Hewlett Packard, Microsoft Join Forces To Build A Bigger, Better Cloud

Includes: HPQ, MSFT
by: Robert Weinstein

Shares of both Microsoft (NASDAQ:MSFT) and Hewlett Packard (NYSE:HPQ) are moving higher today in part due to a new four year contract agreement made by the two titan technology companies. Microsoft develops, licenses and supports a range of software products and services for various computing devices worldwide. Hewlett Packard offers various products, technologies, software, solutions and services to individual consumers and small- and medium-sized businesses (SMBs), as well as to the government, health and education sectors worldwide.

The focus of the new contract is to work cooperatively allowing public and private cloud computing services on a worldwide basis. HP is expected to resell the new Microsoft Office 365 enterprise level software-as-a-service product that includes Microsoft Exchange, SharePoint and the newly renamed Office Communications Server “Lync."

Working with HP is a great step for Microsoft into the white hot cloud computing space. With HP’s wide global sales channel and renewed efforts by both companies we may start to see both top line and bottom line number improvement in 2012. After the last joint effort by HP and Microsoft left investors waiting high and dry for real sales, the new contract will likely build on the past mistakes and inaction.

"This alliance with HP not only broadens Microsoft's geographic reach, it gives customers maximum flexibility to choose a cloud computing solution that meets their organization's specialized messaging and collaboration needs," said Mark Hill, vice president, Enterprise Partner Group, Microsoft, in a statement.

I have been bullish on both Microsoft and Hewlett Packard for some time now. To read my articles on Microsoft please click here and of Hewlett Packard please click here. While Google (NASDAQ:GOOG) is certainly giving Microsoft a run for the money while becoming sexier to own, Microsoft has been discounted to the point of becoming a true value buy without all the usual cracks in the armor most value buys include. The last 12 months of earnings gives Microsoft a PE of less than 10. Who in the free world hasn’t heard and know the name “Microsoft?" As a result, Wall Street may have discounted the company, but Main Street hasn’t discounted the brand at all. I am not suggesting selling Google for Microsoft as I am bullish with Google as well. In fact, I am looking at pair trading through a multi-leg option straddle with Google and Bidu (NASDAQ:BIDU), because I believe Google enters into China once again in 2012.

Microsoft also faces a continuing open source threat which will likely get worse, not better. But again, I believe it’s fully priced in to the point Microsoft needs to be looked at.

Hewlett Packard is already a core holding for my accounts and the latest move confirms the path is being set to direct Hewlett Packard for continued growth in terms of market share and revenue. Like Microsoft, Hewlett Packard’s PE is less than double digits with a Black Friday after Thanksgiving Day sale price of only 8.5 PE. For true investors who are not day trading looking for value buys, it simply doesn’t get much better. Hewlett Packard pays a 1.7% dividend so an investor can get paid to sit on the shares and Microsoft pays over a 3% dividend. What is scary (and part of the reason for the huge discount in price) is the massive volatility of Hewlett Packard stock. While not nearly as bad, Microsoft investors have had to fasten their seat belts. Fortunately there is a way to invest in both and to do so with lower volatility, lower risk and just as important, lower number of sleepless nights.

By using a covered call strategy, an investor can collect the dividend, lower the cost basis for the total investment, and still be able to capture a very respectable gain as a yearly return if the prices of the stocks really move higher quickly. Microsoft is currently trading near $25.75 per share and April 2012 call options with a strike price of $27 are trading for about $0.93 each. With a call write of Microsoft the cost basis is lowered to about $24.83. While we don’t know what the next dividend with Microsoft will be, if any, based on the last dividend of $0.20, if received would further reduce the cost basis to about $24.63. If Microsoft moves higher to above the call option strike price of $27 the return on investment is about 9.6% for about four months, an annualized return of over 28% (although I don’t recommend annualizing possible returns this way). If Microsoft stock price remains the same at $25.75 when the option expires the annualized rate of return is still a very respectable 13%. The best part is the risk management, as Microsoft will have to fall below $24.63 before an investment valuation loss will be felt. Managing risk is job number one with investing.

Using the same theory with Hewlett Packard we see the stock currently trading near $28.30 per share. May 2012 call options with a strike price of $30 per share are trading for about $2.25. If we use the same call write strategy as with Microsoft we are able to bring our cost basis down to $26.05. Hewlett Packard also pays a dividend, and in this case we do know if we buy the stock today, on Friday, December 9, 2011, but not on Monday or after for this current dividend, we will receive $0.12. If we also add in expected dividends of $0.12 in March 2012 we further lower our cost basis down to about $25.81. If Hewlett Packard moves higher beyond our call option strike price of $30, we will have a gain of about 16.2% for about five months, an annualized return of about 40% (again, I don’t recommend annualizing possible returns this way). If Hewlett Packard stock remains at $28.30 per share at the expiration of the option, the return will be an annualized return of over 22%.

If you would like to learn more about options and writing call options please see my article on the subject.

Please feel free to share your thoughts and comments.

I use a proprietary blend of technical analysis, financial crowd behavior and fundamentals in my short-term trades, and while not totally the same in longer swing trades to investments, the concepts used are similar. You may want to use this article as a starting point of your own research with your financial planner. I use Seeking Alpha, Edgar Online and Yahoo Finance for most of my data. I use the "confirmed" symbols from earnings.com that I believe to be of the most interest.

Disclosure: I am long HPQ.