Seeking Alpha
Research analyst, long/short equity
Profile| Send Message| ()  

This was what Hewlett-Packard (HPQ) said in a statement when Dell went private in a LBO worth $24 billion (the largest in the last 5 years) in February this year.

"Dell has a very tough road ahead. The company faces an extended period of uncertainty and transition that will not be good for its customers. And with a significant debt load, Dell's ability to invest in new products and services will be extremely limited. Leveraged buyouts tend to leave existing customers and innovation at the curb. We believe Dell's customers will now be eager to explore alternatives, and HP plans to take full advantage of that opportunity."

Speaking of tough road, HP itself does not seem to be in too good a position. Even after becoming the second largest PC maker, replacing Lenovo (OTCPK:LNVGF), the future of HP still seems rather hazy with PC sales dwindling and the mobile era moving in. A report by IDC says that global PC sales declined by 8.6% in the third quarter of 2012. In the United States alone, shipments declined by 12.4%. Senior IHS executive Craig Stice said:

"Now three quarters through the year, the usual boost from the back-to-school season appears to be a bust, and both AMD (AMD) and Intel's (INTC) third-quarter outlooks appear to be flat to down. Optimism has vanished and turned to doubt, and the industry is now training its sights on 2013 to deliver the hoped-for rebound. All this is setting the PC market up for its first annual decline since the dot-com bust year of 2001."

Looking at the revenue segments table below, it is safe to say that business is shrinking for HP (a bad sign!). PC sales declined by $588 million YoY and by $523 million QoQ. Total enterprise product sales declined to $12.9 billion in the last quarter, compared to $13.7 in the same period a year ago. HP has not yet been able to capture the enterprise software market. With a total of around $16 billion write-off charge on the acquisitions of Autonomy (cost $11.7 billion) last year and Electronic Data Systems (cost $13.25 billion) in 2008, it can be noted that HP has not made any substantial progress toward the cloud infrastructure industry unfortunately.


(Click to enlarge)

(In millions)

One thing to note here is that HP is not at all good at acquiring companies (another sign of bad management). This reiterates what Steve Jobs told Walter Isaacson (the author of the only official Steve Jobs biography):

"Hewlett and Packard built a great company, and they thought they left it in good hands," he said . "But now it's being dismembered and destroyed. It's tragic. I hope I've left a stronger legacy so that will never happen at Apple."

This also invalidates what Trip Chowdhry, Managing Director of Equity Research at Global Equities Research, wrote in an email to investors, "[The] recruiting engine at HP is very weak. HP can get talent only by acquiring smart companies." Without proper R&D or strategic acquisitions, HP's comeback seems to be an uphill task to me.

Nevertheless, HP is looking to resurrect its income statement in the form of tablet sales.

According to DigiTimes, the company wants to ship 40 million notebooks in 2013 - a 25% increase from 2012. This is to offset the 16.4% decrease in worldwide PC sales since last year. It must be noted though that mobile devices cost far lower than PCs and thus, it might take some time to replace the decline in PC sales for HP. And it has already made a move toward that, with introducing its first Android-based device, Slate 7. With competitive pricing at $169 per piece, it is supposed to give a strong play to Amazon's (AMZN) Kindle and Google's (GOOG) Nexus 7. Not to mention the new HP ElitePad 900, based on Microsoft's (MSFT) Windows 8 OS, to be launched very soon, HP is creating a broad base in the tablet market.

With HP being the only company to increase notebook shipments last year, we can only hope that Margaret Whitman knows what she is doing. Samsung's Nexus 10 and another Xbox from Microsoft are right on Slate 7's tail and that is just one factor that might affect HP's tablet sales outlook.

On the financial front, while Apple (AAPL) seems to be far ahead of others with gross margin of 43.87% and EBITDA margin of 37.39%, HP's operating and net margins are running in the negative. Even the gross margin of 22.95% is far lower than IBM's (IBM) 48.13% and Microsoft's 76.22%! With a huge total debt-to-equity ratio of 126.74 (just second to 176.4 of IBM) and strict current ratio of 1.09, the company might face liquidity crunch very soon unless revenue growth is revived in the coming few quarters.

On top of that, HP's expenditures toward research and development were $3.4 billion in fiscal 2012, $3.3 billion in fiscal 2011 and $3.0 billion in fiscal 2010. R&D is an important part of any big technological company. The increasing R&D expenditure shows that the company is putting in effort to better its products, thus positively affecting its future revenue growth. But, you need money to make investments, right?

With high capex ratio of around 70% and declining free cash flow since 2008, the company is not in a good state financially. With $11.3 billion still sitting on the balance sheet and $22 billion in debt, HP does not need to increase its dividend payment (which it increased by 10% last month, adding another $106 million a year in dividend expenses), but rather look upon the fundamentals of the business. Shareholders do not want income that is not going to sustain for the next one year or so.

And that showed in the sharp decline in stock price, just after the downgrade by Goldman Sachs (GS). Analyst Bill Shope cut his forecast on the broader PC sector, with unit shipments expected to come in weak during the first quarter this year. Before that, the price rose by 4% following the dividend increment report.

To sum it up, HP is in a difficult situation right now. Unless newer sources of revenue are channeled, the company might face liquidity crisis in the near future, further restricting its investment in research and development. Fundamentally speaking, HP is not a buy right now. We need to see new signs of hope before we plunge in.

Source: Hewlett-Packard Does Not Impress Me At All