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Can Hewlett Packard Shine Again?

April 02, 2012 | About:

Hewlett Packard (NYSE:HPQ) has lost its way mired in multiple management changes over the years. The rise of Apple took a big bite out of their PC business. Now the questions are: Is there unappreciated value hidden in HP’s software and IT service business? And can Meg Whitman be the change agent for a new HP? Here are reasons why investors should be cautious on the company and why some brave souls may want to jump in now.

What makes HPQ vulnerable?

  • High debt and an urgent need for additional R&D expenditures to stay relevant. These are the hallmarks of failed business models.
  • A decade of abrupt management changes has messed up the company’s strategic direction. And there are rumors of another big change, possibly next year.
  • HPQ’s re-diversification strategy, fighting in all segments of the IT market, could backfire, causing the company to lose focus in the company’s strong hold such as printing and software.
  • The company’s low return on assets (ROA) is reflective of its inability to generate good return on its research and development (R&D) costs, particularly in the struggling PC business.

What makes HPQ a bargain?

  • HPQ carries a long and storied history of success with a broad range of technological products. There is value in the brand. Many users view their products as reliable.
  • The company’s new culture is said to be open, flexible and accessible.
  • HP could have an unique opportunity to provide truly integrated services spanning across hardware and software.
  • An annual growth of 30% in their software business is impressive. Unfortunately, it’s only 3.2% of their total revenue. And software business dropped by 8% in the latest quarter.

Software: 3.2% of total revenue, -8% growth during the latest quarter, annual growth 30%.

IT Service: 28.7% of total revenue, -7% growth during the latest quarter, annual growth 1%.

HPQ’s loss of direction

HPQ, founded in 1939, is a computer technology company that sells its products in electronics stores across the world. Over the years, the company has produced every technology-based product that you can name, having the most success with software products, IT infrastructure, networking services, computers of all types, and printers. Most recently, HPQ has been at the top of its game when it comes to software, printing and IT services but found itself behind other companies in its industry with other products. A major reason is that it hasn’t fully taken advantage of its broad and diversified product offerings during multiple management changes and confusing strategic shifts.

Key financial statistics

HPQ’s 12-month low is $21.50 along with a 12-month high of $41.80. Currently, HPQ’s stock is trading at $23.54. Following are some key statistics that investors should be aware of when deciding whether to make an investment:

P/E 8.34

Price/Book 1.2

ROE 15%

ROA 5%

Current Ratio 1.01

Quick Ratio 0.86

Debt Ratio 0.70

Leverage Ratio 0.79

Disruptive management changes

Top management at HP has undergone changes repeatedly in the last decade. Three CEO’s have come and gone, and there is talk of the current CEO being replaced in the next year. Here is Barron’s list of controversial moves by each of the CEO’s that shortened their stay with HP:

· Carly Fiorina's $25 billion purchase of Compaq in 2002 tilted the engineering-driven company toward the commodity-PC business.

· Mark Hurd, who took over in '05, led the company further from its roots with the $13.9 billion purchase of data-processing manager Electronic Data Systems in August of 2008.

· Léo Apotheker's bizarre 11-month tenure positioned HP as a software company with the $10 billion acquisition of U.K.-based Autonomy — followed by a hasty decision to dump the PC business.

The Debate on Meg Whitman

Meg Whitman is the current CEO. While she is trying to change the culture, the jury is still out on whether she has what it takes to turn HP around. So far, Whitman has transformed the workplace into one that is open, accessible and flexible. For instance, senior executives have been moved out of walled offices into cubicles. On the other hand, her strategy to return HPQ to its roots is being refined. Whitman’s goal is to focus on utilizing research and development (R&D) costs to bring back the broad product diversification that always defined the company. As quoted in Barron’s, her strategy “spans PCs, printing and imaging, software and services and enterprise gear, including servers, storage and networking.” She goes on to stress that R&D needs to be treated more as an investment, not as an expense, to solve existing problems or liabilities HPQ currently faces due to failed or insufficient R&D in the past. That spells trouble for cash-centric value investors.

Some investors may argue that Whitman’s track record is questionable. She had some shining days at the once-dominant e-commerce giant eBay. However, her glory days were short-lived. On her watch, eBay lost its battle in China with Taobao after overpaying for a local leader, eachnet. On her watch, eBay lost its U.S. battle against Amazon, losing a big slice of market share. Even Paypal is now facing headwinds from payment services from Amazon (NASDAQ:AMZN) and Google (GOOG).

Can HPQ shine in good businesses like IT and software?

While HPQ is still sorting out its management fiasco, we should not forget its strengths. HPQ is still the largest company in its industry in terms of market capitalization and operates in an industry with plenty of opportunities to grow. And it has the advantages of being No. 1 when it comes to printers and No. 2 in IT services, where IBM (NYSE:IBM) has produced enviable success. Although HP was once a leader in producing PCs, the company eventually ditched them in favor of notebook computers. While it was a controversial move at the time, it turned out to be a wise one since more consumers use portable computers now. Most importantly, it should be noted that HP’s past success has made its brand name respectable and the company continues to market itself in the right areas to keep consumers interested in its products.

Whether HPQ is a good investment depends on who you ask. Optimists will tell you that the stock could rise up to 25% in the next year under the assumption that the current management can use its limited but valuable resources to its advantage. Evidence suggests that Whitman’s open and flexible culture could make that happen. However, pessimists suggest that there is a lot of work to be done to turn it around at HPQ. They point to the fact that HPQ is losing revenue right now and therefore lacks the cash to pay off its long-term debt, a big minus that is not affecting its major competitors like IBM and Dell (DELL).

(Disclosure: Brian Zen owns shares in Dell and IBM.)

About the author:

SUPERINVESTOR.net is an investment research co-op for next-generation super investors, analysts, and advisors.

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