HP breakup bolstered as takeovers exceed equity value

PUBLISHED : Friday, 07 December, 2012, 11:54am
UPDATED : Friday, 07 December, 2012, 11:54am

Hewlett-Packard’s value has plunged to less than the US$31 billion it spent during a five-year takeover binge, the strongest evidence yet that investors would be better served by disassembling the maker of consumer laptops, printers and corporate servers.

Deals for Autonomy, Electronic Data Systems, Palm and others built on the US$17.6 billion purchase of Compaq Computer a decade ago, when Hewlett-Packard doubled down on personal computers. With the company failing to capitalise on a boom in demand for smartphones, tablets and cloud computing, fiscal 2012 sales fell, and analysts project declines for at least three more years, according to data compiled by Bloomberg. In the latest setback, Hewlett-Packard said it overpaid for Autonomy because of fraud, boosting last year’s deal-related writedowns to US$18 billion.

“All of this points to a company that’s dysfunctional,” Brian White, a New York-based analyst for Topeka Capital Markets Inc., said in a telephone interview. “This whole mishap with Autonomy should be a wake-up call to do something. I think it’s time,” he said. “How much more pain can investors take before you understand that something needs to be done?”

The US$27.2 billion company, valued at more than US$100 billion as recently as 2011, could boost a stock price languishing near a 10-year low under US$14 to more than US$20 by separating into two companies focused on consumers and business clients, UBS said.

By jettisoning PCs and printers, Hewlett-Packard can reinvest that cash into the enterprise unit to enhance its software used for data centres, according to Topeka Capital.

Michael Thacker, a spokesman for Hewlett-Packard, said the company remains committed to its current corporate structure.

“HP has some of the most valuable franchises in the technology industry,” he said. “There are many advantages in one organisation, including branding, go-to-market, supply chain, procurement scale, effective leverage of functional costs and collaborative R&D efforts. HP is committed to keeping our businesses and assets together. Our customers and partners tell us that’s what they want.”

Hewlett-Packard, a Silicon Valley pioneer founded in 1939 and now run by chief executive Meg Whitman, remains one of the US technology industry’s largest companies, producing US$120.4 billion in revenue during the past four quarters. Only Apple, at US$156.5 billion, generated more, according to data compiled by Bloomberg.

Hewlett-Packard also has the second-worst-performing stock in 2012 among technology companies in the Standard & Poor’s 500 Index, following a 46 per cent plunge.

The company bolstered its position in personal computers by purchasing Compaq, a deal former CEO Carly Fiorina completed in 2002 despite the objections of Walter Hewlett, the son of co- founder Bill Hewlett.

While the transaction catapulted Hewlett-Packard to No. 1 in PCs over Dell Inc. several years later, Fiorina was ousted in 2005 after failing to generate the profits she’d promised.

Her successor as CEO, Mark Hurd, struck deals for Electronic Data Systems, expanding Hewlett-Packard’s division providing contract technology services to corporations, as well as mobile-device maker Palm.

After he departed, his replacement Leo Apotheker shut phone and tablet production amid slow sales and increasing demand for Apple’s iPhones and iPads and devices running Google’s Android software.

Apotheker also agreed to buy Autonomy, a developer of data- mining software used by corporations. Hewlett-Packard now says that company committed accounting fraud.

Autonomy’s former CEO Mike Lynch has denied that. Hewlett-Packard wrote down the value of the Autonomy deal by US$8.8 billion during the fourth quarter.

Hewlett-Packard’s acquisition strategy has failed to boost its value, with the US$31 billion spent since December 2007 on acquisitions exceeding the stock’s current market capitalisation, according to data compiled by Bloomberg. The company also has US$35.6 billion in goodwill, the amount paid for acquisitions above the target company’s asset value.

That exceeds Hewlett-Packard’s market value by US$8.4 billion, more than any other US corporation, the data show.

“HP has been a serial disappointment and a case study in mismanagement, dreadful capital allocation and poor corporate governance,” Todd Lowenstein, a Los Angeles-based money manager at HighMark Capital Management, which oversees about US$17 billion and owns shares of Hewlett-Packard, wrote in an e-mail.

“The company is probably worth twice its current share price on a conservative appraisal of its sum-of-parts breakup scenario.”

Fiduciary Trust sold its Hewlett-Packard stake several years ago when the investment firm began losing confidence in the company’s leadership, according to Chief Investment Officer Michael Mullaney.

“It’s absolutely dirt cheap,” said Mullaney, who helps manage US$9.5 billion in Boston. “If they want to try to fix it immediately, it would be by splitting up the company. That’s exactly what they have to do.”

Hewlett-Packard needs to overhaul its board, because some of the current members are responsible for approving the Autonomy acquisition, and then split the company in two, said Topeka Capital’s White.

The personal computer and printer businesses could be spun off together or sold to a buyer such as an Asian computer maker like Taiwan’s Acer or Asustek Computer, White said. The printer business, the stronger of the two, could help entice an acquirer and get a better price, he said. Phone calls and e- mails to representatives at Acer and Asustek weren’t immediately returned.

A breakup would allow management to turn its focus to the enterprise unit and reinvest the cash to bolster its software offerings, White said.

“Why should the CEO have to wake up and spend any time thinking about the PC business when there’s such a negative trend? Why wake up to a losing battle each day?” he said. “If they actually did some of these divestitures, they’d have more capital for acquisitions -- but good ones.”

PCs and printers together made up 49 percent of Hewlett-Packard’s 2012 sales, yet investors are getting those businesses for free based on the current market value, said Steven Milunovich, a New York-based analyst at UBS.

He estimates the company could be worth more than US$20 a share, or almost US$60 billion including net debt, in pieces next year, according to an October 8 report. He valued the PCs and printers groups at a combined US$15.6 billion.

“HP is probably too big for anyone to manage,” he said. “They’re trying to be all things to all people.”

The sum of Hewlett-Packard’s businesses implies a stock price of about US$20 a share, according to ISI Group’s Brian Marshall. That’s 45 per cent higher than yesterday. Still, he cautions that the company’s future sales and profit are so uncertain that it would be difficult to get to that level under the current structure, and a breakup may be too difficult for management to enact right now.

“It’s cheap for a reason,” said Marshall, an analyst for ISI. “It would be extremely difficult, if not impossible, to break up those divisions. HP has so much on its plate right now just trying to keep the ship afloat that they can’t possibly take on that complex of a transaction right now.”

Whitman has said the company reaps advantages by keeping its divisions together, including the strength of the Hewlett-Packard brand on PCs and advantages from buying chips and other components that can be used across computers, printers and servers. Whitman last year decided to keep the PC business, reversing Apotheker’s plan to get rid of it.

Still, analysts see a diminished business should the status quo be maintained. Hewlett-Packard’s revenue in the fiscal year that ended in October was down 5.4 per cent from 2011, the biggest annual slump since 2001. Analysts’ average estimates show a decline in each of the next three years, data compiled by Bloomberg show.

Whitman on October 3 forecast less fiscal 2013 profit than analysts projected, saying the company would earn US$3.40 to US$3.60 a share, excluding some items. The average estimate was US$4.16, data compiled by Bloomberg show.

Hewlett-Packard’s greatest strengths at the moment are in its enterprise computing group, according to Jayson Noland, an analyst at Robert W. Baird & Co. That unit had sales of US$20.5 billion last year and supplies the servers, storage and networking gear that powers corporate data centres. The company is counting on products like its Project Moonshot systems, which let customers cram thousands of computing cartridges into a machine to solve Web serving and data-analysis problems.

“They have to show synergies across these divisions” and show corporate customers what the advantages are of buying PCs, printers, servers, storage and networking gear from one company, Noland said in a phone interview.
If not, “what’s the point of this all being under the same umbrella?” he said. “Then you need to break it apart.”

The company wouldn’t likely sell divisions under “duress” and could wait until performance improves, Noland said.

Hewlett-Packard probably hasn’t pursued a divestiture because it will be difficult to align the company’s asking price for its PC or printer business with what a buyer is willing to pay, said Shaw Wu, San Francisco-based analyst for Sterne Agee & Leach.

Even if a suitor were interested in the entire company, its size could be a deterrent, he said.

“You’ve got to have pretty deep pockets,” even though the shares have already fallen, Wu said in a phone interview.
Still, it behooves Hewlett-Packard to act quickly and not be too discriminating when it comes to offer prices because the value of the pieces may continue eroding, he said.

“It may make sense to do it sooner than later,” Wu said. “There is a bit of an expiration date.”