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Introduction

Hewlett-Packard (NYSE:HPQ) is one of the oldest and most famous technology companies in the world. Like IBM (NYSE:IBM), the company has pioneered many of the daily use technology products we use today. The company is the 2nd largest technology company in the world today, with ~$120 billion in revenue. However, the rise of Apple (AAPL) has hurt HP quite hard in recent times, as the company failed to successfully enter newer product categories like smartphones and tablets. To compound its Apple woes, HP has blundered massively with its recent acquisitions of Autonomy and Palm. Top management has been a disaster with CEOs changing rapidly, as the company's fortunes have touched an all time low. Despite its troubles, HP remains the world's biggest PC and printer producer and generated ~$7 billion in FCF last year. The company has managed to retain its No.1 PC ranking in Q412 and it has performed better than the rest of the PC industry in 2012.

Why we would buy HP

1. Valuation - Due to the collapse in the stock price, HP has become quite cheap compared to the rest of the technology industry, as well as the S&P 500. The company is trading at a forward P/E of just 4.3x and ttm P/S of just 0.3x. Despite all the negative chatter about how the company's revenue is declining, HP managed to generate more than $10.5 billion in OCF in FY 2012. The company is trading at a P/CF of just 3.1x. The company also gives a nice dividend yield of more than 3%, with a payout ratio of just 20%. The company is more than capable of not only servicing but raising this dividend. Even after a 50% rally from its low of $11, HP stock remains quite cheap.

2. Not just a PC and printer company - Many people don't realize that it is now one of the biggest software and services company in the world. The company's acquisitions of EDS and Autonomy has made it into a big software and services player.

3. Spinoff or Assets Sales could be catalyst for the stock - HP management has been thinking of spinning off or selling its PC / printer divisions, to concentrate more on software and enterprise computing. If this event happens, the stock could see a big jump.

4. Wins the legal case against former Autonomy owners - HP accused the former Autonomy management of fudging the books to inflate the value of the company. HP has filed a case to recover $5 billion in dues from former Autonomy shareholders, which has been contested by former Autonomy CEO Mike Lynch. We don't think the market has factored in the possibility that HP could win this case. If HP wins, it will trigger an immediate upside of 10-20%.

5. Windows 8 and Ultrabooks - HP like other PC vendors is coming out with innovative PC and laptop products, to stop cannibalization by tablets and smartphones. HP has already introduced ultrabooks which are thinner, lighter and faster than the traditional laptops. The company is also pushing laptop tablet combos in order to win back marketshare from iPads and cheap Android tablets. While the Windows 8 operating system has not set the world on fire, it is still too early to say that the new Microsoft (NASDAQ:MSFT) operating system won't be a success. With Nokia (NYSE:NOK) joining the Microsoft bandwagon, Windows 8 has got another powerful player in its corner.

6. Sentiment - Investor sentiment towards HP is extremely negative, due to the numerous blunders that the management has made. We rate this as a positive for the stock and the company. The top management realizes that it can no longer afford to indulge in empire building and complacency.

7. Management Capitulation - The Autonomy scandal has been a wakeup call for the whole company. The CEO very candidly said that it will take a huge amount of effort to clean up the company. We view this public expression of the problems faced by the company in a positive light.

Risks

a) Top Management has been a Disaster - HP's top management has been a disaster for the company and one of the biggest reasons why the stock has performed so badly over the past few years. Carly Fiorina made the Compaq acquisition which proved to be very controversial and expensive. Mark Hurd was fired over a sexual harassment case while the next CEO Leo Apotheker was fired for non-performance. The new CEO Meg Whitman (ex-CEO of eBay (NASDAQ:EBAY)) has yet to prove herself in the new job. Reports indicate that the top management and the board is a snake pit with employee morale at an all-time low. The company has missed out on major trends like smartphones and tablets. The company's hurried entry into the tablet space was an unmitigated disaster. Meg Whitman in a recent interview has indicated that the company will have to enter the smartphone space again. HP used to be a leader in smartphones during the early part of the decade, but squandered its early mover advantage.

b) Acquisitions have been a Bigger Disaster - In the technology industry, every big company makes numerous acquisitions to keep up with new technologies and trends. HP's acquisitions have not only been hugely expensive (EDS, Autonomy, Compaq), but they have also managed to wipe out most of the value of the acquired company (Compaq, Palm). The $8.8 billion write-down for the Autonomy acquisition reflected badly on HP. This M&A deal will probably rank amongst the worst technology acquisitions in the history of the technology industry.

c) Main product lines are showing a secular decline - One of the biggest reasons for the underperformance of the Wintel ecosystem, has been the PC decline due to cannibalization by tablets and smartphones. Dell (NASDAQ:DELL) which is very similar to HP in terms of products and revenue mix, has shown a big decline as well. HP's printer division is also showing declining revenues and the server segment has been affected by the changing technology trends like cloud computing and virtualization.

Stock Performance

HP has been one of the worst stock performers in the large cap technology space, in the last few years. The company has managed to significantly underperform the other players in the Wintel ecosystem like Microsoft and Dell. The company has given a loss of 63% over the last 5 years, compared to a ~42% gain for the NASDAQ. In the last one year, HP has lost ~37%, compared to ~15% gain for the NASDAQ. This massive decline in the stock price has led to the current cheap valuation and made the stock a value play.

Summary

HP has been badly punished by investors in the last few years, due to PC industry problems and monumental management blunders. The Autonomy fiasco has resulted in the stock declining to an all-time low. HP has rebounded to $16, however it still remains ~70% below its peak of ~$55. HP is trying to decrease its reliance of hardware and trying to become more of a software and services player like Dell. However, the market does not think that HP can turn around its declining revenue trend. We think that the stock price has discounted most of the current issues with the company and is trading at below fair value. The company has formidable assets and there is no threat that it will go out of business any time soon. HP is present in almost all technology sectors such as servers, PCs, software, services, printers, networking, storage etc. The company has a long history of existence and survival with a brand name that can be matched by few other technology companies. We would start building a position in HP and move in aggressively, once the company starts showing signs of stabilization and growth.

Source: Hewlett-Packard: This Fallen Wintel Angel Is Too Cheap To Ignore