You Should Sell Hewlett-Packard

| About: HP Inc. (HPQ)
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It is never a good sign for a company when it is mentioned in the same breath as corporate raider Carl Icahn. This is particularly true when the company is one of the most highly respected companies in the history of Silicon Valley.

Hewlett-Packard (NYSE:HPQ) is in a tough situation. Put aside the $8.8 billion write-down of Autonomy. Hewlett-Packard is the next Dell (DELL). When Meg Whitman took over as CEO in September of 2011, she faced the difficult challenge of turning around a company that had seen seven straight years of stagnant returns for shareholders. In the most recent conference call in October of 2012, Whitman argued that the company will face a difficult 2013, but should begin to see long-term growth for the company by 2015. Whitman argued that at that point, the company is projected to return to its storied history of being on the vanguard of technological changes in Silicon Valley.

Is this view realistic? I think not.

On December 7, 2012, John Chambers, CEO of Cisco Systems, Inc. (NASDAQ:CSCO), stated at the company's annual financial analyst conference that the future of the information technology industry has been transformed by cloud computing. He argued that the business model of the big technology giants is being challenged. I covered this in "4 Reasons Cisco Will Be The #1 IT Company." This includes companies such as Microsoft Corporation (NASDAQ:MSFT), International Business Machines (NYSE:IBM), Oracle (NYSE:ORCL), Hewlett-Packard and SAP (NYSE:SAP). Chambers even made the following statement, "two or three of those [companies] will not be in that list five years from now."

This argument by Chambers is one of the best statements, by one of the longest serving veterans of Silicon Valley, on the history of the information technology industry. Hewlett-Packard will be one of those companies that fall from the list because it is not following the trends of the cloud computing revolution. There are three reasons why the company will fail to meet Whitman's vision for 2015 - and that its competition such as Cisco - will succeed.

First, the company's core product line is catered to a parochial world, where tablets and smartphones are not on the forefront of consumer demand. When Meg Whitman became the company's CEO, she refocused its efforts on printers and PCs because of the company's competitive advantage in these areas. While it is true that the company ranked highly in both of these categories, the margins from these products - or any hardware products for that matter - are quite low.

Also, Lenovo Group Ltd. (OTCPK:LNVGY), which bought IBM's PC group, has been gaining a considerable market share since the purchase. Just this past October, the company surpassed Hewlett-Packard in market share. Lenovo shows no signs of slowing down either as the company's CEO has focused on expansion in China, where the company sees potential for continued growth of 30%. Moreover, we are in a post-PC world. For the first time in history, smartphones and tablet sales have surpassed PC sales, causing the demand for PCs to decline. The amalgamation of these two factors presents the first blow to Whitman's outlook for the company.

Second, Hewlett-Packard will not be successful in its other key area of revenue: software-defined networking ("SDN"). Recently, Cisco has focused on making several key acquisitions in this space. The acquisition of Meraki was its most significant move, and is part of the company's approach to move toward software and services. You can read about Cisco's Meraki acquisition in "Cisco's Meraki Acquisition Will Post Gains 'For Years to Come."

Moreover, Juniper Networks (NYSE:JNPR), which has also entered this space, has made significant moves. On December 12, 2012, the company acquired Contrail Systems after the company had only been in existence for two days. While that is an extremely quick acquisition, major networking companies have been quick to make deals in this space because it is the key to the future. Companies who do not adapt through acquisition will fail because the innovation takes significant research and development. Hewlett-Packard, however, has not made any significant acquisitions to meet this need nor has significantly spent money on research and development in this area.

Third, the company has failed to enter into the smartphone market. Given Hewlett-Packard's power and range as a company, its failure to create a competitive smartphone is beyond words. This failure is due to two reasons. The first is poor leadership and vision prior to Meg Whitman. The second is the company's woefully insignificant investment in research and development. When Whitman took over, the company was investing only 2.5% of revenue into research and development. It once invested near 10%.

Even if the company wanted to compete in the smartphone market, it would face stiff competition. Samsung Electronics (OTC:SSNLF), Motorola Solutions (NYSE:MSI) and Apple, Inc. (NASDAQ:AAPL) are the biggest players in the market. Recently, Apple, which is the most dominant, released the iPhone 5, making it the most difficult to contend with.

Apple also exceeded expectations in the burgeoning Chinese market, where it sold 2 million phones in just 3 days. Samsung, who has been a fierce competitor of Apple, has fallen off since losing a seminal court case, where a San Jose court awarded Apple $1 billion in damages to be paid by Samsung for infringing upon the company's intellectual property. This has left the door for Motorola and others to gain market share. However, Hewlett-Packard has not taken the bold moves necessary to move into this market.

Hewlett-Packard is struggling, and despite Meg Whitman's prestigious record of being successful in business, she will not be able to turn the company around. Her strategy has been to cut employees, lower expectations and do everything possible to ensure all of the company's past mistakes have been revealed to the markets - including Autonomy. This strategy, however, does nothing to address her goal of meeting long-term growth for shareholders by 2015. That goal must be addressed in the Hewlett-Packard labs and in the executive offices, where a lack of vision has been persistent. In short, the company is standing still in a world that is passing them by.

For these reasons, the company will not meet Whitman's goal for 2015. The company, which has already seen stagnant returns for investors over the past decade, is in a financial position that cannot be solved given its cuts in research and development and poor management decisions over the past decade. The company, which is near its lowest share price this year, will not see a return to $40 a share.

However, the company was hit hard in the wake of the Autonomy write-down, and may potentially be able to achieve a short-term price increase as the United States economy continues to recover. Thus in the short term, investors may buy HP hoping for a bounce. However, look for HP to re-test, and perhaps fall below, its recent $11.35 low. If the stock bounces in the near term, that could provide a nice price to either sell shares or to go short HP.

Despite short-term volatility, the long term remains: Hewlett-Packard is a company whose future grows dimmer with each passing day.

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.