The Other Divide at HP This one's not about making money, but donating it. How the Hewletts and Packards split.
By Adam Lashinsky

(FORTUNE Magazine) – When people in the nonprofit world want advice on how to deal with the economy's devastating impact on their finances, it's no surprise that they turn to Susan Packard Orr. With her ultra-straight graying hair and low-key demeanor, Orr resembles a schoolteacher more than one of the stars of the philanthropy world: Her company, Telosa, sells software used to manage fundraising by groups ranging from the Ronald McDonald House to the Red Cross. But even more important is her position as chair of one of the country's most powerful foundations. It's a title she inherited as the daughter of David Packard, the legendary co-founder of what's commonly thought of as Silicon Valley's first company, Hewlett-Packard.

And the crowd that filled the ballroom of the Crowne Plaza hotel in Foster City, Calif., last September for a conference on giving was looking for help. But before Orr, the keynote speaker, got to their problems, she knew she had to deal with one of her own--the severely declining fortunes of the Packard Foundation. Anticipating the question everyone asks her these days, Orr flashed to a PowerPoint slide reading, "Why didn't you sell your HP stock at the top of the market?" Her answer: "Because Father asked us to hold on to it."

Following Father's suggestion has turned out to be a $13 billion mistake. From its pinnacle in mid-2000, the David and Lucille Packard Foundation has dropped from the country's second-largest foundation, with more than $18 billion in assets, to the seventh, with around $5 billion at the end of 2002. Those five notches represent more than just prestige in the philanthropy world. The loss has led to a sequence of events that few for-profits today have escaped: layoffs, spending cuts, and tough decisions about what stays and what gets tossed overboard.

But the story of the Packard Foundation is about more than just another institution rocked by the stock market collapse. It also highlights a fundamental divide in the philanthropy world about how to invest money--and how to spend it. Ironically, no two foundations illustrate that split better than Packard and the one started by Dave Packard's best friend and lifelong business partner, William Hewlett. Just as folks referred in one breath to "Bill and Dave" when they were alive, the respective foundations that survive them are the fraternal twins of American philanthropy, pumping money into identical causes like environmental conservation and abortion rights.

Yet for all their similarities and shared lineage, the Hewlett and Packard foundations have diverged when it comes to managing their money. While the Packard Foundation has tanked by holding on to HP stock, the William and Flora Hewlett Foundation has invested its funds, diversifying out of the company as early as 1987. As a result, the assets of the two foundations are moving in opposite directions, with Hewlett recently overtaking Packard, long the larger foundation.

Hewlett and Packard are hardly the only foundations to have surged or shrunk financially because of the way they've handled their investments. The Bill and Melinda Gates Foundation weathered the downturn by selling the billionaire's stock as soon as he donated it--and then presciently putting most of the money into bonds. Other philanthropies followed the path of the Ford Foundation, which long ago diversified out of the founder's stock and suffered only a small loss in the past year even as the automaker tumbled 40%. Those that failed to diversify paid a heavy price. The Turner Foundation, for example, stopped accepting grant proposals altogether after failing to unload shares of AOL Time Warner (the parent of FORTUNE's publisher) that its founder, Ted Turner, had donated. Taken as a whole, the nine largest foundations after Gates lost more than $16 billion between the end of 2000 and the summer of 2002 (the most recent numbers available), according to the Chronicle of Philanthropy.

But this tale of two foundations goes deeper than just how these groups invest what's been left to them. It reveals fissures in philanthropy that emerge when times get tough: how foundations are managed, who gets hurt when the funding dries up--and perhaps most important, how closely foundations should hew to the last wishes of the men and women who created them. It's on this last issue that the H and P families differ the most. The Packards, who dominate the leadership of their foundation's board, have stayed true to their father's guidance--and seen their reputation in the charity world diminish. The Hewletts give more and more leeway to their professional managers. "There are different ways of doing philanthropy," says Walter Hewlett, the eldest son of Bill Hewlett and the chairman of his foundation. "My father once said he was indifferent as to whether there were Hewletts on the Hewlett Foundation board. He was making a point. We are not a family foundation."

The story begins, as it does with all foundations, with the people who made the money. "For all their idiosyncrasies, foundations are just the personification of their founding donors," says Sterling Speirn, president of the Peninsula Community Foundation in San Mateo, Calif., who has worked with both the Hewlett and the Packard foundations. "So their greatness and their ineptitude trace back to their founders."

David and Lucille Packard started their foundation in 1964 by writing checks at their dining-room table to a handful of their favorite charities, most headed by people Lucille knew personally. The couple shared keen interests in children's health, abortion rights, and oceanography. At work Packard was a hands-on boss who invented the concept of "managing by walking around." His 6-foot 4-inch frame was a constant sight around HP, where he was intimately involved with all the details of his company's operations.

He kept the same level of interest in his philanthropy until the end. Before Dave died in 1996, he penned an eight-page memo laying out guidelines for the way he wanted his heirs to oversee the foundation. Among other suggestions, Packard wanted the group to maintain a strong link to HP as a way of keeping the family and its foundation connected to the source of its wealth. And indeed, the foundation put its assets solely in HP stock.

For a while Packard's heirs had no need to veer from the memo. When their father died, the foundation inherited tens of millions of shares of HP stock; the booming market sent the endowment soaring. Within two years of his death the Packard Foundation had gone from $2.3 billion in assets to $9 billion. To meet tax rules that stipulate that foundations must give away 5% of their assets each year or pay heavy taxes, the organization's grant-making budget skyrocketed as well, from $132 million in 1996 to $412 million in 1999. "It was like a startup company that's just gone public," says the foundation's chief financial officer, George Vera.

With their newfound wealth, the Packard family looked for outside help. For 20 years the group was managed by a soft-spoken, owlish man named Colburn Wilbur, who'd previously worked at the Sierra Club Foundation and the Hewlett Foundation. In 1999, Susan Packard Orr and her siblings tapped Richard Schlosberg, former CEO of Times-Mirror and publisher of the Los Angeles Times, to replace him. A former Vietnam fighter pilot, Schlosberg was as gung ho as Colburn was laid back.

A year after his arrival the Packard Foundation reached its peak, with $616 million in grants. Part of that went to a $70-million-a-year population program, sending staffers to fund efforts aimed at lowering fertility rates in locales like Myanmar, northern Nigeria, and Ethiopia. It pushed hard into "organizational effectiveness"--the concept of helping philanthropies do a better job of helping people--under the guidance of program director Barbara Kibbe, the acknowledged leader in the area. The foundation staff ballooned to 160 and occupied a total of five unpretentious buildings in Los Altos, Calif., an affluent Silicon Valley suburb between Palo Alto and San Jose.

All the while the Packard Foundation sold only as much HP (and later HP spin-off Agilent Technologies) stock as it needed to maintain about a two-year grant-making reserve, roughly $1 billion at the height. Then HP's shares started tanking.

In the spring of 2002, Hewlett-Packard pushed through an acquisition of competitor Compaq--an acquisition the Packard Foundation opposed but did little to fight. HP shares took a beating as the tech market sank and the battle for Compaq dragged on. From a high of almost $80 in early 2000, the shares dropped to less than $11 last year. The Packard Foundation watched its portfolio--almost 90% invested in HP and Agilent stock--plummet. And as the assets shrank, so too did the grants--to $451 million in 2001, then $250 million in 2002, and $200 million budgeted for this year. In September, Packard laid off 60 people, and it is now using just two of its buildings.

The employees weren't the only ones to feel the pinch. This January the Packard Foundation found itself unable to keep up with all the programs it had started in the boom. Some of Dave Packard's most important interests--children's health policy, population control, and the arts--found themselves with dramatically decreased funding. Whole other areas were axed, including organizational effectiveness. Barbara Kibbe, its nationally known philanthropic star, left the foundation.

The cuts have caused groups like the National Initiative for Children's Healthcare Quality in Boston--which received most of its money from Packard--to scramble for new donors. "We're very grateful to them," says Charles Homer, the group's CEO and a pediatrician who specializes in epidemiology. "But we're disappointed they're leaving the field," he continues, choosing his words carefully. "And we're very concerned about how we'll be able to continue this without their support."

Schlosberg points out that despite the calamitous drop in its fortunes, the Packard Foundation is far from shutting down. Though it's nixing its family-planning efforts in Myanmar and Sudan, for example, it will still spend $30 million this year in Ethiopia, India, northern Nigeria, and other impoverished areas.

But other foundation leaders have scratched their heads at how little the Packard Foundation did to stop its descent. At conferences and in industry meetings, philanthropists wonder why the board never diversified or brought in outside help. But with Packard still such a well-liked heavyweight, few in the industry are willing to criticize it publicly. "I don't think anyone was paying attention," says the head of one prominent San Francisco foundation.

Yet even with all the troubles, the Packard family isn't planning on making drastic changes to the foundation's portfolio. The group expects to diversify its assets, aiming to sell half its nearly 200 million shares of HP over five years. But this will be done gradually. Vera--a CPA by training and the foundation's sole investment professional--says he gets two to three pitches every day from East Coast money mangers. He returns their calls late in the afternoon California time, when he's sure they're gone. "I'm the investment guy. Period," he says, adding that he's leaning toward putting the non-HP money into index funds.

"This is a family foundation. The family makes these kinds of decisions, and the board is comfortable with this as a starting point," says Vera.

The mood couldn't be more different 15 minutes away at the Hewlett Foundation. The group is newly housed in an open-air headquarters that has gone fully "green." The foundation brags that its "waterless urinals" and other devices will allow the building to use 15% less water than a comparable building; sit still for too long in a Hewlett office, and a motion detector shuts off the lights.

The gadgets built into the headquarters are as much a legacy of Bill Hewlett's as the foundation's hands-off policy. Where Dave Packard was the micromanager, Hewlett was the intellectual and tinkerer. Early on, Hewlett wanted the people running his organization to make their own decisions. He kept a small staff--the foundation is now the biggest it's ever been, at 70 people--and left no memo detailing how his money was to be spent.

Deciphering Hewlett's wishes--or choosing not to--has been left to Paul Brest, the 62-year-old former dean of Stanford's law school who joined Hewlett as president in 2000. Brest, rumpled and teddy-bearish, sprinkles his language with words like "capacious," "paradigmatic," and "valence," yet he's not above making the coffee--or fetching it for a visitor. He plays viola in a quartet with Walter Hewlett and counts former Stanford provost Condi Rice, now President Bush's National Security Advisor, as a friend. As a foundation president, he champions the notion that foundations should simply give money to organizations they like and not be overly specific on how the beneficiaries are to use it. "Like a constitution, which evolves over time, this foundation's charter does not specify programs," says Brest. "Instead, it is to 'benefit mankind.'"

So instead of detailing where Hewlett's money should go, the foundation typically gives to large projects others have devised. For example, while the Packard Foundation picks and chooses specific programs at Planned Parenthood to support, the Hewlett Foundation gives millions in general operating support to the Center for Reproductive Law and Policy in New York City, an abortion-rights advocacy group. Same cause, different approach.

"The Hewlett family has a style," says Walter Hewlett. "It's my father's and mother's style. It downplays the personal-interest side and plays up rather the focus on doing a good job and solving problems." Hewlett, 58, is a quiet man who, like all of both Packard's and Hewlett's children, never worked at HP. During the proxy battle he used money from his father's estate to finance a no-holds-barred campaign against the merger with Compaq. The fight got personal. Carly Fiorina, HP's chief executive, belittled Walter in the months leading up to the trial as "an academic and a musician."

Both friends and acquaintances say that his actions were completely out of character for the normally reserved Walter. In fact, staffers say the entire Hewlett clan keeps an incredibly low profile at the foundation. Moy Eng, once a fundraiser for the Alvin Ailey dance troupe and now head of Hewlett's arts program, says that the family members don't think of themselves as "super program officers." Instead they give, and get out of the way. Adds Eng: "It has made for a really lovely partnership."

The love affair between the foundation and its grantees has continued, thanks to the board's decision to get out of HP stock. Fifteen years ago the foundation's treasurer, Bill Nichols, convinced the board--then chaired by Bill Hewlett--that diversification was a better way to ensure that funds would be available in a predictable way over the long term. Recalls Nichols, now retired from the foundation: "It must have been hard for him to sit in the room and listen to Bill Nichols, CPA and former accounting professor at San Jose State University, say, 'I think we should diversify out of the stock of the company you built.'" The foundation first farmed out funds to managers of stocks in U.S. companies. Later it broadened its portfolio to include venture capital, investing in stellar-performing funds run by Benchmark Capital, Crosspoint Venture Partners, and Kleiner Perkins. According to Laurance Hoagland, a former money manager and Hewlett's chief investment officer today, the organization made a total of $1 billion in returns from so-called alternative investments, like venture capital.

Hewlett's stake in HP stock dipped as low as 3% of its assets before Bill Hewlett died in 2001. Since then, however, his estate has been pumping money into the foundation at a faster clip. Today, despite continuous selling, 20% of the foundation's assets are made up of HP stock--that includes $600 million from Bill Hewlett's estate scheduled to shift into the foundation by the end of this year.

In other words, for the Hewlett Foundation, HP still matters. On a brilliantly sunny Northern California winter day, seated in plush chairs in the foundation's Poppy room--Bill Hewlett was fond of photographing wildflowers, hence the names of meeting rooms at the foundation --Brest asks Hoagland how HP stock is doing that morning. "Up a nickel," responds Hoagland. "Every little bit helps," Brest replies.

It's tempting to assume there's a rivalry or competition between the two foundations. If there is, it's kept well hidden. The two are in constant communication, often attending each other's planning meetings, comparing notes on potential grantees, and even helping vet each other's job candidates. Packard's Schlosberg and Hewlett's Brest meet in person at least once a month, and e-mail and telephone more frequently. "We're all very simpatico," says Schlosberg.

The rest of the philanthropy industry still looks up to both foundations, though with a new, critical eye. Packard, after all, preached philanthropic management but allowed an avoidable financial situation to damage it. Hewlett for years has had a prominent program funding the field of conflict resolution. Yet the HP-Compaq merger turned into a morass, due to the antagonism of the Hewlett Foundation's chairman. Much of the millions in financial and legal fees could otherwise have gone to charitable causes.

"It's symptomatic of the field of philanthropy," says Bruce Sievers, formerly executive director of the Walter & Elise Haas Fund in San Francisco, one of several foundations established by the family that founded Levi Strauss & Co. "Everyone's trying to work on these big issues, but when it comes to our own house, it's a different story."

And for all the similarities, one difference will continue to define each foundation: relations with HP itself. The Packard Foundation, continuing to heed Dave Packard's wish that a strong bond with the company be maintained, remains HP's largest shareholder, with about 6% of its outstanding shares. Even after it sells half its current stake, it will own about 100 million HP shares. "We frankly are emotionally as well as financially attached," says Schlosberg. "It isn't just business with us. And I'm proud of that."

As for the Hewlett Foundation, its relations with HP no doubt were soured for many years to come when Walter Hewlett was forced off the company's board last year. Asked to describe the Hewlett Foundation's relationship with HP, Paul Brest replies, "I think it's fair to say there isn't any."