Does A Hewlett-Packard Smartphone Make Sense?

Sep.18.12 | About: HP Inc. (HPQ)

It looks like Hewlett-Packard Co. (NYSE:HPQ) is trying to throw a lot of things at the wall to see what sticks. After spending lots of money on a tablet that didn't sell much, the company is now planning to come up with a new smartphone. The company's management predicts that more and more people will replace their personal computers with smartphones, and it wants to get a piece of the ever-growing pie. However, things aren't that simple for Hewlett-Packard.

Don't get me wrong, I love it when a company diversifies its products and offers new things to its clients. On the other hand, I am a big fan of companies keeping their focus. If a company can successfully diversify, it should diversify. If a company is better at focusing on a few core products and services, it should focus on these core products and services. This is not Hewlett-Packard's first shot at a smartphone either. After acquiring Palm, Hewlett-Packard tried to enter the smartphone business with a few failed products. Eventually, the company backed off from the market.

When companies with a lot of experience in smartphones such as Nokia Corporation (NYSE:NOK), Research In Motion Limited (RIMM) and Sony Ericsson (Sony Corporation: SNE) are suffering due to the rapidly changing market dynamics and harsh competition from companies like Apple (NASDAQ:AAPL) and Samsung (OTC:SSNLF), Hewlett-Packard's task will be anything but easy.

If the company is really serious about getting in the smartphone business, it should look into acquiring one of the established companies in the market such as Nokia or Research in Motion. If the company enters the market with its own name, rather than an established name in the industry, it might not receive much recognition. Besides, if Hewlett-Packard were to build a smartphone from scratch, it would find itself right in the crossfire of the patent war between many companies involved.

Regarding the matter, the company's CEO Meg Whitman said:

"My view is we have to ultimately offer a smart phone because in many countries of the world, that is your first computing device. There will be countries around the world where people may never own a tablet or a PC or a desktop, they will do everything on a smart phone, we are a computing company; we have to take advantage of that form-factor."

At first, it sounds like building a smartphone would be very profitable for Hewlett-Packard because of the higher margins smartphones offer compared to PCs and high demand for these products around the world. On the other hand, there are many companies in the smartphone industry, making the market as crowded as the PC market, if not more crowded.

Many companies in the smartphone market don't make much money. In fact, Apple and Samsung jointly enjoy a profit market share of 108%. A profit market share above 100% becomes possible when many phone companies post losses instead of profits. A total of 71% of all profits in the smartphone industry belongs to Apple.

Could Hewlett-Packard come up with a smartphone to differentiate itself from the competition? Or would Hewlett-Packard choose to produce cheap phones to compete with Chinese companies? If past behavior is the best predictor of future behavior, I can see Hewlett-Packard creating a mediocre smartphone, keeping it in the market for a year, pulling it from the market and changing its mind to decide that it will write-off its smartphone division and lay-off 10,000 employees. Of course, the company would acquire several smaller companies along the way and drag them down with it.

To me, Hewlett-Packard's best bet seems like acquiring a large mobile phone company that is currently selling for less than its book value (like Nokia) and keeping the company as a separate entity. Let the acquired company worry about design, marketing, competition and everything else, while providing financial support for the company. The acquired company should be able to keep its logo on the products. This is the only way HP can be successful in the smartphone market.

There are rumors indicating that the new Hewlett-Packard phone would run on Android. If this is true, Hewlett-Packard might end up competing with Samsung, while hoping to avoid potential lawsuits that might come from the company's Silicon Valley neighbor Apple. Due to the cross-licensing agreements between Apple and Microsoft, the smartphones running on Windows 8 are the only ones that will be safe from a possible lawsuit that may come from Apple.

I am long Hewlett-Packard, because I think that the company is very cheap with a forward P/E ratio of well below 10. The company's management needs focus and direction in order to turn the company around. In order to be more focused, the company should increase its attention to its core areas and keep itself away from distractions.

As for the smartphone market, HP should only get into this market if it is able to takeover one of the existing major players in the market. Otherwise, the company should stay away from smartphones.

Disclosure: I am long HPQ, NOK, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.