Quick Thoughts: HPQ – Another 180 Degree Turn, But Still No Strategic Direction

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–           HPQ’s plan to split in two echoes EBAY’s PayPal spinout, completely repudiating its previous assertion of strategic synergies and capitulating to financial market pressure

–           HP Inc., the PC/Printer business, will be in long term decline, but could be attractive to acquirers looking for scale. Historically, it has been distinctly unsuccessful in entering growth markets.

–           Hewlett Packard Enterprise (HPE) is poorly positioned to compete for cloud services and will face serious deterioration in the demand for its in-house data center solutions going forward

–           More cost cutting or combining with another threatened data center supplier, like EMC, would do nothing to strategically reposition HPE for future success

Is there something in the water in Silicon Valley that is causing CEOs to do things that they had previously said they would never do? First Tim Cook’s Apple announces a phablet; then John Donahoe’s eBay decides to spinout PayPal; and now Meg Whitman’s HP announces a split into two. The moves come in increasing degrees of desperation – Apple finds some growth by finally giving its loyal users the top item on their wish lists, eBay gives Carl Icahn the top item on his personal wish list, and HP tries to make itself less unwieldy in case someone wants to buy a piece or agree to join forces as the ominous threat of the mobile/cloud era rolls in.

The rationale behind HP’s move is classic sum-of-the-parts – break off a business (HP Inc.) that is viewed as detracting from the value of the whole, and, VOILA, the bad stock price mojo follows the spin and the remainder gets a friendly multiple expansion. So HP Inc. gets a ~0.50 P/S ratio and trades at $15-17/share, ostensibly allowing HP Enterprise to break out to ~0.80 P/S and trade at $25-30. Meanwhile, breaking into two eliminates operating synergies and does nothing to address the substantial strategic threats that both of the businesses face.

The danger for PCs and printers has been apparent for a long time – it has now been almost a decade since IBM’s prescient sale of its own PC business to Lenovo. Although the pace of the decline has moderated somewhat – HP PC sales even grew 8% over the past three quarters – the future is a well accepted glide path. Arguably, a business like that can be run profitably and generate attractive cash flows, but the stock market has a long history of valuing declining annuities at a substantial discount. The hope for HP Inc. speculators will be that Lenovo or Dell swoops in to take it private, something that seems a reasonable possibility.

The HP Enterprise side is the more troubling piece for me. The Systems business, comprised primarily of data center servers, storage systems and networking equipment, has already slipped into decline, with servers leading the way. Services, mostly the former EDS consulting and outsourcing business, is also in full retreat, presumably failing at delivering the skill sets that enterprise IT departments need as they plot their transition to the cloud. This is just the beginning – Amazon Web Services, Google Compute Engine and Microsoft Azure have extraordinary scale, design and operating cost advantages, not just over in-house enterprise data centers, but over other less capable cloud operators (like HP) as well. For more details, read this piece (http://live.ssrllc.com/2014/08/august-19-2014-infrastructure-as-a-service-the-race-wont-go-all-the-way-to-the-bottom/) and this piece (http://live.ssrllc.com/2014/03/mach-2-2014-saas-after-the-levee-breaks-competition-in-software/). Amazon, Google and Microsoft will not be buying servers, storage or networking from HP Enterprise, and HP Enterprise will not be able to compete with Amazon, Google and Microsoft in the cloud. An oft rumored combo with EMC would not help to change the reality of industry sea change, even with control of the overrated and not particularly cloud friendly VMWare included. HP Enterprise may well get the hoped for multiple expansion out of the box, but the years of declining sales, profits and cash flows that lay ahead bode poorly thereafter.

Clearly then, I am not a big fan of Meg Whitman’s plan to cleave the sinking HP ship into two smaller, supposedly more nimble, but still equally unseaworthy boats. HPQ shares have had a very nice run, as management downsized itself into profits. Maybe the split will “unlock” that hidden value and give it another leg up. Go ahead trade it if you want to – just don’t start believing that it will turn the business around.

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