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Hewlett-Packard (NYSE:HPQ) has not done any such write-off, but apparently the market is treating it as if it has written off its Personal Systems Group, Imaging and Printers segments. These segments have combined revenue of $65 Billion (half of HP's revenue). Let's take a closer look.

The following table shows HP's segment revenue and income from operations, based upon the latest 10K filing (Note 19: Segment Information):

Net Revenue

Operating Income

2011

2010

2009

2011

2010

2009

Personal Systems Group

39574

40741

35305

2350

2032

1661

Services

35954

35529

35380

5149

5661

5102

Imaging & Printers

25783

25764

24011

3973

4412

4310

Enterprise SSN

22241

20356

16121

3026

2825

1657

Software

3217

2729

2655

698

782

731

Financial Services

3596

3047

2673

348

281

206

Corp Investments

322

346

191

-1616

-366

-300

Total

130687

128512

116336

13928

15627

13367

WA Shares Outstanding

2128

2372

2437

2128

2372

2437

Per Share

61.41

54.18

47.74

6.55

6.59

5.49

3 Years average/share

54.44

6.21

All the figures are in Millions, except for the per share numbers. The currency used is US Dollar.

Now look at the following table which is based upon the above, albeit with some hypothetical adjustments I have made to the segment valuations:

Adjusted Net Revenue

Adjusted Operating Income

Valued at

2011

2010

2009

2011

2010

2009

Personal Systems Group

0%

0

0

0

0

0

0

Services

60%

21572

21317

21228

3089

3397

3061

Imaging & Printers

0%

0

0

0

0

0

0

Enterprise SSN

60%

13345

12214

9673

1816

1695

994

Software

60%

1930

1637

1593

419

469

439

Financial Services

50%

1798

1524

1337

174

141

103

Corp Investments

100%

322

346

191

-1616

-366

-300

Total

38967

37038

34021

3882

5335

4297

WA Shares Outstanding

2128

2372

2437

2128

2372

2437

Per Share

18.31

15.61

13.96

1.82

2.25

1.76

3 Years average/share

15.96

1.95

Price @ multiple

10

$19.46

Price @ multiple

15

$29.18

All the figures are in Millions, except for the per share numbers. The currency used is US Dollar.

As you can see, I've adjusted these segments at different valuations. For example, I've adjusted the Services, ESSN and the Software segments at 60%, Financial Services segment at 50%, and the Corporate Investments segment at 100% of the stated values respectively.

Above all, I've adjusted the Personal Systems Group, Imaging and Printers segment at zero valuation.

My reasoning behind such adjustments is the following:

Services, Enterprise SSN and Software: I believe that there is a valid argument that the customers are moving to the cloud based products and services and therefore these segments will be hit to some extent. In addition, a decision by Oracle Corporation (NYSE:ORCL) to discontinue the support for Itanium based servers (which have strategically been an important part of HP's server business) is allegedly expected to hit these segments to some extent or at least that's how it's being interpreted by the market. Here is the link to the ongoing lawsuit HP filed against Oracle. So, without going into the intricate details to determine an accurate extent of the alleged hit on these segments, I chose to remain ultra conservative and adjusted these segments to 60% of the stated values.

Personal Systems Group, Imaging and Printers segments: Why did I adjust these segments to zero valuations? Honestly, I did so to see where it takes me. What I witnessed as a result turned out to be the basis of this article.

Financial Services: Based upon the latest 10K filing, this segment supports and enhances HP's global product and services solutions, providing a broad range of value-added financial life cycle management services. Again, I didn't see a need for accurate valuation, so I have adjusted this segment to a conservative 50% of the stated value.

Corporate Investments: These are not the exotic or hard-to-value securities such as CDOs, Credit Default Swaps or any other structured product but still you can't come up with 100% accurate valuation for this segment. I've left this segment to 100% of the stated value. In fact, this is such a tiny segment and so immaterial that it does not move the needle much either way, even if you value it at zero.

Based upon my adjustments, what I see is the following:

3 years average adjusted earnings after (hypothetical write offs) = $1.95/share

HPQ's price after applying a multiple of 10 = $19.50

HPQ's price after applying a multiple of 15 (S&P multiple based upon TTM earnings is ~ 15) = $29.15

HPQ's closing price as of July 16, 2012 = $18.81

As you can see, only after writing the whole of the PSG, Printer and Imaging segments off (which is half of HP's business) and valuing the remaining segments ultra conservatively (almost at half of the stated value) and using conservative earnings (3 years averages instead of the last year's or the TTM earnings), you come anywhere near what the market is willing to pay for HP.

A note about the valuation: In reality, all these segments have much better intrinsic values and should rightfully be treated so. I've chosen to remain conservative for this article to reduce the margin of errors. Remember that a good analyst should not obsess too much about the exact valuation; a range of numbers based upon a well thought out research, is sufficient to make an investment decision. As they say, no two analysts in the world (including Santa Cruz, CA which some say is not in this world) can come up with the same exact valuation for a business. An investment thesis which can hold water in extremely pessimistic situations, is usually the one which makes you a great amount of money.

In reality though, the pending Windows 8 release by Microsoft Corporation (NASDAQ:MSFT) should enhance valuation of the Personal Systems Group, Imaging and Printers segments in a major way for HP. I believe that this is true even after you discount a perceived conflict of interest posed by Microsoft's Surface tablet to a vendor such as HP. Of course, I'm assuming that HP doesn't spin or write these businesses off. In fact, a decision by HP to develop its own competing tablet or an ultra book type of device, based upon Windows 8, will be icing on the cake.

Similarly, the remaining segments are likely to contribute much more than, what is assumed in this article, in the foreseeable future.

Now for those who are more realistic/optimists and who don't want to go to such extreme impairments, there appear to be good news. HP is selling at a deep discount on the basis of the most traditional valuation metrics. Take a look.

  • It's selling at almost half of the 7 years average Earnings multiple.
  • It's selling at almost one third the of 7 years average Book Value multiple.
  • It's selling at almost 3/4th of the 7 years average FCF multiple.
  • It's selling at an EV/EBITDA multiple of 4. That's 25% cash-on-cash return. This means that HP is returning over 16 times 10-Year Treasury bond yield of 1.5%. Additionally, with S&P valued at ~ 15 times TTM earnings (that is an earnings yield of 6.x %); this also means that HP is returning almost 4 times of the broad market.
  • As for the relative valuation; in addition to selling at a deep discount to S&P, HP is also selling at a substantial discount to the comparable competitors such as International Business Machines Corporation (NYSE:IBM), Cisco (NASDAQ:CSCO) and Oracle.

Even after considering such major impairments, HP as a whole (and in parts) will still have lots of consistent cash flow to have enough interest coverage to handle an LBO type of a deal. That's how inexpensive HP common shares are right now. Now, the problem is that there are not many players big enough, with a pristine/AAA credit, who can take on that kind of a debt load.

I believe that the market is making a huge mistake in equating HP with the likes of Nokia (NYSE:NOK) and Research in Motion (RIMM). HP is not a patient diagnosed with a terminal disease.

I have never liked phrases such as "it's all priced in," "there is not much downside" or "there is no way but to go up from here" and so on. Why, because the prices can still go down for any number of unforeseen reasons. What I know however, is that one cannot consistently buy something at its bottom, therefore as long as there appears to be more upside than the downside to an investment, I'm up for it. I have initiated a long position in HPQ Monday July 16, 2012.

Source: Hewlett-Packard's '$65 Billion Write Off'