April 24, 2016 - 6:03pm EST by
2016 2017
Price: 12.61 EPS 1.589 0
Shares Out. (in M): 1,727 P/E 7.9 0
Market Cap (in $M): 21,773 P/FCF 7.6 0
Net Debt (in $M): 3,044 EBIT 0 0
TEV (in $M): 24,817 TEV/EBIT 0 0

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Hated? Despised? Terminal decline? Going broke? Legacy dinosaur? Negative book value?
HP Inc generates lots of negative sentiment. I would like, however, to suggest that this creates an
opportunity – and is potentially the unloved and ignored part of the split company. (Out of 31
analysts covering the stock according to Bloomberg there are 12 buys, 18 holds and 1 sell – I take the
‘holds’ as a sign of frankly ‘ignoring’ the company).
[Before we delve into the detail it is appropriate to remind readers that HP’s fiscal year ends Oct 31]
[Note that there has been previous coverage of HPQ which is worth reading - but no coverage of HP Inc (ie HPQ post split).]
1. What is HP Inc?
The consensus is that HP was split into HP Inc (‘HPQ’) and HP Enterprise (‘HPE’). To be
pedantic this is not quite correct; HP Enterprise was spun out of Hewlett Packard Company
(‘old HP’) which then changed its name to HP Inc.
This is important because HP Enterprise took assets and cash – and the write downs of
previous acquisitions (eg Autonomy) got left at HP Inc. There are other potential liabilities
that have also been hidden in HP Inc – eg 6m sqft of vacated property (of which 2m are
leased to third parties), tax and pension liabilities (these should have been equitably split
between the companies but only time will tell).
Furthermore HP Inc has been left with business lines that do not clearly fit with it but
perhaps reflect assets that HPE did not want – for instance (from the 2015 10-K):
‘In connection with the Separation, effective at the beginning of its fourth quarter
of fiscal 2015, we implemented an organizational change which resulted in the
transfer of marketing optimization solutions business from the Software segment
to the Commercial Hardware business unit within the Printing segment. We have
reflected this change to our segment information in prior reporting periods on an
as-if basis, which resulted in the transfer of net revenue from the Software
segment to the Commercial Hardware business unit within the Printing segment.’
[And no I have no idea what a ‘marketing optimization solutions business’ is either – but it
does not look like something that is a conventional bedfellow of a ‘commercial hardware’
printing business.’]
Thus I would suggest that HP Inc starting with a negative book value is like the poor kid who
gets left at home to look after the parents and the family’s small holding whilst his siblings
go and see the wide world.
I would even go further and point out that Hewlett Packard Entreprise Co took $9.842 bn of
cash and $33.918bn of stockholders equity (as of 31 Oct 2015 in Q1 2016 10-Q filing of HPE),
announced mass firings and a sharebuyback of $3bn. Though I know many people will be
excited by the ‘dynamic’ management action at HPE I remain to be convinced that an
increasing stock price in that business reflects an improving economic moat or returns.
2. So what is in HP Inc?
The two principal assets inside HP Inc are printers and PCs (but it is important to note that
this does not include servers – those are in HP Enterprise). We will dive into the two
divisions in more detail shortly.
3. Why the split?
I am sure it would be possible to write some nice words to say that management and the
board decided to undergo a split for proactive business reasons or to release value. My
personal view is that this is nonsense – but rather was a reactive response to the ‘distressed’
situation the company was in following the Autonomy ‘debacle’.
Allegedly Meg Whitman was not initially in favour of the split but then ‘flexible’ enough to
recognise it needed to be done (‘She is someone who is flexible when it comes to change. As
an executive who was opposed to the split at the beginning, she came around after realizing
the benefits outweighed the negatives.’ – source -
http://seekingalpha.com/article/3960797-hewlett-packard-look-enterprises-incorporated ). I
think HP has had an established track record of doing a transaction (M&A or split) when
management is under attack.
Page 41 of the 2015 10-K has a chart which shows that from Oct 2010 to Oct 2015 HP stock
fell roughly 30% whilst the S&P 500 rose 95% (and the S&P Information Technology Index
rose 102%).
In my view ‘old HP’ had suffered chronic mismanagement for a much longer time:
- The acrimony around the Compaq acquisition – including the alienation of Walter
Hewlett (son of the founder – Bill Hewlett)
- The ‘spying scandal’ where board members were investigated (see
- The Mark Hurd scandal http://www.businessinsider.com/heres-the-sex-letter-that-got-mark-hurd-fired-as-ceo-of-hp-2011-12?IR=T
- Allegations of sales to Iran despite sanctions (https://en.wikipedia.org/wiki/Hewlett-Packard#Sales_to_Iran_despite_sanctions )
- The Autonomy debacle itself
- Previous acquisitions such as EDS and numerous other deals (and the attempted
acquisition of PwC services arm)
- ‘Naïve’ deals eg the iPod+HP deal http://gizmodo.com/remember-when-carly-fiorina-made-a-terrible-deal-with-s-1734021292 and http://fortune.com/2015/10/01/carly-fiorina-apple-steve-jobs-ipod/
- Top leadership setting ‘top down’ targets and using a ‘revolving door’ management
policy to have their targets implemented – ‘Whitman has now replaced the heads of
every major HP business unit (and many corporate functions) since she arrived in late
2011.’ (source - http://www.cnbc.com/id/100977172 ) and ‘While questioning the HP
boss during the recent earnings call, Sanford C. Bernstein equity analyst Toni Sacconaghi
indicated that in the past two months alone Ms. Whitman changed the heads of
business units that make up over 80 percent of the firm’s profits.’ (source -
http://www.action-intell.com/2013/08/23/hp-printer-shipments-up-in-q3-as-revenue-continues-to-fall/ )
- Slightly ‘arbitrary’ wage cuts on the ‘EDS’ side of HP and then partial restoration (see
https://en.wikipedia.org/wiki/Hewlett_Packard_Enterprise_Services and
http://www.businessinsider.com/hp-employees-rejoice-as-new-ceo-returns-pay-to-previous-levels-2010-11?IR=T )
I would also suggest that Hewlett-Packard ‘apparently’ spinning out divisions as a
management response to external criticism is not a new occurrence (eg the spin out of
Agilent) [I am perhaps being a tad unfair – allegedly the plans for the Agilent spinout
predated Carla Fiorina’s arrival) – and the management has often abandoned technological
and / or hardware leads (eg the iPaq) in order to pursue ‘ephemeral’ dreams of going into
software and services.
I think in passing it is also worth noting that other ‘management actions’ at HP over the
years have also been predictable – mass layoffs (eg
http://www.channelregister.co.uk/2015/08/28/hp_redundancy_coming_to_an_end/?_ga=1.189035503.595533166.1461496682 ) to achieve cost savings that never really come
through and restructuring involving moving businesses between divisions so true LFL
numbers are often hard to ascertain.
4. Where did the management go?
With corporate splits / spin-outs it is often instructive to see where the management goes.
The most important person in the ‘old HP’ was Meg Whitman who was Chairman, President
and CEO – she became CEO of HP Enterprise and Chairman of HP Inc.
The CFO (Catherine Lesjak), who in most companies would be considered to be the second
most important person in the executive structure has become the CFO of HPQ. There are a
number of issues I think it is important to highlight with respect to Ms Lesjak – (a) she was
not a board member of ‘Old HP’ (see table page 19 of the following -
http://h30261.www3.hp.com/~/media/Files/H/HP-IR/documents/reports/2015/hp-proxy-2015.pdf - this sounds surprising and shocking to me – but needs to double check it) and (b)
market ‘belief’ is that she objected to the acquisition of Autonomy but was overridden (c)
she acted as interim CEO of ‘Old HP’ from August to October 2010.
The lead independent director of ‘Old HP’ was Patricia Russo. Some will recall her tenure at
Lucent and then Alcatel Lucent. At Lucent one might suggest that the biggest contribution to
earnings was often the _assumed_ rate of return of the pension fund. Her departure from
Alcatel was ‘sudden’ but pushed by a lot of tech investors in Europe after some ‘remarkable’
results calls and investor meetings. Far be it for me to comment in detail but I observe that
she is Chairman of HP Enterprises (HPE) but not involved in HP Inc (HPQ).
Unusually this may be a spinout story where, given the comments earlier re revolving door
management, and other issues it pays to bet with the business that management does not
go to.
5. Why does the history matter?
Historically HP was one of the titans of the tech world; it was renowned for its engineering
and the robustness of its products. I appreciate it had become a gigantic conglomerate but I
feel that over the last 15 or so years it has been ‘managed’ by managers who
(i) failed to understand the culture (indeed actively sought to destroy the ‘HP Way’)
(ii) in the process losing the loyalty of staff
(iii) letting the engineering expertise go
(iv) the areas where the company had leadership (eg the iPaq and the HP potential competitor
to the iPod) were prematurely abandoned, and
(v) instead acquisitions were attempted to move to the promised land of software and
services. The performance of IBM which perhaps managed to progress further in the
same direction shows that such a transition does not necessarily add value to
(vi) as part of the above the company treated its hardware divisions (in particular the
printer division) as a ‘mature cash cow’ with little top management focus on
anything but the size of the check sent to HQ each quarter
(vii) The following article discussing HP’s new logo including immortal lines such as
involving ‘an endless litany of meetings with “somewhere in the hundreds of
people” ’ and ‘spanning two and a half years of work’, ‘manufacturing 100 million
devices per year and had in excess of 47,000 different models on its books’ and ‘we
had three CEOs during our tenure’. Perhaps it is me but given the crises HP has been
in during the last few years deciding to increase the angle of the logo from 13
degrees to 20 degrees perhaps ought not to have been the highest priority for the
company. Article at http://www.theverge.com/2016/4/20/11457746/hp-new-logo-spectre-13-moving-brands-interview
I may be a little ‘above my station’ in making the above diagnoses but I think it is important
in order to understand why I am interested in HP Inc.
6. The ‘big change’
I will shortly dive into the individual divisions but my overarching hypothesis is:
(i) The two divisions – ‘printing’ and ‘personal systems’ are global leaders in #1 or #2
positions in most major countries
(ii) The printer division is no longer a ‘cash cow’ sending money to HQ but can actually
invest for the future.
(iii) Dialogue with management gives the distinct impression that there is a more
distinct focus on only selling profitably and avoiding loss leading sales to show
‘revenue growth’.
(iv) Greater clarity for investors – as an example I challenge new investors to interpret
the following sentence for the 2015 10-K ‘This organizational change resulted in the
transfer of third-party multi-vendor support arrangements from the TS business unit
within the EG segment to the ITO business unit within the ES segment.’
(v) The introduction of new technologies offers the printer division some margin
(vi) There are adjoining adjacencies that could provide growth opportunities for the
printer division
(vii)Most investors have a negative view of PC businesses on the basis that they have
low margins. However what really matters for a value investor is also asset turnover
and returns on capital. Thus I am perhaps not as negative as most on PC hardware
businesses (and would also remind investors that allegedly Apple has a hardware
(viii) Management now has more of a degree of permanence (I would perhaps be more
comfortable if Meg Whitman ceased to have connections with HPQ but it is hard to
imagine the CEO being changed within a year or two of the new structure)
(ix) There can be less shuffling of businesses between divisions
(x) There is likely to be less significant M&A for HP Inc going forward (the only rational
M&A deals I think that are likely to ever make sense are the acquisition of Canon’s
printer division by HP for reasons highlighted below – however I have no expectation that that will ever happen;
additionally there might be some sense in acquiring 3-D Systems to have Vyomesh Joshi take over HP Inc
if the present management fails and to augment HP’s attempts in 3-D printing - again I have no
expectation of this actually happening)
(xi) I do not believe that the printer market is going to fall off a cliff – rather I think the
Q4 weakness was specific to some channel changes (discussed below) – I do accept
there will be declines in the overall market but it will be slower than most believe
(xii)It is important to note that Ms Lesjak has moved to HPQ. As well as her opposition
to the Autonomy acquisition it is also worth noting that she is a long term HP
executive and also was briefly interim CEO after the departure of Mark Hurd. I
appreciate that HPQ seems to have been stripped of assets and ‘higher multiple’
businesses but my suspicion is that Ms Lesjak as CFO probably knows where the
skeletons are and has been rather astute. (Note that I have not met her and my
suspicions may be incorrect).
7. The accounts
a. HP is / was an October year end company.
b. The split into HPQ and HPE occurred formally on 1 Nov 2015.
c. Though the filings lay out a lot of details I think it will take a while for analysts
(including myself) to fully understand and build models for the new business
8. The printer division
The general consensus is that the printer division is in terminal decline. In particular critics
focus on the fall in sales in Q4 2015. I would also highlight that the quarter to January 2016
showed consumer hardware sales of $322M vs $601M in the year prior equivalent quarter ie
a fall of 46%.
(Q1 2016 revenues $4.642bn – minus 17% y/y growth or minus 11% if currency adjusted;
operating margin of 17%)
I have a variant perception:
(a) Most investors’ direct impression of HP is from their office printer and product they see
sold in retail stores. Market impressions from the retail market are transported over to
the corporate market in investors’ minds.
(b) In the retail sector historically electronics retailers focussed on ‘events’ such as Black
Friday ‘$29.99 (printer) specials’. These were frankly loss leaders with the hope that the
subsequent ink sales would generate long term profits. (In comparison corporate units
are typically sold at breakeven or a profit). The typical home printer lasts 3 years versus
7 years in a corporate environment (numbers from investor relations). In addition a
typical home user prints only a few pages per month whilst a corporate printer might
print a thousand or more pages in a month.
(c) Dialogue with IR suggests that the management is, going forward, now much more
focussed on the NPV of any units it sells. (‘Heaven forbid if we do any $29.99 Black
Friday specials in future’ – quote from a conversation with IR). I think this is a positive
development – and likely to explain some (undefinable part) of the fall in sales (both
retail but also perhaps across other parts of the business).
(d) Let me add a couple of additional points on the ‘$29.99 printers’ issue – cheap printers
that fail rapidly destroy brand value (and mean a customer is less likely to buy a HP
printer at home OR at work in the future); and customers buying at that price are likely
to be price sensitive so less likely to buy full price HP inks as opposed to 3rd
party inks. So getting out of that vicious circle is important for HP.
(e) Historically the printer market could ‘roughly’ be split into ‘ink-jet’ single function and
multi-function printers at home; and (typically mono-function) lasers at work. I
appreciate this is a loose classification but I think it is important to appreciate this
(f) Over the last decade or so there has been an ‘upgrade’ cycle in the corporate world with
companies upgrading to colour laser printers, duplex printers and to multifunction
printers (eg incorporating scanners and photocopiers) - this ‘cycle’ has slowed down
over the last couple of years.
(g) One of the big dis-synergies of the separation is that I suspect some value added
resellers who are focussed on eg server / enterprise services will drop stocking other
parts of the HP range including printers and PCs. I cannot put a figure on this but suspect
it is responsible for some of the poor sales numbers (see also
t_pps_comment/ )
(h) I will discuss Windows 10 under the PC division but I suspect it has impacted the printer
division as well
(i) Clearly tablets and ‘phablets’ (large screened mobile phones) have impacted the need to
print documents. Indeed I would go further and suggest the new Microsoft Surface Pro 4
and the Apple Ipad Pro could lead to further impacts on corporate printing needs
(j) The margin for HP’s printer division is high double digits (17% in Q1 – see page 6 of
http://h30261.www3.hp.com/~/media/Files/H/HP-IR/documents/results/2016/quarterly-results/q1-2016-results-presentation.pdf). For
laser printers HP relies on Canon for the ‘printer engines’ and laser toner cartridges
(see page 24 – http://h30261.www3.hp.com/~/media/Files/H/HP-IR/documents/reports/2016/2015-form-10k.PDF ). (The background to this is in
Wikipedia – see https://en.wikipedia.org/wiki/Laser_printing. ) The key point, that
anyone who has bought printer suppliers for themselves will appreciate is that the
operating margin is ‘as low as 17%!)’. [Sales to HP represented 17.8%, 17.4% and 17.6%
of Canon sales in the calendar years 2015,2014 and 2013 respectively – see page 54 of
Canon’s annual report - http://www.canon.com/ir/annual/2015/canon-annual-report-
2015.pdf – hence my suggestion that it might make sense for HP to buy this business
from Canon but I suspect it is unlikely to ever happen for a variety of reasons)
(k) Traditionally lasers have been targeted at the corporate market and inkjet to the retail
market but the ‘OfficeJet’ range has gradually been bringing inkjet technology into the
lower tiers of the corporate market.
(l) In comparison to the laser side, I understand that the HP has recently launched its
‘Pagewide’ technology which is derived from its inkjet technology and hence does not
require purchases or payments to Canon. This technology has already been introduced
in some office printers (the X-series – see http://www8.hp.com/us/en/ads/officejet-pro-
printers/officejet-x-series.html?jumpid=va_tai49bw67f and http://www.hp.com/united-states/campaigns/pagewide/media/4AA5-7513ENW_hires.pdf ). I leave it to readers to
delve into the X-series but the key points are speed, quiet (the ink-head does not move)
and a large ink tank, lower print per page costs; and potentially harder for 3rd party ink
cartridge OEMs to replicate. There are plenty of reviews of the X-series on technology
websites (search for ‘HP X576DW review’). [Technically the PageWide engine comes
from HP’s Color Inkjet Web Press which is a commercial (as opposed to corporate)
printer business so the technology is ‘proven’ in highly demanding applications already].
(m) I believe, there is a decent chance that the X-series could penetrate the corporate
market – if it does then clearly HP will cannibalise its laser sales – but the benefit of not
relying on Canon could be a positive impact on margin.
(n) The X-series is also the key to HP’s attempt to enter the office photocopier market; this
is a market of roughly the same size as the printer market. (Presentation from investor
(o) I appreciate that HP has failed in office photocopiers before but I think that the
Pagewide engine gives HP its best shot for a long time.
(p) The company has also launched an ink subscription service – ‘HP Instant Ink’ where for a
monthly fee it will post ink cartridges based on your usage (requires a printer that
communicates back to base). The key point for investors is that this increases the
probability customers will stick to HP ink rather than 3rd
party products. For the corporate market (and perhaps with half an eye on the photocopier opportunity) HP is
pressing ahead with ‘printing as a service’ (also known as ‘managed print services’ ie HP
takes charge of printers (and photocopiers) for a corporate and is paid per page – to be
fair HP is probably already global #2 in this but there is a new emphasis).
(q) There has also been a change in which channel partners can stock and distribute HP ink
(ahead of the split there were articles in the industry press suggesting HP was tightening
the distribution channel for ink). I believe that the subscription model will also mean
that over time the profit share between HP and the channel on ink will change. It would
not surprise me if ultimately HP ink will only be available directly from HP and only a
limited number of partners (like Nespresso capsules).
(r) Conversations with IR also suggest that going forward some cartridges will be
regionalised (ie a US cartridge will not work with an European printer or vice versa) – if
this occurs it is likely to reduce grey market parallel imports and sales and thus make the
economics of third party ink manufacturers harder.
(s) Also perhaps being missed by some investors is that some competitors – eg Xerox and
Lexmark have, over the last few years, withdrawn from parts of the market (particularly
the retail / inkjet markets). [Lexmark is currently under a bid from Apex Technology – a
Chinese 3rd party ink maker and Legend Capital – if this closes it may lead to some IP
cross licensing issues for the whole industry].
(t) In passing it is worth mentioning that HP has a market leading position in some niches
where it is continuing to grow eg ‘Design and Large Format Industrial Printers’
(u) In summary my variant perception for printers is:
a. A business with an IP / distribution / market position / branding moat
b. New technology (X-series) which potentially improves margins (no Canon
c. A potential to enter adjoining adjacencies (photocopiers)
d. A weak few quarters partially due to distribution in the ‘channel’ as a result of
the split and the ‘reconfiguring’ of the distribution of ink
e. Potential to improve sales (ie cutting out 3rdparty inks) due to (i) regionalisation
(ii) new technology (X-series) (iii) ‘instant ink’ (for retail market and small
corporates) and ‘printing as a service’ (larger corporates)
f. Reduced competitive intensity (Lexmark / Xerox and others undergoing a degree
of entrenchment)
g. The entry into an adjoining adjacency (ie photocopying) possibly offsets the
declining number of pages being printed in the traditional print business
h. The disappearance of $29.99 printers reflects management showing some
degree of rationality in capital allocation
i. Printing no longer being merely a ‘cash cow’ business
j. (Management would also argue that they lost market share in 2015 to their
Asian competitors due to a strong dollar – I have some sympathy with this but
not too much given; what would be intriguing would be to know the terms of
the Canon relationship and if it is impacted by exchange rates).
9. 3-D printing
a. Though many will include 3-D printing within the printing division I believe it is best
to separate it out when looking at HP.
b. HP has announced that it will be bringing 3-D printers to market shortly. It originally
announced them in 2014 but frankly I think that announcement had more to do with
senior management looking to find something to distract investors with (see
http://www.bbc.co.uk/news/technology-29817650 and
and http://www.it-director.com/blogs/louella-fernandes/2015/9/hp-multi-jet-fusion-a-game-changer-for-the-3d-printing-market/ )
c. I understand that the latest plan is end of 2016 / beginning of 2017 for launching 3-D
printers. Details of HP’s Multi Jet Fusion are at
http://www8.hp.com/us/en/commercial-printers/floater/3Dprinting.html .
Interestingly it appears to be aimed at the industrial customers. The key point to
watch as an investor will be if HP masters materials beyond thermoplastics – note
that in some documents the company refers to using ‘color, biocompatible, metal
and other materials’ in the future. (See
http://h20195.www2.hp.com/v2/getpdf.aspx/4aa5-5471enw.pdf and
https://3dprint.com/113630/hp-multi-jet-fusion-plans-info/ and
http://www.computerworld.com/article/3042983/3d-printing/hps-industrial-3d-printer-on-track-to-ship-this-year.html )
d. As an aside I would note that the CEO of 3-D Systems (DDD US), Vyomesh I Joshi was
previously Executive VP of Imaging and Printing for HP (2002 to April 2012 – source –
Bloomberg). [Hence my suggestion that acquiring 3-D Systems at some point in the
future may not be completely unexpected if HP needs new management and bulk in
the 3-D printing side]
e. My variant perception is:
i. Most investors have totally ignored any 3-D printing upside as ‘vapourware’
ii. I think for investors 3-D printing is a hidden ‘call option’. The amount of
‘noise’ that has emanated from HP suggests that it is a serious project and
potentially ‘revolutionary’.
10. Personal Systems
The Personal Systems division had $7.467bn of sales in Q1 (minus 13% y/y or minus 8%
currency adjusted with an operating margin of 3.1%)
Generally hardware businesses and in particular PCs are hated with venom by investors.
My variant perception is:
a. I have built PCs myself over the years and indeed at one stage tried to sell them. Actually
building PCs is easy – however designing robust platforms with ease of use is hard. Even
small things make a difference – eg at work we have a combination of Dell and HP
towers – the Dells have carry handles built into the case, tool-less entry, an easier to
navigate website and easier download of drivers etc – though those may appear small
points for an IT department such things make a massive difference. Despite my
background I gave up on my last home PC (homebrew) for an off the shelf Dell because
maintaining drivers was becoming a nightmare and the machine was becoming unstable.
b. Despite the above issue with my homebrew, the various PCs (homebrew, Dell, Acer,
Asus) at home upgraded to Windows 10 seamlessly except for an Asus All-in-One. This
highlights the issue of drivers and post-sales support.
c. For any business / corporate use the cost of a PC is only part of the total ‘lifetime cost’ –
and businesses therefore are careful in what they use. At the end of the last century
corporates would have considered Dell, HP, IBM, Compaq, Apple (in some industries),
Packard Bell NEC and Gateway. Now the roster for corporates (/governments) comprises
of Dell (taken private), HP, Apple and Lenovo (the ex-IBM business).
d. Similarly in the laptop market Toshiba and Sony have retrenched.
e. So similarly to the printer market the competitive intensity has changed. I appreciate
that there are a number of Asian names – such as Asus and Acer – and despite owning
PCs from both – I would question the depth of their penetration into larger corporates.
(There is useful market share data at
https://en.wikipedia.org/wiki/Market_share_of_personal_computer_vendors but it
combines the retail and the corporate market). Also see
http://www.idc.com/getdoc.jsp?containerId=prUS40909316 and
http://www.gartner.com/newsroom/id/3090817 and
f. After the Compaq acquisition I believe the HP PC business was badly run – I think my
frustrations hit an extreme when I found HP and Compaq products being sold side by
side with literally similar specifications in Staples but based on different designs. Also
there were occasions when HP’s website asked you to ring a contact centre to obtain
more information on a PC – and the contact centre would then tell you to go to the
g. In essence HP had become a ‘box shifter’ that was trying to saturate the ‘channel’ (both
retail and corporate) with products which were ‘me-too’ without any thought; and often
filled with bloatware (on the retail machines). Products were often also designed with
the lowest priced components (eg the difference between a quiet and a noisy fan on a
PC is literally a couple of dollars (probably less than a dollar at the OEM level) so why
incorporate a noisy fan?). A lot of HP products also were poorly supported in the field
(eg drivers which were hard to find, or ceased to be provided).
h. Over the last few of years, though it is a soft sign, my impression is that HP has gradually
improved on these issues. [As an aside I think Beelzebub ought to have a special place
put aside for the team that writes (or rather fails to write, fails to upgrade or maintain)
software and drivers for HP scanners and printers – and none of the soft signs apply for
any of these.]
i. The latest generation of HP machines appear to be finally allowing the engineering
talent at HP to bring out differentiated products – in particular the HP Elite, Envy and
Spectre laptops. I have too much grey hair to say there is an overnight revolution but by
moving the products away from competing on price but rather design and quality I think
there is a chance that HP can improve its margins. Consider for instance the following
from a review of the HP Spectre X360 – ‘With a starting price of $1,149, the X360 costs
around $400 more than similarly specced competitors like the $800 Dell Inspiron 15
7000 and the $700 Toshiba Satellite 15 P55W. However the difference in quality and
endurance are well worth the premium.’ (Source -
www.laptopmag.com/reviews/laptops/hp-spectre-x360 - note that the writer observes
HP continues to ship bloatware on its machines)
j. I appreciate Apple has control of its operating system, but the premium pricing of Apple
laptops and desktops has shown that (some) customers are willing to pay a premium for
k. Historically every new generation of Windows led to an upgrade cycle and a spike in PC
sales. Windows 10 was launched on 29 July 2015 – but Microsoft gave free upgrades to
Windows 7, 8 and 8.1 users. Furthermore the new OS did not require upgraded
hardware. Combining this with the increased use of tablets (some with detachable
keyboards) and phablets was, I believe, responsible for the decline in global PC units
(according to Wikipedia 2015 global PC units were 288.7M vs 315.9M in the year prior –
see https://en.wikipedia.org/wiki/Market_share_of_personal_computer_vendors ).
There also is a non-trivial impact from Google based ‘Chromebooks’ but I am not clear if
these units are included in PC sales or not.
l. In the case of HP, the split (which was well signalled) also probably (I cannot prove this
but various channel checks suggest this) led to the channel hedging their bets by running
down inventory. I think that this might be behind HP’s particularly atrocious
performance (see
http://www.channelregister.co.uk/2016/04/12/pc_market_shambling_towards_an_unquiet_grave/ )
m. Unlike most analysts I actually like manufacturing and PC systems businesses – as they
can, if run properly, with differentiated products have high asset turnover, limited
working capital and high returns on capital. I appreciate that the PC market is in decline,
but I think the launch of Windows 10 is also moving the PC market from a cycle driven by
new OS launches to one driven by a longer cycle (dependent on obsolescence). [HP
reported a cash conversion cycle of minus 15 days in 2016 – see slide 19 -
http://h30261.www3.hp.com/~/media/Files/H/HP-IR/documents/results/2016/quarterly-results/q1-2016-results-presentation.pdf )
n. I could argue that the ending of mainstream support for Windows 7 should lead to an
upgrade cycle for corporates but given that there will be extended support until 2020 I
think there will be a slow migration to Windows 10 in corporates over the next few years
(see http://windows.microsoft.com/en-gb/windows/lifecycle). I think the real drivers of
PC upgrades in the corporate sector will be convenience (more staff moving to 2-in-1
tablets / laptops), design (some staff are in the position to demand attractive laptops),
performance (SSDs provide significantly better performance than HDDs) and screen real-
estate (dual screens or 40” 4K screens – search for Philips BDM4065UC on Amazon) –
however there are plenty of corporate roles where a 1990s DOS based machine will
work perfectly well. Hence my view is that the global PC market will probably range
between 220 – 270M units per year in the future (totally finger in the air, assuming the
lifetime of PCs continues to length). [Incidentally I am finding Windows 10 actually
surprisingly stable – and easy to use].
o. Within the PC market a lot of smaller brands (or whitebox shifters) will suffer
significantly so I anticipate the bigger players to retain their market share and perhaps
even increase it (see http://www.theverge.com/2014/2/6/5385212/sony-sells-off-vaio-pc-division and http://www.alphr.com/news/enterprise/390874/toshiba-beats-retreat-from-consumer-pc-market and http://www.engadget.com/2015/12/24/fujitsu-spins-out-pc-division/ )
p. On the negative side I think HP still has work to do to ‘edit’ its product range and ensure
all products are targeted at specific applications / roles and are differentiated.
Furthermore the company frequently launches products that appear well designed but
are under-specified and then fails to follow through to develop the niche (eg the HP
MediaSmart Server – see https://en.wikipedia.org/wiki/HP_MediaSmart_Server ).
q. Thus in summary my variant perception for PCs is:
a. There is reduced competitive intensity with a number of competitors folding /
b. In the corporate (and government) markets there are only a very limited number
of serious players (in many tenders Lenovo will suffer because of its ownership
and Apple because of its non-Windows OS so in some corporate / government deals
the only two serious players are HP and Dell)
c. Good design and engineering, and product support can drive sales (and
improved margins) – HP appears to be finally understanding this
d. Windows 10 and the split has probably damaged HP’s distribution and some of
the channel destocked
11. HP Mobile
There has been some speculation whether HP is going to launch a new phone. It actually has
some experience in the area of PDAs / phones and tablets (see
http://www.phonearena.com/phones/manufacturers/HP ). I am sceptical that a HP mobile
phone will receive any considerable traction so I am happy to ignore this whilst accepting
the optionality.
12. Corporate Investments
There are elements of HP Inc that are ‘blackholes’ – one in particular is Corporate
Investments. This includes HP Labs but it is not clear to me what exactly HP Inc kept and
what went with HPE. The key point for investors is that R&D was $3.5Bn for ‘Old HP’ in 2015.
The ‘corporate investments’ unit also held various minority stakes in other companies. It is
not clear if this will bring out any surprises (eg some hidden asset sales) or it can have a
meaningful impact (in Q1 2016 HP reported non-GAAP operating profit of $100 for
‘corporate investments’ which was a meaningful 10% of total ‘key segments’ (ie printing and
personal systems (=PCs) ) operating profit of $1,016m. (Note that there were also some IP
sales which may have distorted historic numbers).
13. Valuation
I would like to be able to put together a financial model for the divisions of HP Inc – however
given the prolonged process of the split and my uncertainty of how bad the dis-synergies are
I think it is a futile exercise. I do not think it is as easy as taking historic numbers and
projecting them forward because if there is a true culture change then the company may
well abandon some markets (eg $29.99 printers) yet its margin could improve. The change in
competitive environment in both printers and PCs could also benefit the company
significantly. I also currently have some areas of major uncertainty:
o How will pension liabilities change in the future
o There have been some IP sales in the past – I am not entirely clear on what was
sold and the impact
o How important is / was HP Financial Services for PC and printer sales in the
corporate market
o The CEO is relatively unproven at this level
The company’s current guidance for 2016 is:
o GAAP Eps of $1.52 – 1.62
o Free cashflow of $2.3- 2.6bn
I am happy to take these numbers at face value for the moment. Given a share price of
$12.61 this implies a PE of 8.3 – 7.8x and a FCF yield of 9.3 – 10.5%. My view can be
summarised as ‘awful 2015, with possibly some self-inflicted goals, hence currently cheap
but with a number of embedded free call options and reduced competitive intensity – albeit
in declining markets’.
In Q1 the company paid a dividend of $221M ($0.124 per share – annualised yield of 3.6%)
and repurchased $797M of stock (67M shares). Though I generally prefer companies to pay
dividends rather than buyback stock (as usually companies buy above intrinsic value) in this
case I think the stock repurchased are value enhancing. Given the current market cap of
$21.77bn (1.7267M shares outstanding) the buyback is 3.6% of the share count.
I think it is not unreasonable to compare HP to the situation that Microsoft was in when
Ballmer left – ie a transaction from unit sales to an annuity stream (in the case of Microsoft
moving from selling Office to making it a subscription product; in the case of HP trying to
convert ink sales to subscriptions).
Given the current share price, and that the company is buying back shares I think the
downside is limited. With the current cash generation it is reasonable to assume the
company undertakes approximately $2 – 3 billion of buybacks over the next 3 years – which
(if the share price did not move) would be the equivalent of 10 – 12 % of the market cap. In
addition the dividend would return the equivalent of another 12% or so of the share price
over 3 years. However this is really a base case (say 24% return over 3 years so 8% per year).
It is clear that the company (/ management) believe that the cost savings from restructuring,
could start delivering soon. In a normalised year the management suggests it could generate
a free cash flow of approximately $3bn with 70% or so of this spent in buybacks and dividends.
On a three year basis this is extremely interesting as I think a turnaround would help bring the
multiple to nearer 10x together with the impact of a reduced sharecount making the returns
very attractive.
[It is worth reading the Q1 Conference Call transcript – in this the CFO refers to ‘normalised
annual free cash flow [target] in the range of $2.9billion to $3.2billion’. (See
http://h30261.www3.hp.com/~/media/Files/H/HP-IR/documents/results/2016/quarterly-results/q1-2016-results-transcript.pdf ).The transcript also implies that total
buybacks in 2016 could be $1bn (see Toni Sacconaghi’s question).]
However if the subscription ink business, the PageWide engine and the photocopier business
deliver over the next three years then the economics of the business could change
significantly. If the 3-D printing business also delivers and the PC business stabilises then I
think it is not unreasonable to anticipate the stock reaches $20 over three years due to
multiple expansion, increased cash generation and some market share gains. However the
precise path is hard to predict or model.
It is hard to use comparable multiples from other businesses to value HP. I appreciate Dell
(with revenues of $57bnin 2013) was taken private with an equity value of $20bn (in Oct
2013). However the printer business and market share is truly unique for HP. The
comparison also breaks down as Michael Dell clearly was capable of running the business
and the current HP CEO is not tested at this level.
I would also like to refer you to ValueGuy’s excellent write up of HP prior to the split on 11
Sep 2015. He provides a lot of valuation analysis that I could not aspire to beat – see
https://valueinvestorsclub.com/idea/HEWLETT-PACKARD_CO/137096 .
I would really appreciate views / comments from other members of VIC on this one – is it an
interesting value play / neglected ‘spinout’ or is it a value trap (and I am being too


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.


Market recognition of a business with leading global market positions, decent free cash flow generation (and potentially upside in a 'normalised year') with new products (X-series) driven by new technologies (Page Wide) which could enhance the margins of the core printer business. In addition a change in distribution of ink ('instant ink' / 'managed print services') provides visibility and squeezes out 3rd party manufacturers and potentially changes the profit share with the channel.

Possible excitment in the next 24 months if the 3-D printing entry delivers - some suggestions in industry that it may be revolutionary.

On the PC side the improvement in design may lead to better margins.

The CEO, though unproven at this level, might have longer tenure than the revolving door management style of recent years and be able to drive through a real strategy.

Finally annualising a terrible year where the channel is likely to have been uncertain and destocked is also likely to have help going forward.

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