Hewlett-Packard (HPQ) has been making headlines on Wall Street recently. The company was among three companies removed and replaced from Dow Jones industrial Average in the biggest revision to the index since 2004. Though this outcast may be ignored by investors, as the index is calculated based on the price weight mechanism, thus the higher the price of the stock the larger the weight of the company.
HP has been reviving its fortunes through its turnaround initiatives, but a slump in the PC market has adversely affected the company's top line. Last year was among the toughest years, with HP reporting a $12.65 billion net loss mainly because of the $8.8 billion write down of its acquired database search and enterprise software company Autonomy. This year wasn't the brightest either, with the company reporting an 8.2% year-over-year revenue decline in third quarter ending July 31, due to the PC market slowdown. The company is restructuring its business to consolidate this declining revenue.
Is there a way out?
Personal computers, or PCs, are the biggest revenue contributor of HP, with 28% share in total revenue in the third quarter ending July 31. The company is facing headwinds from a contracting PC market, with worldwide PC shipments declining 11.4% year over year in the second quarter of this year, as per IDC. This fall in demand was because of growth in tablet sales, which are devastating the PC market.
As per IDC's first-quarter report ending March 31, HP was the PC market leader, but in the second quarter ending June 30, HP lost its leadership position to Lenovo (OTCPK:LNVGY) and Dell (DELL) is also catching up. Lenovo had 16.7% market share in the second quarter, compared with HP's 16.4%, and Dell commanded 12.2% market share. Both HP and Dell were amongst the most affected companies, with HP's world PC shipments declining 7.7% year over year and Dell's world PC shipments reducing 4.2% year over year in the second quarter.
This decline is expected to continue this year. Worldwide PC shipments are expected to shrink from 349.2 million in 2012, to 315.4 million in 2013. If we assume that HP maintains an average similar to the first two quarters of this year's market share of 16.05%, then its 2013 PC shipments will be 50.62 million, down from 58.11 million in 2012.
Looking at the slump in the PC market, HP announced its restructuring initiatives last year, which focus on reducing the company's cost structure by reducing its workforce by 29,000 by the end of fiscal year 2014, thus saving $3.5 billion in employee cost annually. The company has laid off 22,700 as of July 31, 2013, and it plans to eliminate the rest of the jobs by the end of its fiscal year 2014.
Under the leadership of Meg Whitman, the company is revitalizing its future prospects. As per her recent interview with CNBC, HP could again enter the acquisition arena utilizing its $1.5 billion in cash reserves for deals ranging from $100 million to $300 million. The company hasn't made any significant acquisition since the first quarter of 2012, and with its $1.5 billion cash utilization for acquisition, the company is expected to benefit from possible synergies from these deals. During the interview Meg Whitman stated:
Acquisitions will become part of our future, to further some of our strategic initiatives and shore up some of the product holes.
Dell, another important player in the market, has been trying to take the company private as an important initiative for laying the foundation of restructuring. Although the intent to make it private was announced earlier by Michael Dell, Chairman and CEO, the approval from shareholders was received only recently. On September 12, 2013, Dell announced the $25 billion buyout to make the company private. This will end the company's 25-year public history. Dell established itself as a PC maker, but its focus has shifted towards enterprise solutions, which include servers and networking. This is evident from the company's $13 billion spend on 20 acquisitions made in the enterprise computing business since 2009. Going private will speed up the strategy implementation.
The declining PC market is affecting Dell, but with the private label tag, the company will have more freedom to implement initiatives for offsetting this negative impact. This will help its flexibility of resource deployment for its forward-looking strategy with less regulatory hurdles.
An initiative for technological upgradation
In July this year, HP announced that it will launch a transition program for its commercial clients to upgrade their operating systems from Windows XP to the latest available version, i.e. Windows 7 and 8. This program comes in line with the announcement from Microsoft (MSFT) to end its support service for Windows XP by April 2014. As per an HP survey, 40% of business customers have not yet deployed a Windows XP alternative operating system. Therefore, looking at the upgrade requirement, HP will use its enterprise services for designing and implementing this migration plan for businesses.
In addition to this, HP is offering financial incentives to business clients for this upgrade. Organizations can now take advantage of the company's financial services program, which includes a deferred payment option for up to 90 days or 1% cash back on required payment for this upgrade. This program will increase customer loyalty, as customers can upgrade their outdated operating system with ease. As per Lisa Baker, director of worldwide business PC marketing at HP:
Specific benefits for businesses by transitioning from Windows XP include cutting lost productivity costs per PC in half, reducing technical support needs by up to 70 percent per PC, and saving $700 annually per user from reduced support costs and power usage.
HP's commercial segment in PC had performed much better with revenue declining 3% year over year in the third quarter ending July 31, as compared with the consumer segment's revenue decline of 22% year over year. Therefore, it is important for the company to maintain customer support for its products in the declining PC market.
As one of the biggest PC manufacturers, HP has been an important customer for Microsoft. Both the companies have been working together to pool their respective expertise in delivering enhanced customer offerings. Microsoft, a market leader in PC operating systems, is also feeling the effects of the PC market decline. To offset this fall, the company had been focusing on growth in Windows 8 enabled smartphones, touch enabled notebooks, and tablets. It considers the acquisition of Nokia's (NOK) mobile division an important step. This smartphone hardware and software collaboration will help Microsoft achieve top line growth from the growing smartphone market. This growth is expected to come from expanding Nokia's smartphone portfolio with the latest technological requirements. Windows 8 has taken the third position in the smartphone operating system market, and with growth in Nokia smartphones sales, which had increased 73.2% year over year in the second quarter, Microsoft can expect its operating system to compete with Android and iOS.
The fall in the PC market is expected to continue, thus affecting HP's top line. Therefore, it is important for the company to implement initiatives to offset this negative impact. Restructuring is an important part of this initiative for reducing the cost base. Although the company started implementing these restructuring drives last year, the fall of its biggest revenue contributor has hurt the company's top line.
The company has a Price Earning Growth ratio of 9.21 for the upcoming five years, compared with Dell's 2.43. This denotes that HP is overvalued with low earnings growth in the future as compared with stock price appreciation. Therefore, it is important for the investors to take notice of this metric before investing. The company is restructuring, and it will take time to see any significant impact of these initiatives in the future. Therefore, we would recommend holding this stock, as the PC sales are expected to further impact the company's top line in the future.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
Additional disclosure: Fusion Research is a team of equity analysts. This article was written by Rohit Gupta, one of our research analysts. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.