For many companies, their CEO is one of, if not the most important asset. Would Apple (AAPL) be the company it is today without the vision of Steve Jobs? Would Disney (DIS) have become the media icon it is without Wal Disney? The quality of a CEO is important in all sectors, but especially in technology. That is because it is perhaps the most fluid and dynamic sector of the economy, where a company's position and place in the market can change rapidly.
HP (HPQ) has been a company that has been seemingly adrift for some time. A revolving door of CEO's, perhaps the worst board of directors in the industry, and an unclear and uncohesive strategy. It is unsurprising that HP has lost more than 50% of its value in the past 5 years.
But with Meg Whitman in the corner office, can HP turn things around? We think so. Too often, we hear that HP is no longer relevant, that thanks to Apple, the company has no future. We see things differently, even with Apple being our largest individual equity holding. HP and Apple compete in personal computing, an area that represented 31.1% of HP's business in fiscal 2011, compared to 34.9% in fiscal 2007. HP's future will not be driven by the PC market, but by overall trends in the technology industry, such as the cloud, data management, and services.
HP may have lost its standing as a true leader in the technology industry, but it is far too early to count it out. HP posted revenues of $127.245 billion and EPS of $3.32 in fiscal 2011, and has grown revenue by 4.06% and earnings per share by 4.06% annually over the past 5 fiscal years. While that is not the kind of growth people usually see in the technology sector, it makes HP a deep value stock, trading at a P/E ratio of just 8.64 as of this writing.
The question on everyone's mind is can HP recover? Can the company that was one of the founders of America's technology sector recapture its former standing? With Meg Whitman at the helm, it is a distinct possibility. It is important not to cast this as an HP vs. Apple story. While the two companies may be competitors in computing, success at Apple does not have to translate into failure at HP, or vice versa.
Meg Whitman was appointed CEO of HP in September 2011, and since then has been working hard to make her mark on the company. And that is why we our focusing this article not on HP's products, or its technological prowess (or to some, a lack thereof). Without a capable CEO, none of those things matter. And from what we have seen so far, Meg Whitman is a capable CEO. Under her tenure at eBay (EBAY), the stock rose nearly 1,600%, trouncing the major indices.
(click to enlarge)Whitman guided eBay through the dot-com bubble, and helped build the company into a major force in the e-commerce sector. And we think she can turn HP around, and we delve into our thesis below.
Employees or Shareholders: Whom to Please?
It is exceedingly rare to see a CEO respected and lauded by both employees and shareholders. Rare exceptions include Steve Jobs at Apple and James Sinegal at Costco (COST). And HP's CEO's have historically been unable to balance these 2 camps. Mark Hurd was admired by Wall Street for his steady management and rebuilding after the tenure of Carly Fiorina, but was generally reviled by employees for his incessant cost-cutting and failure to bring true innovation to HP. Morale plunged under his leadership and employees were unhappy. And Leo Apotheker was loved by neither shareholders or employees.
Meg Whitman, however, seems to have had a better reception with employees, and in the short and medium-term, that matters more than the how Wall Street sees the company. Ever since Mark Hurd was ousted from the corner office, HP has effectively lost the trust of the investment community. Once lost, that trust is hard to rebuild. Meg Whitman will not be able to earn that trust in 8 months, or even a year. It will take at least 2, with tangible results, both financial and operational, for her to regain the confidence of institutional investors and Wall Street.
For now, how Whitman is perceived by employees matters more. The best companies, in both the technology sector and in the broader economy, are those with happy employees. Google (GOOG) is a prime example. It treats employees like royalty, and they work hard for their company. Apple may be a fierce place to work, but every employee takes great pride in being able to say that they work for Apple. Under Mark Hurd, however, HP's employee morale sank. And under Leo Apotheker, employees despised their CEO. Both morale and respect for the CEO are vital to the success of any company.
Under Meg Whitman, indicators are pointing to a turnaround in both. Whtiman has done away with a good deal of the bureaucracy that has been suffocating HP. She has set up a "Bureaucracy Busters" email account where employees can send their concerns. HP's top executives, from Whitman on down, now work in cubicles alongside rank and file employees. She has removed the gated, private parking spaces that have long been reserved for executives, and were fenced off with barbed wire. Whitman has also gone on long tours of HP's offices across the world, not holing herself up in Palo Alto. Employees see her as down-to-earth, and she eats in the company cafeteria, despite an estimated net worth of $1.4 billion.
Employees who respect their CEO's and see them as dedicated to turning the company around are much more likely to want to work to restore the company.
27,000 Layoffs: A Cause for Concern?
Given that much of our bullish thesis is predicated on the credibility Meg Whitman has won with employees, HP's announcement that 27,000 employees will be leaving the company may seem to put a dent in that. That 27,000 headcount reduction amounts to about 8% of HP's global workforce. The majority of those cuts, however, will be made via early retirement offers, and not outright firings, and that is likely to soften their impact on the employee base. That is why HP is set to record pre-tax charges of $2.5 billion through fiscal 2014 ($1.7 billion in fiscal 2012 and $1.8 billion in the remaining years). The savings from these early retirements will amount to $3.0-$3.5 billion annually by fiscal 2014. The key is what HP will do with those savings, and that is where Meg Whitman differs from Mark Hurd.
Under Mark Hurd, those cuts would have been simply applied to the bottom line, which may be good for HP's earnings in the short-term, but damages the company in the long-term. Meg Whitman, however, will use these savings to boost R&D spending across its various business divisions, and invest in its sales process to make buying from HP an easier task. That is what HP needs to succeed in the long-term. Simply gutting costs does nothing for HP in the long-term. Whitman seems to realize that, and while it is early in the restructuring process, HP is on the right track.
PC's: Fading Relevance and the Apple Effect
The majority of consumers (and a fair amount of investors) see HP only as a PC company, and therefore a company that will succumb to the tablet future, meaning Apple. We do not think that this is the right argument to be having. Why? Because Apple has already won. The PC business has become a commoditized, low-margin business, and HP is not the only company affected by this. HP plays in the PC market not to claim that it is the dominant personal computing company (we all know who is), but so that it can apply the supply chain leverage it receives in its other business lines. HP's Personal Systems Group exists to support the rest of HP. The fact that it is profitable is an added bonus. In the first 2 quarters of fiscal 2012, the PSG had revenues of $18.325 billion, or 30.18% of HP's total revenue. But thanks to its 5.39% operating margin, the PSG was responsible for 16.38% of HP's operating income in the first 2 quarters of fiscal 2012. HP's future will not be won or lost in personal computing, but in areas like services, storage, and networking. Thanks to the Mac, the iPad, and the effects of commoditization, personal computing has become a low-margin business for most traditional PC players.
As long as HP can extract at least some profit from the PSG, the group is serving its purpose. Worries over Apple's effect on HP are overblown, mostly because those worries have already come to fruition. And Apple and HP do not compete in most business lines. Apple does not play in the storage market. HP does. Apple does not play in the printing and imaging markets. HP does. Apple does not play in the services market. HP does. Saying that Apple will be responsible for bringing HP to its knees is like arguing that because Allstate (ALL) can beat Geico, Berkshire Hathaway will fail (the comparison is apt because Geico is perhaps the most visible business line of Berkshire, just as PC's are HP's most visible product). Geico is but one part of Berkshire's business, just as PC's are but one part of HP's business.
Too many Apple investors bristle at seeing anything negative being said about Apple. What we are saying is that is important to know that Apple has already won the personal computing market, and that Apple is not a negative for HP. It is impossible to expect every computer in the world to be replaced by an iPad. When it comes to profitability, Apple is the clear victor, just as it is in the smartphone space. Apple does not compete to win marketshare. It competes to win profit share, which is what matters. And on that front, Apple has won, in both smartphones and personal computing.
We think it is too early to count HP out. The company is trying valiantly to regain its stature as a leader in the technology industry, and Meg Whitman is winning the respect of her employees, which is vital to the success of any restructuring. Whitman has shown that she will not simply cut costs. She has shown that she is willing to invest in HP's future, and learn all that she can about the company. HP's turnaround will take time, but we believe that the it can be accomplished, and think that at these levels HP's stock reflects a far too bearish opinion on the company.
Additional disclosure: We are long shares of HPQ and DIS via the SPDR Dow Jones Industrial Average ETF. We are long shares of GOOG via a mutual fund that gives the company a weighting of 2.1%.