Hewlett-Packard's Efforts To Be Big Blue Leave Some Bruises

By Stephen D. Simpson, CFA | August 19, 2011 AAA

Wow.

A lot of analysts look at Fridays as slower-paced days where they can tie up loose ends, get out early, and work on their golf game. Hewlett-Packard (NYSE:HPQ) pretty much trashed that idea for tech investors, though, with an avalanche of information and major transformational changes. While Hewlett-Packard has given people a lot to chew on, a few basic ideas emerge - the company is taking a new strategic direction that makes sense (but will take time to realize), current performance is not very good at all, and investors are going to have to be patient to get value out of this name.

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Earnings Looking Pretty Sad
Hewlett-Packard announced that reported revenue rose 1%, while currency-neutral revenue fell 2%. These are admittedly not great days for big tech (and Dell's (Nasdaq:DELL) revenue growth was similar), but those results are fairly pathetic when compared to IBM (NYSE:IBM), EMC (NYSE:EMC), or Cisco (Nasdaq:CSCO).

Software was pretty strong (up 20%) and financial services (arguably a non-core business) revenue was up 22%). Enterprise servers, storage and networking (ESSN) did alright with 7% growth, while services grew 4%. Personal systems (PCs, mostly) dropped 3% and the imaging and printing group saw revenue fall 1% for the quarter.

While GAAP operating margin did improve half a point, non-GAAP operating margin fell almost a point and a half and the company once again lowered its guidance (the third time in a row). (Evaluate the past performance before investing in these types of gadget funds. For more, see Technology Sector Funds.)

Farewell to PCs and Palm
There has been plenty of noise around the idea that HP would do something, like how I suggested back in July to restructure its consumer-facing businesses, and the company is doing exactly that.

HP management is going to "explore options" for the PC business - likely preferring to sell it, but probably realizing that a spin-out is more likely. This announcement comes about seven years and 4 months from IBM's decision to sell its PC group to Lenovo - which in turn followed about two years after the HP-Compaq merger. It's good to see that HP realizes that the PC business is no longer a growth (or margin) opportunity, but HP has likely waited too long and will find it hard to find a lot of buyers lining up for this asset.

Turning to tablets and phones, HP is raising the white flag and basically acknowledging that the Palm acquisition is a total disaster. Although the company hopes to find ways to extract value out of webOS (the operating system), they are scrapping efforts to compete in smartphones as well as TouchPad and other tablets. Simply put, HP just couldn't compete with Apple's (Nasdaq:AAPL) iOS or Google's (Nasdaq:GOOG) Android, nor develop attractive hardware. It is worth wondering if Google's acquisition of Motorola Mobility had anything to do with this announcement, and it further highlights how this increasingly a winner-takes-all market (bad news, then, for Research In Motion (Nasdaq: RIMM) and Nokia (NYSE:NOK) bulls counting on a recovery). (For related reading on acquisitions, see Biggest Merger And Acquisition Disasters.)

Hello Autonomy
Last and not least, HP also announced a $10 billion deal for U.K. software company Autonomy. The 75% premium that HP is paying looks steep (though magnified by the recent market declines), but it gives HP an invaluable content management and analytics software company and will make it more competitive with the likes of IBM, Oracle (Nasdaq:ORCL) and Microsoft (Nasdaq:MSFT) in enterprise software.

Bottom Line - So Much to Digest
Hewlett-Packard looks like yet another company looking to morph itself into IBM 2.0 ("this time, with printers!"), but this ongoing transition has not been smooth or easy. While I have thought Hewlett-Packard shares have looked cheap for a while, I have not bought them for my own account, as I did not believe management had been clear enough about how it was going to stay competitive and adapt to the emerging trends in enterprise and consumer IT.

Now there is more clarity, but the 20% drop in the stock after the announcement highlights just how little appetite investors have for uncertainty and underperformance these days. HP seems to be on the right track, but a large number of investors will not touch this name so long as management can only deliver very low-single-digit revenue growth from these assets. So Hewlett-Packard still looks like a value, but this one is likely to be a slow-cooking name for quite some time to come. (For related reading, see New Technology: Pay Without Your Wallet.)

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