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Stratagem
 
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INTERNATIONAL : HEWLETT-PACKARD COMPANY: RESTRUCTURING
Is Apotheker destroying HP?
Nine months back, B&E had questioned whether Leo Apotheker was the right choice to fill Hurd’s shoes at HP (article titled, “Wrong person. Wrong place?”). With his recent announcement to restructure HP’s healthy business, the questions are back. Will his bet pay off; or is it a fatal move for HP?
Issue Date - 15/09/2011
 
A week before former SAP CEO Leo Apotheker was set to assume the corner office at HP’s Palo Alto headquarters (on November 1, 2010), B&E had put forward two forecasts for HP. First, was an adoption of inorganic means to grow in the enterprise space. [Claim #1: “What is inevitable, is that HP under Apotheker will join the battle to capture the enterprise space from the likes of Oracle and IBM. This would call for an expensive acquisition.”] Second, was a tamper with HP’s old order – the hardware business. [Claim #2: “He (Apotheker) has options. The most irresistible one will be not to tamper with HP’s pride – its hardware business – which he will.”] Both became reality on August 16, 2011, when HP announced the purchase of LSE-listed software-maker & cloud-search specialist Autonomy for $11.69 billion and decided to spin-off (and put on sale over the next 12 months) its $40.74 billion-a-year topline earning Personal Systems Group (PSG unit that includes hardware – PCs, tablets & mobility devices).

Many claim that such a prediction would have been easy. Not so. Even as recently as April 2011, Apotheker was heard singing hymns about HP’s webOS and how it would make up for the core OS on all HP PCs shipped post-2012. In fact, it was only on July 1, 2011, that HP’s tablet – the TouchPad – was launched. The company’s announcement to therefore acquire Autonomy and pull the shutters on hardware is a sign that Apotheker was undecided until the first week of August 2011 (when it announced a discount of $100 on all variants of its tablet to clear out inventory), whether or not he was to adopt enterprise software & services as the sole breadwinner for HP. Now that he has made a public appearance on the subject, question is – will this decision work in favour of HP?

The thoroughly flummoxed stock market thinks otherwise. In the trading session that followed this announcement, the company’s m-cap shrunk by $16 billion – the single-largest fall in a day since the Black Monday crash of 1987 (taking the tally of HP’s value destroyed by Apotheker to $47.52 billion in 10 months; under him HP’s m-cap as on August 29, 2011 had fallen by 47.47% to $51.48 billion). Frankly, the bourses have it rightly calculated. There are reasons.

Forget the risks. Even at face value, the Autonomy purchase is an expensive one. What logic explains the pricing of an entity, whose current revenue equals 1% of your expected annual topline (FY2011), at 13.12% of your est. revenues of $89.12 billion for FY2012 (as per Credit Suisse)? Even if paying a 75% premium over Autonomy’s closing price on August 15, 2011, is not an indication of the deal being overvalued, then a valuation in excess of 64x of Autonomy’s current P/E and 16x its forward revenue (for FY2011) surely is.

The purchase does carry an upside in the sense that it could provide exposure to HP’s enterprise software business (which currently contributes to 46.51% of its topline; FY2010), as well as a push into the analytics arena. But the opportunity cost renders the deal unappealing. What the Autonomy buy has in store for HP is better understood in the light of revenues that will be lost due to the coupling of this inorganic strategy with the hardware unit sell-off. Competition has lowered profits in the hardware business, but “brave” is the only adjective to describe the sacrifice of a business, where HP is currently the indisputed leader. Be it in US, EMEA or globally, HP controls the largest share in the PC market, across geographies (see chart titled “Global market shares of PC sellers”). Financially therefore, it is difficult to imagine a future without the PSG division starting FY2012. The revenues lost?

 
A $73.64 billion sacrifice at the altar of the enterprise software and services gods between just the two years FY2012-FY2013. Not to say that the hardware unit is not faced with greater competitiveness by the day, but to jettison it in a single shot is absurd. What makes us believe that HP’s most recent shot at restructuring (and Apotheker’s attempt to win over his shareholders) is more about hype than hope? Read the numbers.

Even if you were to go by the rate at which the contribution of hardware (PCs and mobility devices) to HP’s topline has been declining over the past half-a decade (4.09%; primarily because on one hand, while the former CEO Hurd focused little on innovation in the mobility platform, on the other, Apotheker, had little clue about what could potentially be done with a PC-plus-services portfolio), post sell-off of the PSG unit, the company stands to lose $400.74 billion in expected revenue earnings over the next 20 years (arrived at using a binomial regression forecast model; R2=0.99; Eq. y = -37.75x2 - 1395x + 42154). In stark contrast, the complimenting move of buying Autonomy – assuming optimistically that the entity’s current CAGR of 20% in revenues will be maintained – will end up adding $49.03 billion to HP’s topline over the same period. Translation: a direct loss of more than $350 billion over the next two decades! This comparison especially assumes importance considering the valuation of HP’s hardware business. Based on a review of PC focused peers (Lenovo, Dell, Acer and Asus), HP’s PSG segment could warrant a valuation of 0.3x EV/Sales (or 4.8x EV/EBITDA) multiple, which would put the pure enterprise value of the business at roughly $12 billion – the amount that is being spent on Autonomy to save its service dream. A bad bargain. The restructuring also brings to surface the inability of HP to keep its head above the water in a world of devices where convergence is the magic word. The company has made clear its intentions to wash its hands off webOS devices. The HP management has confessed that it lacks the innovation and the execution to become an Apple in any decade soon. Come Q4, 2011, and webOS will live no more. The webOS write-off will further put pressure on HP’s cost base, as there will be a $1 billion cash charge over the next quarter due to inventory clearance costs and supplier commitments with respect to the Touchpad tablet. In addition, there could be a non-cash charge at a later date if goodwill is marked down.

          

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