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When Hewlett-Packard (HPQ) announced its decision to reduce its payroll by 27,000, markets rejoiced, sending its shares higher. That came on top of Hewlett-Packard reporting that it had exceeded market expectations on earnings, unlike fellow Technology bellwethers Dell (DELL) and Cisco Systems (CSCO), which continued to warn of challenges ahead.

Despite the obvious human factor involved, Hewlett-Packard's move to trim its workforce was, to quote its Chief Executive Meg Whitman: "highly critical." Indeed, Hewlett-Packard expects that it will save anywhere from $3 billion to $3.5 billion through the end of 2014. That's equivalent to a cost savings of $1 billion a year - or $1.51 per share.

It's really not that surprising that Hewlett-Packard resorted to the move. Technology spending is expected to rise by 5% this year - but the drivers for growth are expected to be mobile devices, networking equipment and data storage.

Of the three areas, Hewlett-Packard has a respectable presence in two: networking and data storage, which account for 17% of its revenues. Regardless, it doesn't face smooth sailing in either area.

On the storage front, it faces challenges from storage leaders such as NetApp (NTAP) and EMC, which are heavily investing in high-speed, flash-based storage solutions - investments that it may not be able to match given its current cost-cutting and restructuring plans.

Meanwhile, its rival in the networking space, Cisco, warned the fragile economic environment in the U.S. continued to weigh on its earnings, despite moves it had made in the past to streamline costs and re-focus the company.

The biggest challenge for Hewlett-Packard, of course, is in the Personal Computer (PC) space, where it is currently the leader ahead of rivals like Apple (AAPL), Dell and Lenovo (OTCPK:LNVGY). It actually saw its revenues from PCs rise by 6.5% in its fiscal 2nd Quarter, as it shipped new lines of slim, premium notebooks marketed as "Ultrabooks" and "Sleekbooks" that were designed to challenge Apple's popular MacBook Pro and MacBook Air products.

Hewlett-Packard's problem in the PC space, which constitutes 31% of its revenues, is that it isn't well positioned in its growth segment: Tablets. Tablet PC shipments are expected to exceed that of traditional PC shipments by 2013. Unfortunately, Hewlett-Packard's travails in the Tablet market have been well documented: it wrote-off its investment in Palm and WebOS (which also doubled as its bet in the Smartphone market) to the tune of $3.3 billion in late 2011 and conducted a $99 fire sale on its WebOS-powered TouchPad tablets.

It hasn't quite recovered from that debacle, despite the fact that it has given every indication that it intends to ship Tablets running Microsoft's (MSFT) Windows RT to users this year and focus its Tablet efforts on the underserved Enterprise space. The major worry for Hewlett-Packard is that it may have backed the wrong horse - at least for now - Windows RT tablets are expected to constitute just 7.5% of the Tablet market by 2017.

In any case, there's good news for Hewlett-Packard in the near-term: the combination of the attractive form factor of Ultrabooks and Windows 8 is expected to drive strong PC sales in the second half of this year and the whole of next year.

Clearly, despite the short-term fillip from PCs, Hewlett-Packard faces a tough environment ahead. In such an environment, large organizations like it attempt to drive earnings through the reduction of operating leverage, which is what its payroll cuts were intended to do.

It looks like it may need to do more than that.

For starters, Hewlett-Packard keeps a little too much of its liquidity in its inventories. Its already-dicey Current Ratio of 1.1 when stripped of inventories yields a Quick Ratio of 0.6 - that means that 45% of Hewlett-Packard's current assets are in hard-to-liquidate inventories.

Contrast that with the superior supply chain management of its rival PC manufacturer, Dell. Dell's Current Ratio is 1.3 but its Quick Ratio remains high at 1.1 - meaning that just 15% of its Current Assets are in hard-to-liquidate inventories. Hewlett-Packard has nearly 5 times as much cash invested in inventory than Dell does.

Other than slimming its inventories, Hewlett-Packard could opt to alleviate liquidity pressure and buttress its cash by cutting its dividend, which yields a generous 2.4%, compared to the technology industry's 1.5%. That would be in line with Meg Whitman's recent moves, given that she's already slashed payrolls and laid out a reorganization plan.

That said, while moves that reduce corporate fat tend to play well with investors, cutting dividends usually does not - and considering that Hewlett Packard is on its 4th CEO in 7 years, Whitman might be loathe to pull the trigger.

To the extent that Hewlett-Packard is unable to free-up liquidity, it also won't be able to pay down its long-term debt of close to $22 billion - which is a drag on performance; more debt means more interest expense. In fact, its Interest Coverage Ratio of 10.6 compares very poorly to the PC Industry's 36.9.

Of course, that doesn't mean that Hewlett-Packard is tight - far from it - what it does mean is that it isn't in a strong position to invest meaningfully in growth technologies like Flash storage that could help it drive up its revenues and help it compete against EMC and NetApp.

Conclusion

With the tough environment ahead, Hewlett Packard's layoffs are probably only a small portion of Meg Whitman's playbook to streamline and re-focus the venerable technology giant.

She might, for example, follow-through on former CEO Caroline Bartz's strategy of diving more meaningfully into services, which now account for 29% of revenues. Alternatively, she could pursue a spin-off of Hewlett-Packard's valuable but stagnant Printers and Imaging divisions - although that might face a challenge from its Board considering how closely associated its ubiquitous printers are with its brand.

Whatever the case, it's clear that there's a lot that Hewlett-Packard will have to do in order to regain the market's favor. Currently, its Price-Earnings Ratio of 7.6x earnings is less than half the Technology Sector's 18.6x - and also the S&P500's 21x.

Yet even at those ratios, I don't find Hewlett Packard compellingly cheap to warrant a value play because there's just so much uncertainty on how deep or effective its cost-cutting efforts will be or where its future growth will come from.

Consequently, I see its shares falling by another 20% to 30% from current levels.

Source: HP Could Tumble 20-30%