Hewlett-Packard (HPQ) has led the market news in the past two days with several radical announcements. Following HPQ’s Q2 results, the company also announced that that it would abandon WebOS development, potentially sell off its PC division, and has made an offer to acquire British software maker Autonomy.
Although there has been speculation for several months that HPQ would be making a large software acquisition, the other two pieces of news have largely hit the market by surprise. Upon further review of HPQ’s new direction, the crucial question is whether its large share price drop and new direction is the recipe for a huge value play -- or if HPQ is simply another value trap in the making.
Spin-Off of PC Division
Hewlett-Packard used to be the number one PC maker in the world, a distinction now reserved for Chinese PC maker Lenovo. However, even though its number one status has not been retained, HPQ’s Personal Systems Group (PSG) is still a huge revenue machine (albeit low-margin). In the past 6 months, PSG has produced over $19 billion in revenues and $1.1 billion in profit (a 5.8% profit margin). Although this is a low-profit-margin business, the revenue and profit streams have been steady, and represent the legacy of HPQ.
There are currently no listed buyers for the PSG unit; however, Lenovo (LNVGF.PK) is a likely candidate. Whether or not this deal is accretive to HPQ in the long run will be determined by the multiple that HPQ can receive for this division, as well as the efficiency of the planned acquisition of software maker Autonomy.
During the previous 6 months, HPQ’s software division only accounted for $1.5 billion in revenue, yet still managed to earn over $300 million in profit (20% profit margin). Since software is currently earning 4x the margins of the PSG, it is not surprising that this is the company’s focus. However, with an asking price for Autonomy of $10.3 billion, HPQ is spending a revenue multiple of 11.8x (Autonomy’s 2010 revenues were $870 million), which represents cloud bubble valuations.
On the upside, Autonomy is wildly profitable with operating margins of over 40%, and has rapid revenue growth over the past 5 years. Regardless of what Autonomy has done so far, with HPQ’s offering price, it is obvious that CEO Leo Apotheker thinks he can dramatically increase the business. With a strong competitive market that includes Salesforce.com (CRM) and Oracle (ORCL), this new direction will not be easy. The question is whether or not Apotheker has the skills and patience to pull this off.
Cancellation of WebOS
Although Hurd’s $2 billion purchase of financially struggling Palm gave HPQ a quick entry point into the mobile devices market, the short-term failure of WebOS is not entirely surprising. With the mobile market dominated by the iPhone and Android and a tablet market dominated by the iPad, HPQ needed to spend immense development and marketing in any realistic attempt to gain meaningful market share. The surprising factor to the WebOS announcement is how quickly HPQ gave up on their product. Similar to the Microsoft Kin flop of 2009, it appears that HPQ didn’t even give its WebOS tablet a chance on the market. This quick retraction over what seemed to be obvious headwinds leads investors to wonder if Hewlett-Packard still has any sort of managerial sense of direction. The only logical reason for HPQ’s quick exit of WebOS is for Apotheker to quickly distance himself from former CEO Mark Hurd’s acquisition, rather than take a fall of inept management.
HPQ was once the worldwide leader in PC sales, then transitioned into a multifaceted tech company supported by high printer margins, and now appears to have lost its sense of direction. Apotheker has stated before that wants to take his company down a new road of software development and enterprise services; the questions are whether or not HPQ will remain disciplined in their acquisitions, and whether or not the new businesses will be managed effectively.
Value Play or Value Trap?
HPQ is trading early in the markets following these announcements at under 5x P/E. However, there is a large overhang regarding future performance. I recently wrote a valuation piece on HPQ, and everything that I published two weeks ago (Aug. 9) regarding valuation metrics have only improved. I mentioned WebOS as a potential upside catalyst, but I’d rather see the cord cut sooner than later if the end result would be market failure. I believe that the value upside makes HPQ a strong value play at today’s prices.
Disclosure: I am long HPQ.