Hewlett Packard's (NYSE:HPQ) shares are up nearly 50% since last October on the coattails of presumed business stability. The operating results from last week offered little encouragement. The best year over year revenue growth a division could muster up was 4% for Personal Systems. This business unit is roughly 30% of revenues and 11% of operating profits--based on Q1 results. The Printing division has always been the crown jewel of HP--that business (21% of company revs) was down 2% on the top line and the operating profit there represented a whopping 41% of company-wide profits. This is where the big problem lies in my opinion.
Many investors can hope and wish that the company will break itself up to enhance shareholder value. It is the best solution because HP has some serious legacy issues, along with some market trends that are going against them. Some legacy issues are:
- An "old line" tech company, HP has a bloated payroll and corporate administration model compared to today's emerging technology companies. As cruel as it sounds, the work-force has to be turned over to get the company to move faster and become more nimble. This is easier to achieve and organize if the company is split up and specialist CEOs can make the decisions necessary to go forward and run individual units competitively without having to "go to corporate".
- HP's business model for R&D relies on a stagnant percent of revenues model that can't compete with the plethora of upstarts in the market they compete in. Their R&D as a percent of revenue (and dollars) is dwarfed by that of IBM (NYSE:IBM), Cisco (NASDAQ:CSCO), etc. Why? Because a monopoly in printing allowed the company to enter other markets with mixed success and profitability--the printer business always saved the company from any mistakes it made along the way and there were plenty.
- I won't go into the perpetual corporate leadership fiasco--that's another article.
Market trends are now going against their crown jewel business-individuals are printing less. Ink prices for cartridges are at the point people would rather leave all their lights on in the house than print a draft document! All kidding aside, with tablet use skyrocketing, people are just printing less. Gone are the days of printing documents for daily commutes and long air flights--people are saving PDFs. Printing documents and pictures is becoming more of a special occasion--like say a calendar. They practically give away Deskjet Printers as loss leaders so you buy the ink.
I'm a big believer in observing the change in behavior of people and how these changes can impact companies and stock prices. It's easy to see why Amazon (NASDAQ:AMZN) is doing well--they change the way people, read, shop, host their online businesses, etc. Remember when people stopped using the Walkman, opting for music stored on hard drives and flash drives (iPods)?
HP's corporate profitability is so tied to the printer business, the company's future is at risk. True, the printer business has some very high-end printing applications that will continue to grow modestly and flourish, however, the majority of this business is seeing an unfavorable change in consumer/business behavior.
Until they undertake a massive restructuring and divest (spinoff) businesses, I suspect the company's struggles will only get worse. The stock is cheap on a P/E basis, but it is not growing and the profit margins are likely to continue their decline. This will put more pressure on the business model which is already heavy in SGA, dividends and share repurchases, at the detriment of more competitive R&D spending, capital expenditure and human capital models.
In summary--the company's priorities are wrong and the free cash flow contributed by the printing business is at great risk if they don't re-assess the other business and let them be independently run.