Hewlett-Packard - Whitman's Clean Up Continues After New Multi-Billion Charges

| About: HP Inc. (HPQ)
This article is now exclusive for PRO subscribers.

Shares of Hewlett-Packard (HPQ) were being dragged down once again. The diversified information technology company reported its fourth quarter results on Tuesday before the market open. Disappointing earnings and a soft guidance were not the biggest worry of investors. The company took a $8.8 billion impairment charge, mostly related to its acquisition of Autonomy on fraud charges. Shares ended the day 12% lower after trading with losses up to 15%.

Fourth Quarter Results

Hewlett-Packard reported fourth quarter revenues of $29.96 billion, down 7% on the year. In constant currencies, revenues fell 4%. Revenues fell short to analysts expectations of $30.43 billion

The company reported a surprising fourth quarter operating loss of $6.9 billion, with diluted losses per share coming in at $3.49 per share. Losses were driven by $8.8 billion impairment charges, of which roughly $5 billion was directly related to the Autonomy acquisition. Non-GAAP operating income fell 3% to $2.3 billion, as non-GAAP operating margins rose 70 basis points to 10.4%. Non-GAAP earnings came in at $1.16 per diluted share, beating consensus estimates by two pennies.

CEO Meg Whitman made the following comments, "As we discussed during our Securities Analysts Meeting last month, fiscal 2012 was the first year in a multiyear journey to turn HP around. We're starting to see progress in key areas, such as new product releases and customer wins. We're particularly pleased that in Q4, we were able to improve our balance sheet, generating $4.1 billion in operating cash flow, and we returned $384 million to shareholders in the form of share repurchases and dividends."

Segmental Information

Personal Systems

Revenues for the personal system business fell 14% on the year to $8.70 billion. Operating income fell over 46% with operating margins falling to 3.5%. The decline in revenues and income was driven by a 12% decline in desktops and notebooks as customers switch for tablets.


Revenues for the printing business fell 5% on the year to $6.08 billion. Operating income rose 35% to $1.07 billion for operating margins of 17.5%. The boost in margins is impressive and is the result of price hikes as total hardware units volumes fell 20% on the year.


Revenues for the service business fell 6% to $5.12 billion. Operating income rose 2% to $1.23 billion. Revenues fell across the board, but price hikes boosted earnings.

Enterprise Servers, Storage and Networking

Revenues in the ESSN business fell 9% to $5.12 billion. Operating income fell 41% to $423 million. Networking revenues were a bright spot, up 7% on the year. Revenues in the standard servers, critical systems and storage business were all down.


Revenues from the software business rose by 14% to $1.17 billion. Operating income rose 12% to $318 million. The results include the contribution of Autonomy.

Acquisition of Autonomy

HP took an incredible $5 billion non-cash charge for impairment of goodwill and intangible assets of the $10.5 billion acquisition. The charge comes down to almost half of the purchase price.

Hewlett-Packard blames accounting improprieties, disclosure failing and misrepresentations at the time of the acquisition.

CEO Whitman commented on the charges, "There appears to have been a willful sustained effort to inflate Autonomy's revenue and profitability. This was designed to be hidden."

HP said that Autonomy's management inflated revenues and gross margins to mislead potential buyers. Autonomy booked revenues from low-end hardware sales as software sales in order to boost software revenue growth. Furthermore the company already booked revenues from licensing deals, even if products were never sold to customers.

Former founder Lynch of Autonomy rejected the allegations. He said he was "shocked" but confident that he would not be convicted for any wrongdoing.


For the first quarter of its fiscal 2013, Hewlett-Packard estimates non-GAAP diluted earnings per share to come in between $0.68 and $0.71 per share. Earnings are expected to come in between $0.34 and $0.37 on a GAAP basis. Analysts expected Hewlett-Packard to guide for non-GAAP first quarter earnings of $0.85 per diluted share.

Full year 2013 non-GAAP earnings are expected to come in between $3.40 and $3.60 per share. Hewlett-Packard maintains its GAAP earnings per share target of $2.10-$2.30 per share. As such, the company expects amortization charges of intangible assets, restructuring charges and other acquisition-related charges of $1.30 per share, or roughly $2.6 billion for the next year.


Hewlett-Packard ended its fourth quarter with $11.3 billion in cash. The company operates with $28.4 billion in short and long term debt for a net debt position of $17.1 billion. Despite the record charges, the company still holds over $35 billion in goodwill and purchased intangible assets on its balance sheet.

The company generated full year revenues of $120.4 billion. HP reported a net loss of $12.6 billion, or $6.41 per diluted share. Non-GAAP earnings came in at $8.0 billion, or $4.05 per diluted share. Hewlett-Packard has racked up multi-billion dollars in debt in recent years to make large acquisitions in the software and cloud area, in an attempt to combat the decline in the personal computer and printing business.

Factoring in Tuesday's 12% decline, the market values Hewlett-Packard at $23.0 billion. This values the firm at just 0.2 times annual revenues and 5-6 times its 2013 expected GAAP net earnings.

Hewlett-Packard so far maintains it quarterly dividend of $0.132 per share, for an annual dividend yield of 4.5%.

Some Historical Perspective

Year to date, shares of Hewlett-Packard have lost more than half of their value. Shares advanced from $26 in January to highs of $30 in February. The acceleration of the personal computer market decline and multi-billion impairment charges later send shares to lows of $12 at the moment.

Shares have lost some 80% from their highs around $54 in the beginning of 2010. Shares are now testing their lows of 2002 after the burst of the dot-com bubble. Between its fiscal 2008 and 2012, the company reported stagnant revenues around the $120 billion mark.

Poor Acquisition Track Record

Hewlett-Packard paid the price for the poor acquisitions made in the recent past. Besides overpaying for EDS and Autonomy which resulted in the impairment charges, the acquisitions were too small to transform the company away from its declining core business.

Hewlett-Packard took a total of $20.7 billion in charges related to goodwill, intangible assets and restructuring efforts. In the third quarter, the company took an $11 billion write-down mostly related to EDS, followed by a $8.8 billion write-down taken today, the majority related to Autonomy.

Investment Thesis

Hewlett-Packard continues to cut 29,000 jobs within the next two years to save an estimated $3.5 billion. Whitman wants to streamline the company's printer business and technology services.

In the beginning of October, when shares traded around $15 per share, I took a look at HP's prospects. I said that Whitman took the right steps by cutting costs in order to make the company more competitive. After almost $21 billion in write-downs, there is little room for new impairments on the acquisition of Autonomy and EDS. A potential problem could be that Whitman approved the acquisition of Autonomy, as she was a member of the board of directors at the moment. A CEO changeover is the last thing that HP's shareholders can wish for at the moment.

I am fairly disappointed with the operating results over the past quarter. It seems that HP has rapidly increased prices in most of its divisions, which boosted operating earnings in the short term, but resulted in large volume declines. The downturn is more prolonged than anticipated which makes valuation levels appealing, but for now a value-trap. It is not just shareholders who panicked today, bondholders took a beating as well. The company's 4.65% $1.5 billion bonds which mature in December 2021 fell more than 3%, trading at just 95 cents on the dollar. Bondholders are frightened by accounting improprieties, failure of disclosure and outright fraud despite the reduction in the net debt position.

I remain on the sidelines, as I fear for the value trap.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.