HP Server Sales Shoot For The Moon

Apr.23.13 | About: HP Inc. (HPQ)

Is the Moonshot a Shot in the Arm for HPQ?

Hewlett-Packard (NYSE:HPQ) is the largest PC maker shipping just shy of 1.2 million units in the first quarter of 2013 and has a market capitalization of approximately $38 billion. Though it might not be all that impressive to be the largest PC maker as that particular industry has been dealing with a steep decrease in sales. In the 1st quarter of 2013 PC sales were down by almost 14% and the International Data Corporation (IDC) has modified its forecast for the 2nd quarter from -7% to -10%. HPQ did worse than the overall market and saw PC sales drop almost 24% over last year.

HPQ's valuation is low on almost all metrics; Price/Book is 1.3, Price/Sales is .32, and Price to Earnings is 4.81 for the trailing 12 months. This is incredibly cheap for HPQ with a 5-year P/E average of 11.62, almost half price for this stock. The market is punishing this stock for the perception that it's headed toward sustained negative growth and with sales dropping faster than the overall market this may be an accurate forecast. Reviewing the latest 10-Q one can see the only segment of the company that saw growth over last year is the printing segment. The printing segment showed excellent growth with earnings from operations up 25% over last year but not enough to make up for the 50% reduction in earnings from the personal systems segment and the 20% drop in the enterprise segment, the two largest segments of the company.

The newest server product from HP is the Moonshot system, a product aimed squarely at the new and extremely fast growing sub-set of the server market: the microserver segment. The Moonshot is specifically designed to consume almost 90% less energy, take up 80% less space and cost more than 20% less than traditional servers. The Moonshot system and the microserver market in general are trying to address the incredible amount of server resources needed to serve the billions of mobile devices being connected onto the internet. The growth of cloud computing, the use of social media, and the mobile explosion are changing the requirements of data centers. These computing tasks require very little in terms of computing power so chips commonly seen in smartphones can be used effectively to manage these workloads. The Moonshot system can support up to 1800 servers in each rack and utilizes the Intel (NASDAQ:INTC) Atom 1200 processor, which is the world's first low-power 64-bit server class system on a chip for high-density microservers. This allows the system to take up 1/8 the physical space and greatly reduce the energy use for the product.

The real question is; can this new product add badly needed revenue to HPQ? The microserver market is growing at an astounding 60% CAGR and is estimated to reach 1.2 million units by 2016, according to IHS iSuppli Research from February 2013. If HPQ, through its first mover status with the Moonshot system, could garner a large market share in this sub-set it could be what is needed to turnaround revenues in the enterprise segment. The CEO, Meg Whitman, is hoping the Moonshot system is just the item to jump start the turnaround for the company. With a potential market of 1.2 million units by 2016 and a price of almost $62,000 a piece (Whitman Blog) even at HPQ 22% profit margin a third of the market could add $5 billion in gross profit for the company. If Moonshot truly has the potential to earn that kind of profits for HPQ it would practically double earnings from its enterprise group. Of course competition is coming quickly on HPQ's heels in this segment but the potential is amazing for HPQ and seems to answer the question at the beginning of this paragraph. Yes, Moonshot can add badly needed revenue to HPQ.

The PC market is expected to stabilize by the end of the year which, as the largest segment of HPQ, is absolutely necessary for HPQ to recover. The IDC is predicting mild growth in PCs for 2014 and into the future mostly on the demand from emerging markets. The 10-Q shows the weakness in revenue for the personal systems segment is in the notebook market. The other markets for desktops, workstations, and other all show mild growth when compared to last year. HPQ had sales drop by almost 24% while Lenovo (OTCPK:LNVGY), the second largest PC maker had flat sales and Dell (NASDAQ:DELL), the third largest, only lost about 11%. HPQ's performance in sales of PCs is dramatically worse than the next two largest PC makers. The concern I have is a 10% drop in revenue equated to a 50% drop in earnings from the segment. The gross margins for HPQ are extremely low when compared to its peer group. For this company to recover it needs to both find ways to grow new revenue and reduce its cost structure to allow for a healthier gross margin.

HPQ already has a dominate position in the server market with almost 25% market share and leading the charge into the microserver segment might just be the shot in the arm HPQ needs to start growing revenues and help catch International Business Machines (NYSE:IBM) in server sales. The microserver market is small today, estimated at fewer than 300,000 units but is expected to reach 600,000 units in 2014. This is an excellent market to enter for HPQ with its extreme growth rate. If HPQ can successfully serve this market it begins to show the company is capable of developing excellent products that meet an industry need. HPQ has been suffering from mismanagement and this new product could be the symbol for the beginning of a turnaround story. I am personally not convinced yet and will wait on the sidelines for a little while longer. With this new product just rolling out and the PC market expected to drop another 10% next quarter I think we have time to watch the story unfold and judge the company on how well it executes its new strategy. But I am now very interested in the company. I have always enjoyed finding value companies and the 50% off of HPQ's 5-year average for P/E is very attractive to me. The story for me will be how HPQ can modify the structure of the company and take control of the supply chain to allow them to grow the profit margin. It appears the competitors have more than double the gross profit margin of HPQ; this is a major issue for the company.

Disclosure: I am long INTC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.