2 Problems With Hewlett-Packard's Turnaround

| About: HP Inc. (HPQ)

Hewlett-Packard's (NYSE:HPQ) turnaround remains intact. On Thursday afternoon, the company reported Q4 results that beat analyst estimates and own previous guidance:

· First quarter non-GAAP diluted net earnings per share of $0.90, up 10% from the prior-year period, versus the previously provided outlook of $0.82 to $0.86 per share

· First quarter GAAP diluted net earnings per share of $0.74, up 17% from the prior-year period, versus the previously provided outlook of $0.60 to $0.64 per share

· First quarter net revenue of $28.2 billion, down 1% from the prior-year period and flat on a constant currency basis

· First quarter cash flow from operations of $3.0 billion, up 17% from the prior-year period

· Returned $843 million to shareholders in the form of dividends and share repurchases in the first quarter

· Improved operating company net cash position by $1.6 billion, the eighth consecutive quarterly improvement of over $1 billion

But there are two problems with the company's turnaround: The first problem is that it is uneven, concentrated in two segments, Personal Systems and Enterprise Group. Other segments and most notably Enterprise Services and Software continued to decline:

  • Personal Systems revenue was up 4% year over year with a 3.3% operating margin. Commercial revenue increased 8% and Consumer revenue declined 3%. Total units were up 6% with Desktops units down 3% and Notebooks units up 5%.
  • Printing revenue was down 2% year over year with a 16.8% operating margin. Total hardware units were up 5% with Commercial hardware units up 6% and Consumer hardware units up 4%. Supplies revenue was down 3%.
  • Enterprise Group revenue was up 1% year over year with a 14.4% operating margin. Industry Standard Servers revenue was up 6%, Storage revenue was flat, Business Critical Systems revenue was down 25%, Networking revenue was up 4% and Technology Services revenue was down 4%.
  • Enterprise Services revenue was down 7% year over year with a 1% operating margin. Application and Business Services revenue was down 4%, and Infrastructure Technology Outsourcing revenue declined 9%.
  • Software revenue was down 4% year over year with a 15.8% operating margin. Support revenue was down 2%, license revenue was down 6%, professional services revenue was down 12% and software-as-a-service (SaaS) revenue was up 6%.
  • HP Financial Services revenue was down 9% year over year with a 6% decrease in net portfolio assets and an 18% increase in financing volume. The business delivered an operating margin of 11.6%.
  • Corporate Investments revenue increased due to the sale of a portfolio of mobile computing intellectual property.

The second problem is a decline in operating margins, suggesting that the company continues to compete on prices rather on innovation, an unsustainable strategy. Hewlett-Packard's margins remain less than half of that of IBM (see tables).

Key Statistics as of February 21, 2014


Forward PE

Operating Margins (TTM)

Qtrly Revenue Growth (yoy)

Qtrly Earnings Growth (yoy)











Source: Yahoo.Finance.com

Key Statistics as of February 21, 2013


Forward PE

Operating Margins

Qtrly Revenue Growth (yoy)

Qtrly Earnings Growth (yoy)











Source: Yahoo.Finance.com

Hewlett-Packard has been hurt by a number of strategic mistakes that wasted the company's resources and talent. In 2001, Hewlett-Packard made the first strategic mistake, the purchase of Compaq Computer that was supposed to provide the company with the scale advantage in the PC market to compete effectively against Dell (NASDAQ:DELL), International Business Machines (NYSE:IBM) and all sorts of emerging Asian competitors. The problem, however, is that the PC market was already saturated and ravaged by price wars, as the PC was turning into a "commodity." Besides, Compaq Computer itself didn't have an internal innovation system, but it relied on external acquisitions to expand its product portfolio (buying up Tandem Computer, and Digital Equipment Corporation).

In April 2010, Hewlett-Packard made the second strategic mistake, the purchase of near-bankrupt Palm that was supposed to help the company enter the fast growing market for mobile devices that began to replace PCs. The problem, however, was that Hewlett-Packard was a follower rather than a leader in this market, going against Apple that enjoyed the first-mover advantage in this market.

Two years ago, Hewlett-Packard made the third mistake, announcing the acquisition of enterprise software maker Autonomy (at a hefty price of $10.3 billion), as this move will pit the company against three major competitors, Salesforce.com (NYSE:CRM), Oracle (NYSE:ORCL), and IBM.

What does it mean for investors? Is it time to buy or sell?

It depends on the investment horizon of individual investors. Short-term oriented investors may want to take profits at this point, as the stock had a big run-up from its lows. Long-term investors may want to wait and see whether Hewlett-Packard solves these three strategic problems returning to its innovation trait.

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.

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