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
https://en.wikipedia.org/wiki/Hewlett-Packard_spying_scandal)
- 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
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
shareholders
(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
improvement.
(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
business….)
(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).