton says he is trying ``a kinder, softer
approach'' with Digital. He says his June
meeting will be geared toward asking
questions about Digital. ``This is a
company that has lost billions of dollars
in the last five or six years,'' says
Denton. ``It is quite appropriate that
critical questions be raised.''
He is surprised how much interest big
shareholders had in his meeting. ``We've
talked to the top 15 shareholders and the
vast majority have indicated an interest in
attending,'' Denton says. None of the
biggest shareholders we called would
comment.
One group that won't be there is Digital
management. A spokesman said there is no
need: The company has an active investor
relations program and regularly
communicates with shareholders and the
investment community.
Digital thinks it is making progress.
``We're not satisfied with our performance.
We know we can do a lot better and we are
going to do a lot better,'' says spokesman
Dan Kaferle. ``That said, we are light
years away from where we were five years
ago when we were hemorrhaging money.'
Denton, 50, got his MBA from Wharton and
started his career as a stockbroker in
Boston for the firm of White Weld. He later
moved to Donaldson, Lufkin
&Jenrette,starting a Hong Kong office for
them before leaving to start his own
brokerage firm there. Among his passions
are motorcycles, and he spends 10 days a
year roaring around such exotic places as
Nepal and Corsica with a group of friends,
including the big Chicago investor Sam
Zell.
The companies he has targeted tend to be
glad he's gone and do not want to comment.
He does have an admirer in Robert A.G.
Monks, the Maine shareholder activist who
has taken on Sears, Roebuck & Co., Kodak,
and Stone &Webster,among others.
Says Monks: ``He is a doer. Digital is
something that would come into his
framework. There seems to be such an
attitude of defeatism there. It has taken
so many hits. Probably the market has
oversold it. That would be the kind of
situation where Bert would be very
helpful.''
Bert Denton seems ready to lead. The key
question now: Are Digital's shareholders
fed up enough to follow?
Steve Bailey (929-2902) and Steven Syre
(929-2918) can also be reached by e-mail at
[email protected].
This story ran on page d1 of the Boston
Globe on 05/22/97.
� Copyright 1997 Globe Newspaper Company.
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May 25, 1997
For Digital Equipment's Chief, a Last Grab for Glory
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Related Article [Image]
* Profit at Digital Equipment Fell 59% in Third
Quarter (April 18)
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By LAURENCE ZUCKERMAN
[E] ager to change its stodgy image, the Digital
Equipment Corp. was host for "a night of fun and
frivolity" for reporters and industry analysts at a
Manhattan comedy club last week, a world away from its
headquarters in a converted mill outside Boston. But
Robert B. Palmer, Digital's chairman and chief
executive, skipped the event, choosing instead to have
dinner on the town.
"In this job, you don't get much time to decompress,"
he explained.
Indeed, after five years of trying to halt Digital's
seemingly inexorable slide from the top ranks of
corporate America, the pressure on Palmer is building.
Since taking the helm in 1992 after the ouster of
Digital's legendary founder, Kenneth H. Olsen, Palmer
has cut 59,000 of the company's 114,000 jobs and posted
billions of dollars in losses. But in this booming
market for information technology, Digital still has
not been able to find its way: it is expected to post
only a modest profit this fiscal year after losing $112
million last year.
While its products are praised by analysts, the
computer maker, long plagued by weak marketing, has
been unable to figure out how to sell them.
Known as a demanding leader who expects his executives
to make their numbers, Palmer has forced out three of
his top lieutenants and ushered in two major corporate
reorganizations after a series of embarrassing
management fumbles. Digital's stock price, which closed
on Friday at $36, is slightly below where it was when
he won the top job, while the values of rivals like
Hewlett-Packard and Sun Microsystems have quadrupled.
Now, in the wake of the company's headline-grabbing
patent infringement lawsuit against the Intel Corp.,
filed earlier this month, and with another corporate
reshuffling set to take effect on July 1, Palmer seems
poised to either start making his numbers or find
himself out of a job.
"The company has to start showing a sustainable
turnaround, or you would assume that the board is going
to start to get frustrated and get somebody else," said
Gary Helmig, an analyst at the Soundview Financial
Group in Stamford, Conn.
Even Digital's shareholders, who have accepted the
40-year-old company's dismal performance with little
protest, may be losing patience. Next month, Digital
investors will gather in Manhattan for a meeting held
by Providence Capital Inc., an investment firm known
for its aggressive campaigns against corporate
management.
In addition, shareholder resolutions have been proposed
for consideration at the company's annual meeting later
this year to force Digital to remove its poison pill
anti-takeover defense and to hire an investment banker
to consider selling the company.
Two years ago, Digital, the nation's fourth-largest
computer maker, came close to selling itself to the
third-biggest, Compaq Computer, for about $60 a share,
according to a recent report in The Wall Street
Journal. But the negotiations were said to have fallen
apart when it became clear just how much operating
independence Digital would lose. Both companies
declined to comment.
With its stock now trading at just over half of what
Compaq reportedly offered, Digital appears to be even
more attractive to a potential buyer, especially
because it has $2.48 billion in cash, or nearly $9.50 a
share after accounting for its debt.
The president of Providence, Herbert A. Denton, said
that he expected to draw 30 percent to 40 percent of
Digital investors to the meeting his company is
sponsoring. It will feature experts discussing the
various aspects of Digital's business, he said, and is
merely a forum for shareholders to learn more about the
company. But Denton was quick to add that a similar
meeting held last fall for the shareholders of the oil
refiner Ashland Inc. led to big changes at that
company.
"Palmer has been there for a while," he said. "A lot of
folks have come and gone. I don't know how many cards
he has to play."
In an indication of how Digital views the meeting, the
company, based in Maynard, Mass., has declined to send
a representative, saying it already has adequate
communications with its shareholders.
One thing that activist stockholders are most likely to
criticize is Digital's board. Most of the directors are
retired executives from other companies whose
experience predates the rise of the Internet and other
developments that are transforming the computer
industry.
In addition, no director other than Palmer holds a
substantial number of Digital shares.
"I like to see directors who are willing to make a
capital commitment to the company and put some of their
net worth at risk," said Nell Minow, a principal at
Lens, an investment firm that also specializes in
shareholder activism. "If they don't feel bullish on
the company, then how can you expect anybody else to?"
Born in Stephenville, Texas, in the northeastern part
of the state, Palmer worked his way through Texas Tech
University, where he received a master's degree in
physics. He eventually helped to found the Mostek
Corp., a semiconductor maker, which was later bought by
United Technologies. He joined Digital to run its chip
operations in 1985.
In an interview last week, Palmer defended the board,
which he said has given him its full backing. He also
readily acknowledged that he had made mistakes. "I've
made errors," he said. "People who worked for me made
errors for which I am responsible. I am not trying to
duck it."
Yet he says he is the right man to be running Digital.
"I've learned a tremendous amount in this job, and it
is not the sort of thing you can learn by reading
textbooks," he said. "I think I have accomplished a
great deal, not by myself, but with all of the support
of the Digital employees."
Others disagree. "He doesn't understand computers,"
said C. Gordon Bell, who led the team that created
Digital's Vax minicomputer, which rang up huge profits
for the company in the 1980s. Bell, now a senior
researcher at the Microsoft Corp., added, "He has only
been able to do one thing and that is financial
control," referring to the job cuts.
But Palmer also has his defenders. "He is a very smart
guy," said Larry Walker, the former head of Digital's
networking products division who now runs Certco, an
Internet software company in New York. "He is decisive.
He is a person driven with the right values. I don't
know what else you can ask for."
Known around Digital as GQ Bob, the dapper Palmer, 56,
was wearing his trademark double-breasted suit during a
visit to Manhattan last week. With his hair slicked
back and his face tanned, he appeared relaxed. He still
jogs four or five miles a day, he said, and highly
recommends it.
But he also acknowledged that he was in the hot seat,
admitting that he put his reputation as chief executive
on the line when he decided to sue Intel. The suit,
filed in federal court in Worcester, Mass., contends
that the chip maker violated 10 Digital design patents
to increase the performance of its Pentium, Pentium Pro
and Pentium II chips, which are at the heart of more
than 85 percent of the world's personal computers.
Most analysts have concluded that Digital has little
chance of getting anything from Intel, which said it
will vigorously defend itself against Digital's
accusations. They assume that Intel, which holds
hundreds of design patents of its own, will countersue.
And while the legal action drags on for years, Intel
will continue to sell its products.
But Palmer and other Digital executives said they never
intended to stop Intel from selling Pentiums. Doing so
would cause the PC industry to grind to a halt, hurting
Digital, which sells more than $2 billion of
Pentium-based computers a year. (Intel is also a
Digital customer, and both companies have said that the
lawsuit will not affect their commercial relationship.)
Instead, the suit is aimed at slowing Intel's efforts
to introduce its next-generation chip, which is a
crucial step in the company's campaign to move from
low-end desktop computers into the more powerful
servers that are the workhorses at large enterprises.
These machines had been the preserve of companies like
Digital and IBM.
Based on an architecture jointly developed by Intel and
Hewlett-Packard, the new family of chips will process
64 bits of data in each gulp, compared with today
chips, which process 32 bits. It will also run software
written for today's Pentiums as well as for
Hewlett-Packard's PA-RISC chip, which uses the Unix
operating system.
The first of these new chips is code-named Merced
(pronounced murr-SED), and is set to be introduced at
the end of the decade.
That is a direct threat to Digital, which was the first
company to introduce a 64-bit chip three years ago.
That chip, called Alpha, is the world's fastest. But
Digital has had trouble selling it, in large part
because it does not run all the software written for
Intel-based machines.
For the last year or so, however, Digital has offered a
translator that enables Alpha machines to run software
written for Intel-based computers.
The greater the performance of Alpha over the Pentium,
the easier it is for Digital to sell customers on the
chip's raw power. But 18 months ago, Intel introduced
the Pentium Pro, which narrowed the gap with Alpha.
Many of Digital's corporate customers are willing to
accept a somewhat slower chip to avoid the headache of
changing their software. And now with the promise of
Merced in the near future, the case for Alpha is that
much weaker.
"The acceptance of Alpha by other systems companies
would have been much greater had Intel not been able to
improve the performance of their own processors by a
wide margin," Palmer said. "In that regard, there is no
question that we have been greatly damaged."
Digital believes that the patent-infringement suit will
either delay the introduction of Merced, giving Digital
more time to establish Alpha, or force Intel to
introduce a slower chip than it might have otherwise.
"As they move up into the enterprise world, we want
them to do it on Intel technology, not Digital
technology," Palmer said.
Of course, if Intel ends up paying Digital some of the
billions of dollars in damages it is seeking, that
would be nice for the company, too. To lead its fight,
Digital hired Herbert Schwartz, a New York lawyer who
helped Polaroid win an $873 million damage award from
Eastman Kodak in a patent infringement case in the
1980s.
But few people in the industry seem to believe that
Digital will ever receive that kind of money. Another
potential resolution could be some sort of settlement
between Intel and Digital that assures a future for
Alpha.
"I think there are many possible outcomes," Palmer
said. "But it is hard to speculate on what those might
be."
Inside Digital, the lawsuit has proved to be a
surprising morale booster.
Digital, well known as a technology innovator, invented
the minicomputer, which was the first challenge to the
mainframe, back in the 1960s, and it was the first
company to link its computers in networks.
In the 1980s, its Vax minicomputers were as hot as
Intel chips are today. And the company's financial
results were equally heady: growth in revenue and
profits averaged 30 percent a year for the 20 years
prior to 1990.
But the losses and layoffs that came in the early
1990s, as a result of Mr. Olsen's refusal to
acknowledge that the Vax line was going out of style,
have shaken Digital to its core.
"The company has been going through an identity crisis,
or maybe a grieving process," said Lucia Quinn, a
Digital marketing executive who will soon be in charge
of Digital's global brand image. "The Intel suit has
energized people. It changed the conversation inside
the company. Instead of talking about growth and
profitability, people are taking pride in the fact that
Digital was responsible for all those innovations."
But outside Digital, the suit is increasingly seen as a
sign of desperation, an attempt to make up in the
courtroom what the company has failed to do in the
marketplace.
"Digital doesn't have a lot to lose," said Steven
Milunovich, an analyst at Morgan Stanley in New York.
After taking over from Olsen, who racked up $3.4
billion in losses in 1991 and 1992, Palmer set out to
embrace the open standards that were sweeping the
computer industry. The bottom had fallen out of
Digital's business because customers were no longer
willing to buy from a single vendor complete systems
that came loaded with proprietary operating software,
like Digital's minicomputers.
The new era was a culture shock for companies like
Digital, IBM, Unisys and Data General. Selling complete
systems provided profit margins of nearly 50 percent,
while selling the parts was much more competitive,
leading to lower prices and profits. Technological
prowess became less important than speed and slick
marketing.
Digital, which prided itself on its technology, was fat
and slow. It could no longer support 114,000 employees.
Palmer had the unenviable job of shrinking the company
while remaking its strategy.
He focused on Alpha, with its world-beating speed, and
cut a deal with Microsoft to have Windows NT, its new
network operating system, run on the new chip. (To
Digital's embarrassment, David Cutler, the leader of
the team that created Windows NT, was a longtime
Digital employee who was lured away by Microsoft after
Digital canceled a similar project he was working on in
the 1980s.)
In August 1995, Palmer and Microsoft's chief, Bill
Gates, announced a broad alliance in which, among other
things, Microsoft would pay to have 1,500 employees of
Digital's large services division trained as certified
Windows NT engineers -- more than the number at
Microsoft itself.
But because Windows NT is still only a 32-bit operating
system, Palmer ordered Digital's engineers to write a
version of the Unix operating system to take advantage
of Alpha's 64-bit capability. The results have been a
powerful line of computers that are now used to run
some of the busiest sites on the World Wide Web, among
other applications. For example, an Alpha server powers
Digital's popular Alta Vista search site.
But the market for such products has remained narrow
because there is still relatively little software that
can take advantage of Alpha's power. As a result,
Digital has failed to get a large computer maker to
sell Alpha-based systems, though Samsung, the South
Korean chip maker, has agreed to produce inexpensive
Alpha chips that Digital says will soon be available
from outside vendors in PCs priced as low as $2,500.
The Microsoft pact, while still promising, has been
slow to show results because Windows NT is only now
beginning to be widely adopted. While Digital's NT
revenues have more than doubled in each of the last two
years, they still only amount to about $450 million, a
small fraction of the company's roughly $14 billion in
overall sales.
In March, Hewlett-Packard, Digital's archrival,
announced its own partnership with Microsoft to promote
Windows NT to businesses. The move was widely seen as a
blow to Digital, which has been trumpeting its close
relations with Microsoft.
But Palmer and other Digital executives played down the
significance of that agreement, saying that it was not
as deep as Microsoft's alliance with Digital.
Digital has also been plagued by Palmer's inability to
settle on an executive team and on a corporate
structure that produces sustained earnings growth and
profits.
In 1993, Edward E. Lucente, who spent more than 30
years at IBM, was hired to be the head of sales and
marketing, which has been a particular weakness for
Digital for years. But after a disastrous quarter in
early 1994, Lucente was forced out after just a year on
the job.
Another casualty was Bernard Auer, who was hired to
increase Digital's personal computer sales. Auer was
ousted in 1995 when he did not produce the desired
growth.
Auer was replaced by Bruce L. Claflin, who was hired
away from IBM's PC division. Two weeks after he arrived
at Digital, in November 1995, Claflin recalled
recently, he asked members of his team how many Digital
PCs had been sold by computer dealers. He was greeted
by blank stares.
That quarter, Digital had its best PC sales ever but
Claflin quickly realized that few of the machines were
actually getting to customers. Digital had been booking
millions of dollars in sales to dealers without paying
attention to how many computers the dealers themselves
sold.
"Every quarter, we were putting in 30 to 50 percent
more than was selling out," Claflin said.
The bubble burst when PC prices began dropping sharply
in the spring of 1996. Like other PC makers, Digital
was committed to taking back unsold computers and
covering dealers when prices fell. The inventory glut
cost Digital tens of millions of dollars over the next
few months as it discovered similar practices had
occurred in other parts of the company.
Digital's stock price, which climbed as high as $76.50
in February 1996 as investors became optimistic about
its prospects, began to decline. Enrico Pesatori,
Lucente's successor and Palmer's de facto No. 2,
resigned in July 1996 after Palmer dealt with the mess
by announcing a $492 million restructuring charge and
7,000 new job cuts.
Palmer now attributes the costly mistake to the fact
that Digital, which had always relied solely on a
direct sales force, was new to selling through a
network of dealers.
"That clearly was an error that had to be corrected,"
he said. "That was because we had to learn the channels
business practically overnight while our competitors
spent years learning it."
The news got worse last October, when Digital reported
a quarterly loss that was three times larger than
analysts had predicted. Palmer said that the company
had cut its direct sales force too deeply to reduce
costs. To fix that problem, he said, the force, which
had been reduced to 1,000 people, would be expanded to
cover Digital's 2,500 largest accounts.
Last month, Palmer announced a third reorganization
that would put Claflin, who has succeeded in turning
around the PC business, in charge of worldwide sales
and marketing, beginning July 1.
Claflin said Digital had stumbled because its various
divisions had operated independently of each other. He
likened Digital's marketing to Mercedes-Benz's selling
cars by engine type, with different showrooms, sales
forces and marketing efforts for each engine.
"Every little piece of Digital had their own market
budget and none of them really cared about the brand,"
he said. "That was assumed to be somebody else's
problem."
Aping IBM's turnaround strategy, Claflin said he would
bring together Digital's products and fast-growing
services business and stress the company's ability as a
global player with strong technology and decades of
experience to pull together many types of technology
and make it work for customers.
As part of the effort, he is planning a new global
branding campaign, with Ms. Quinn in charge, that will
use the company's strong technology heritage to promote
its new emphasis on solving customers' problems.
"We are going to look at every way we touch the
customer," Claflin said. "The boxes we ship, the
literature we send out, even our stationery, and ask:
Is it consistent with the brand we want to establish?"
While investors and analysts praise Claflin's record
and energy, many on Wall Street have lost faith in
Palmer's ability to deliver on his promises, including
higher per-share earnings.
"He said at last year's annual meeting that they would
earn $2.32 this year," said Helmig, the analyst at
Soundview Financial. "Now he says they will earn a
dollar. When they don't make that, they will have lots
of excuses as to why -- everything from the change in
the organization to customers not understanding the
lawsuit."
The consensus among analysts is that Digital will earn
around 64 cents a share this fiscal year, which ends
next month.
Despite Digital's poor performance over the years,
Palmer has been richly rewarded by the company's board.
Although he earned no bonus on his $900,000 salary last
year, he received options worth $10.7 million. Graef
Crystal, the compensation consultant, said that was 74
percent higher than the average compensation of a chief
executive at a company of comparable size and
performance.
Several board members, including Thomas P. Gerrity, the
dean of the Wharton School at the University of
Pennsylvania, declined to comment on Palmer's
performance.
Interestingly, three Wharton professors, in a recent
study, found six characteristics of boards that are
linked to higher pay for the chief executive and weak
performance by the company. Digital's board exhibits at
least three of them: the same person serves as chairman
and chief executive, the board has busy outside
directors and several outside directors are over 70.
The average age of Digital's nine-member board is 66;
except for Palmer they are all outsiders, and five are
over 70. For example, Delbert C. Staley, 72, retired as
chairman and chief executive of Nynex in 1989 and
serves on five other boards. Colby H. Chandler, the
former chairman and chief executive of Kodak, is 72 and
retired in 1990.
Asked about the advanced age of the board, Palmer said:
"I like having seasoned executives that know that there
aren't any quick fixes. They understand what it takes
to change an entire culture." But he also said that the
board included younger members, referring to Gerrity
and another director, the economist Kathleen Foley
Feldstein, who he said were in their 40s. Gerrity is
55; Ms. Feldstein is 56.
"Digital is an interesting situation because there are
lots of moving parts here," said Denton, of Providence
Capital. "There is no question that the stock is cheap.
The issue is, what does the company need to do?"
One thing that some critics have suggested is a new
chief executive who understands sales and marketing.
But Palmer is convinced that no change is necessary.
"When you look at marketing gurus around the industry,"
he said, "it's not obvious what individual knows more
about marketing than we do."
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