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HP: Grow UP, Already

Vitaliy Katsenelson's picture




 


Anger and frustration are the two emotions pulsing through my veins as I write this.  HP, once the symbol of innovation, is being dismantled by its high-pedigreed board and the CEO of the hour (I truly hope his tenure will be measured in hours, not years).  I vividly remember the early 2000s, when Carly Fiorina, then CEO of HP, engineered the HP merger with Compaq.  She argued that the merger was a must for HP’s future to be bright.  Walter Hewlett, the son of one of the founders, was publicly opposed to it, and I remember the drama of the proxy fight, the TV interviews and arguments from both sides, and the finale – Walter Hewlett lost and the merger went through.  But it was not the finale, because nine years and two CEOs later HP has announced that the PC business, the one it so desperately wanted just a decade ago, is too hard a business and that it will look for ways to get rid of it.  Almost in the same breath HP announced that it will kill WebOS devices, a business it acquired in April 2010 for $1 billion; and management, possibly missing the irony in those two announcements, went ahead and announced another acquisition, which this time will for sure transform the company.

HP will buy Autonomy, a UK software company, for $10 billion. I understand $10 billion doesn’t sound like a lot of money in today’s post-trillion-dollar-bailout world, but it is plenty for HP, especially considering what that money bought.  There are many ways to illustrate how expensive and meaningless to HP’s future this acquisition is: $10 billion is about a fifth of HP’s market capitalization, while Autonomous will contribute 0.7% to HP’s revenues, and 2.7% to its earnings; and HP paid 10x revenues and about 25 times earnings.

Leo Apotheker, HP’s CEO, bragged about Autonomy:

“Autonomy has grown its revenues at a compound annual growth rate of approximately 55% and adjusted operating profit at a rate of approximately 83% over the last 5 years.”

Keith Backman, a sell-side analyst from BMO Capital, asked a very pertinent question about Autonomy:

“… metrics that you threw out for Autonomy, particularly on top-line growth, included a lot of acquisitions for Autonomy. What’s the organic growth rate that Autonomy has achieved lately?”

Leo did not have an answer, whereupon HP’s stock started to drop.  HP had reported an OK quarter, expectations were already low (its stock was at about 6x times 2011 estimates, which remain intact), and Dell had already lowered guidance a day before; so no one was surprised when HP lowered its revenue guidance for 2011 by a few percentage points.  Management said that since it will pay for Autonomy from cash on the balance sheet, it will not be buying much of its stock in the near future, and then they mentioned that this acquisition will be accretive.  Yes, accretive!  Nothing to worry about.  This transaction is accretive only for illiterates in economics and those short on common sense.

HP is using cash on the balance sheet to pay for this transaction, and thanks to the Federal Reserve this cash yields zero and thus brings zero income.  As long as Autonomy’s income is greater than zero (I am oversimplifying a little) then it will be accretive (at least on a cash basis).  However, this assumes that HP’s cost of capital is equal to the return it receives on its cash.  Which is not the case, as that would ignore such minor details as the time value of money, inflation, the risk premium (after all, unlike the US government, HP cannot print money and doesn’t have nuclear weapons) and, simply, opportunity cost.

Any investment HP makes today should be compared against an opportunity set that includes its own stock, which at 6x times earnings results in about a 16% yield (cost of capital).  In fact, if HP used $10 billion to buy its own stock, its earnings per share and dividend would jump by 16%.  Autonomy will not be able to match this return, by a long mile.

I don’t need to have a great imagination to envision another conference call in August 2015, where a new CEO decides that the software business is too difficult, and HP needs to come back to its roots (maybe going back to making calculators) and will spin off the software business into a new company, take an enormous charge, and then maybe announce an acquisition that the same highly pedigreed board will rubber-stamp.

HP’s valuation has not changed that much – the PC business only represents about 16% of operating profit, so even if HP gives it away, earnings power will not decline greatly.  HP should still be able to get a decent price for it, as there has got to be a Chinese company out there swimming in US dollars that wants to put them to work before they become worthless.  HP’s core businesses, will be slightly impacted by the global economic weakness, but the company should maintain its earnings power largely intact.  Autonomy reduced HP’s value by about $3; but with my lack of confidence in management, I’d not buy HP at a P/E higher than 10, which would bring the stock to the mid to high 40s.

HP’s stock sold off not because the company disappointed Wall Street but because Wall Street grew tired of the overpriced “must-have” acquisitions.  Wall Street has smartened up and assumed that this acquisition, as with many other “transformative” acquisitions, will do nothing of the sort.  And so, today we are faced with a decision: buy, hold, or sell.  At 4.6 times earnings HP is not a sell; but considering that the company is still trying to figure out what it wants to be when it grows up, it is hard to add to our holdings of the stock; so unfortunately this company has turned into a hold.

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here.

Investment Management Associates Inc. is a value investing firm based in Denver, Colorado.  Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.

Copyright Vitaliy N. Katsenelson 2011.  This article may  be republished only in its entirety and without modifications.

 

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Sat, 08/20/2011 - 10:13 | 1580824 billsykes
billsykes's picture

They haven't been run right through the whole internet age. Carley was  a big steaming pile. I think that the game for these CEO's is to see how much money they can fuck out of the company before they get axed.
The average span of a public CEO is 2 years, 70% leave because they get fired.

Looking at it another way, the hardest thing they had to do in their careers is pick the phone and take a call from an executive recruiter, then make a call to their media adviser for prepping and their resume writer. These guys don't have the guts that any garden variety entrepreneur has, the guy who quits his job, the guy that risks everything for his vision of the future, who is tired of corporate ladder climbing.

None of these big public co. guys have any of their own money invested in the company and the board expects things to run the way the founder ran them? Not a chance.

 

Sat, 08/20/2011 - 08:47 | 1580701 Ungaro
Ungaro's picture

I am a 20-year veteran of HP, joined right out of college in 1979 and I was mighty proud to help it grow to be the "best managed company in the world". Alas, when you are on top, there is only one way to go. The corporate culture replaced the HP Way and morale went right with it. Marketing pukes replaced engineering leadership and the bean counters replaced the most skilled management team the world has ever known.

One stupid acquisition (Compaq) followed another (Apollo and ad nauseum). The bean counters waived their arms and blew a lot of smoke ("$40 billion brick wall", "must have a presence on the desktop" and crap like that) and refused to listen the voice of reason. Doing acquisitions has become one of HP core incompetencies, even though we invited John Chambers to tell us how to do it right. No one was willing to hear that Compaq was a horrible strategic fit for HP (low-cost, commodity manufacturing vs. high IP, value added content; Dell could make money even when selling everything at factory cost vs. HP being plagued with bloated and rapidly depreciating channel inventory, etc.)

I got so frustrated with the institutional stupidity that I quit and never looked back. It is a crying shame that a handful of Harvard MBAs can destroy a great company that two Stanford EEs built. HP has sadly become a follower, a "me too" company. The hard-to-measure value of innovation has been replaced by the easy-to-measure EBITDA. Need evidence? Steve Jobs and Steve Wozniak have brought their first Apple breadboard to HP's board and were practically laughed out of 1501 Page Mill Road. Marc Andreesen at the University of Chicago (Champaign Urbana) has brought a great peice of software to HP which he called the Mozilla web browser, the likes of which have never been seen before. HP executives could not see a way to monetize the invention.

A very sad tale of a once really great company. I still admire the leadership of Bill Hewlett and Dave Packard and genuinely respect John Young for his stewardship of a great legacy, and like Lew Platt for not screwing up the company. After Lew, all that could be heard is this great flushing sound...

Sat, 08/20/2011 - 08:22 | 1580683 Smiddywesson
Smiddywesson's picture

OK, with all this talk about Carly Fiorina as the shining example of what is wrong with corporate America, let us not forget the worst CEO in American history who pulled a chew and screw right after the tech stock bubble burst and spent the next ten years being lauded for his track record:  Jack Welch, CEO of GE.

Jack, author of The Jack Welch Way, and the icon of successful corporate management built GE Capitol and moved America's most successful and oldest surviving company into the financing business.  When the tech stock bubble burst, he saw the handwriting on the wall and retired with a ridiculously sweet retirement deal, leaving his successor, Jeff Immelt, with a company that was destroyed and $300 billion in debt.  You see, Jacko gambled GE to create a 20 year record of "success" and whebn those gambles ended in ruin, he split.  He never was a success, he was just a gambler and a fraud.  Complete idiots, of course, blamed Immelt and idolized Welch. 

To this day, Welch doesn't have the common decency to STFU and slither under a rock,  and he is still idolized by fools who deserve to lose every single dime they have.  For years, you couldn't turn on a television without seeing his deceitful lying mug.  Today, GE has been reduced to sucking Obama's cock for Washington handouts like a negative tax rate.  It is a smoking ruin.

Carly is nothing next to Welch.  He goes down in history as the biggest fraud in the whole corporate/market/fiat ponzi game.

Sat, 08/20/2011 - 06:27 | 1580565 Setarcos
Setarcos's picture

Top of my head.

HP mirrors the demize of the Washington Empire ... well not some remark plucked out of thin air, but I cannot be bothered to explain.

Sat, 08/20/2011 - 09:38 | 1580766 mikla
mikla's picture

+1, enough said.

Sat, 08/20/2011 - 03:59 | 1580471 The Peak Oil Poet
The Peak Oil Poet's picture

 

I started using HP calculating machines in the early 70's

fantastic quality and superb design - amazing what you could do with 49 lines of code

every HP device i have ever used has been of the best quality - i have an HP 350 DL as my home firewall running linux - never ever misses a beat - it's been running flawlessly and without a reboot for more than 5 years

their servers are still excellent - i'd hesitate to choose anything else - we have lots of them at work and everyone there would agree they are excellent

if not HP for a server then what?

 

as eloquent and timbered voices
lilted out their verse
a drunken long-haired patron stood
and threw curse after curse

http://thepeakoilpoet.blogspot.com/2011/08/great-australian-poem.html


 

Sat, 08/20/2011 - 01:08 | 1580321 tony bonn
tony bonn's picture

outside of the assholes at bank of america, hp has the most concentration arrogant smartasses in corporate usa...(of course i am ignoring warren buffet for the moment)

Fri, 08/19/2011 - 22:15 | 1579932 masterinchancery
masterinchancery's picture

HP is a printer manufacturer with pretensions in other areas.  The pc business is a commodity business in which only companies with low costs and smart management can survive.  HP flunked on all counts, and should never have acquired Compaq.  Note that Buffet got Berkshire out of the shirt business because overseas companies had inherently lower cost structures--the HP board took a decade to figure this out.

Fri, 08/19/2011 - 21:43 | 1579847 chrispycrunch
chrispycrunch's picture

Excellent piece of writing. I called HP a 'SELL' on a Seeking alpha article the moment I read about this mis-direction for HP.

HP clearly doesn't have the ability to navigate through growth or winding down legacy business.

BTW this author has a book called "Active Value Investing." It is a must read and is relevant to today's market and for the market over the next 10 years.

Sat, 08/20/2011 - 07:56 | 1580659 Smiddywesson
Smiddywesson's picture

Thanks for the advice on the book.  Everything I read by VK is good, so I'll pick up the book.

Fri, 08/19/2011 - 21:28 | 1579810 TerraHertz
TerraHertz's picture

The first company HP fucked was themselves. For those who don't know, Hewlett Packard started off as a manufacturer of high quality electronics test equipment. For eg see http://www.kennethkuhn.com/hpmuseum/  (Not my site, though I do have an identical cat, and some of the same gear.)

As an electronics engineer, for much of my life I worshiped HP test gear. In Australia, on a salary, most of it was unaffordable, so it was a love affair at a distance except where I got to use such gear through work. Then ebay came along and was usable for a few years... now I have about as much of it as I want - which is quite a lot.

While HP was still run by Mr Hewlett & Mr Packard, it was a good, sane company. The gear was built to last, and came with beautiful service manuals that included complete theory of operation, schematics, diagnostics and calibration procedures. Then the founders died, and the company gradually developed 'taken over by marketing dept and accountants' syndrome.

The first sign of rot was when they stopped including complete schematics in the manuals. All the better to make money on their service dept, and no doubt some lawyers argued against 'giving away company secrets'. Like anyone who really wanted to copy the stuff couldn't reverse engineer it anyway.

Eventually the company got a CEO who was a woman, Carly Fiorina, who was some kind of marketing droid. Probably didn't even understand what all that high tech equipment did, or who needed it. That division was hived off, to become 'Agilent' - who still make impressive test gear, but as for being able to maintain it for private use, forget it. It's gone totally corporate-stupid.

The remainder of the company seems to have no idea what it wants to do. Consumer ink jet printers, some pretentious networking gear, shitty laptops with built-in closed computing platform hardware... fuck that.

Also, any HP equipment that is a few years old - "no longer supported". Which means zero support, not even an archive of the original manuals as pdfs, and software sets. Companies that don't support their 'older' products should be given a lead implant in their corporate craniums.

Present-day HP can die in a fire as far as I'm concerned. But their test gear from the 70s, 80s and early 90s is still perfection. Plenty of it around, full manuals easily available via the net. Not from HP/Agilent of course. Apart from Tektronix, there's nothing else like that HP gear. I think of it as a sad remnant of a declining technological civilization; a memento of the days when engineering was done right.

In the context of the 'global cull - de-industrialize and de-populate' conspiracy theme, I wouldn't be surprised if HP management ever since misters H & P were deliberately using the company as a technological wrecking ball. I wonder what Autonomy does, that TPTB might be bothered killing off?

Sat, 08/20/2011 - 06:31 | 1580569 Setarcos
Setarcos's picture

Put a woman in charge of anything - except bra size and cosmetics - goodbye.

Sat, 08/20/2011 - 07:41 | 1580639 falak pema
falak pema's picture

That is uncalled for. I Cat Balou you on that. They can be good in the sack; other people's sack is where the slack becomes real whack in the divorce courts.

Sat, 08/20/2011 - 04:01 | 1580472 StychoKiller
StychoKiller's picture

I own an Hp1631D Logic Analyzer -- please tell me where I can find some info on how this instrument does its CRC calculations for GPIB data transmissions.  Look for my email at: http://www.frontiernet.net/~jimbot/

Hp does not use a standard algorithm for the CRC!

Sat, 08/20/2011 - 19:36 | 1582320 TerraHertz
TerraHertz's picture

Oh great. I have a 1630G logic analyzer, and lots of other HP GPIB equipment, that I'm planning to PC-interface as the workshop progresses, for a particular project. So, 'custom CRC' eh? Wonderful. I expect extracting that bit of arcana from the retro-computing circles will be an adventure.

I'll contact you.

As for HP vs Tektronix scopes, yeah. Tek were better. In analog scopes the 7000 series were brilliant. My all-time favorites, still. But my HP 54121T 20GHz digitizing scopes are pretty nice too. Except they are post-schematics, post-support, so if they die they are gone.

Sat, 08/20/2011 - 00:33 | 1580280 gmj
gmj's picture

HP had great test equipment, but their scopes were inferior to Tektronix, IMO.  Tektronix tried to compete with HP on test equipment, but I think HP was better on everything except for scopes.

Fri, 08/19/2011 - 23:28 | 1580145 dwdollar
dwdollar's picture

Sir, please file that with the other evidence of a waning civilization.

So...

Who's ready for football season?

Fri, 08/19/2011 - 22:45 | 1580014 High Plains Drifter
High Plains Drifter's picture

i always liked the older hp gear,  now everything is made in china and is total junk..... my brother in law works at compaq in houston. i used to go with him sometimes when he went over there and he showed me around. many of the buildings are vacaant. they just go around taking care of empty buildings. mostly all they do is make servers there now i think. that place used to be a shining ruby in houston's crown, but no more. the men who started compaq started it in their garage and then it became bigger than their wildest dreams and then they flat lined and then they were bought by hp. i always thought hp should not have bought compaq. waste of money if you ask me............oh well............

Fri, 08/19/2011 - 20:54 | 1579735 IQ 145
IQ 145's picture

I bookmarked your website. It's a bit startling such well written and well researched material on the web. I very much appreciated being able to read your article about Chinese Banking. Cheers.

Fri, 08/19/2011 - 21:05 | 1579760 Dick Fitz
Dick Fitz's picture

Thanks for the endorsement IQ- I've never seen this guy post on ZH (granted, I've only been coming here for about 6 months) but I've liked your posts and trust your judgment. I'll check it out.

Sat, 08/20/2011 - 08:02 | 1580664 Smiddywesson
Smiddywesson's picture

His work is interesting, and well thought out in my opinion.  I don't expect to agree with everything I read, but I have never seen anything he wrote that was dead wrong.

Fri, 08/19/2011 - 20:45 | 1579707 GeoffreyT
GeoffreyT's picture

Whenever someone mentions Carly Fiorina's name, they should take pains to point out that she threatened Deutsche bank with a loss of investment banking work unless their sell side research supported the HP/CPQ merger... and was stupid enough to do so on a line that she knew was being recorded.

For example, I made my view clear in Bye Bye Carly, You Hopeless Trout back in Feb 2005, and I always use Fiorina as the archetypal example of 'deal fever' CEOs that would rather grow the size of a company, than its EPS or gross margin... see for example Good To See from Jan 2005.

Nobody was surprised when that dishonest value-wrecking cunt decided to try to be a politician. HP has been fucked since the CPQ merger.

Sat, 08/20/2011 - 07:45 | 1580645 falak pema
falak pema's picture

I am always amazed that people won't give a true jucy cunt her due in a me too froufrou.

Sat, 08/20/2011 - 00:25 | 1580269 gmj
gmj's picture

GeoffreyT, may I suggest that you date your articles?  The calendar to the right shows the current date, not the date of the article's publication.

Fri, 08/19/2011 - 21:02 | 1579754 Dick Fitz
Dick Fitz's picture

Great observation about Cuntly Fiorina, and whenever she uses the "Former CEO of HP" title someone should point out how disastrous her management of the company turned out. She's an opportunist political hack and will hopefully fade into obscurity. Better yet, maybe she can become CEO of BofA or GS and drive them into the gutter as well.

Fri, 08/19/2011 - 21:44 | 1579854 MayIMommaDogFac...
MayIMommaDogFace2theBananaPatch's picture

My experience was that during Carly Fiorina's reign I went from something like 98% trust level in this company's products to ZERO.  This was due to a long string of problems with many different products: out-of-box quality problems or failures that were just too close to warranty expiration to view as anything more than disposable crap.

First it was "I will buy no more HP peripherals."

Then it was "I will buy no more HP computers."

Finally it was "holy shit, HP is now making garbage-laser-printers as well."  That was the final straw.

Yeah, Carly was awesome.  </vomit>

Sat, 08/20/2011 - 03:55 | 1580467 StychoKiller
StychoKiller's picture

I hope that Agilent Tech. will be able to acquire the Hp name/logo for a song after the bankruptcy.

Fri, 08/19/2011 - 20:29 | 1579682 max2205
max2205's picture

So Compaq is gone? No tablet. No PC's. Just overpriced printer ink? Maybe Ben will outsource dollar printing to HPQ

Corp Boards are the best of the worlds genius's NOT

Fri, 08/19/2011 - 23:24 | 1580123 High Plains Drifter
High Plains Drifter's picture

i used to love compaq portables with dual 5.5 inch floppy drives....

Fri, 08/19/2011 - 20:49 | 1579728 Bruin4
Bruin4's picture

I cant believe it, has anyone used an HP product lately? Absolute Junk all of it the PC's, printers , scanners pure crap. they all last exactly one year plus one day...

Sat, 08/20/2011 - 07:51 | 1580653 goldinpenguin
goldinpenguin's picture

I got one of their early netbooks, never worked well, no customer support, within about 60 days it was an expensive paperweight. I'm thinking they cut the quality out of their PC products to price compete with Dell and others and now that they've destroyed their reputation they plan to unload the whole PC business.

HP from Carly forward is one for the textbooks, Hurd saved the company and then got the death penalty for talking dirty.

Fri, 08/19/2011 - 23:25 | 1580136 High Plains Drifter
High Plains Drifter's picture

i was playing around with one of their tablets at office depot.  so you say total junk?  well so much for their tablets then....

Fri, 08/19/2011 - 21:46 | 1579858 MayIMommaDogFac...
MayIMommaDogFace2theBananaPatch's picture

Exactly my experience.  Thank you for that.

Fri, 08/19/2011 - 20:11 | 1579639 Zero Govt
Zero Govt's picture

Aren't you really glad HP has a non-Executive Board that put paid to stupid business decisions over the past 10 years?

Please remind me sometime what the non-Executive Board (useless crones for short), regulators, auditors/accountants and biz consultants are there for sometime! 

...layers of absolutely useless Western institutionalised fluff (over-paid crones moonlighting as safety systems) about to be blown away in the hurricane of 'The Greatest Depression'

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