HEWLETT-PACKARD PLANS TO SPINOFF ITS PERSONAL COMPUTER BUSINESS, STARTS SHAREHOLDER REBELLION, STOCK PLUNGES 20% ON FRIDAY

Investors abandoned Hewlett-Packard Co. after its plan to get out of the personal-computer business left serious questions about the technology company's strategy.

H-P shares plunged 20% Friday to $23.60, erasing about $12 billion in market value, and leaving the stock near six-year lows.

 

Hewlett-Packard's business and management moves can't seem to please its shareholders, MarketWatch's Dan Gallagher reports on the Markets Hub. Despite steps to try to streamline its business, shares were pushed lower a day after reporting it was spinning off its personal computer business.

It capped a tumultuous week for the tech industry, which began with Google Inc.'s surprise $12.5 billion purchase of Motorola's cellphone business, as Silicon Valley giants react to the shift away from computers toward smaller mobile devices.

H-P shocked investors Thursday when it said it is looking to sell or spin off its PC business, the world's largest. It also agreed to pay more than $10 billion for British software maker Autonomy Corp.

H-P's moves in large part reverse a controversial $25 billion deal it sealed nearly a decade ago to acquire PC rival Compaq Computer Corp. At the time, H-P ran into significant opposition from investors and even some objection from its own board.

Much has changed at the company since then—it has switched CEOs two times, and the current board is loyal to new chief Leo Apotheker—but it must again tame rebellious investors.

Pat Becker Jr., a fund manager at Becker Capital Management in Portland, Ore., said.

"They're damaging the business they're trying to sell."

Becker Capital Management held about 1.2 million H-P shares as of June.  He thinks H-P may have bungled its chance of getting a good price for its PC unit by disclosing its new strategy too early.

Mr. Becker said he's concerned H-P plans to let the PC division operate as a lame-duck arm for a year or more while it completes a spin off.  H-P felt it had to announce the plan as soon as the board approved it to comply with Securities and Exchange Commission disclosure rules, according to two people briefed on the matter.

H-P will decide on a course of action soon, but completing a spinout could take as long as 12 months, people familiar with the matter said. The new company, dubbed "Spin Co." within H-P, would need to assemble a board of directors and the tax implications of a separate entity would need to be worked out. In an interview Thursday, Mr. Apotheker said a spinoff could have tax benefits.

PC growth and profit margins were below all of H-P's other businesses, and getting rid of that business will let H-P focus on high-margin software and services, said Basu Mullick, a managing director at Neuberger Berman LLC, H-P's 25th largest shareholder. But he questioned the abrupt way Mr. Apotheker announced the new strategy.  He said.  

"Their communication definitely is not right, the way that they're handling it.  Obviously don't talk about it before you do it."

Another worry driving the sell-off: the Autonomy deal's price tag. H-P is paying an 80% premium for the British firm. It is paying more than $10 billion for a company with only about $1 billion in annual revenue.

Mr. Mullick, who said he was speaking personally and not for his firm, said he supports the plan to get out of PCs, but dislikes the Autonomy acquisition. He said.  

"It seems to me a destruction of shareholder value.  Leo has not delivered yet and he wants us to trust him with making an expensive acquisition."

Mr. Apotheker spent much of Friday talking to investors about the decision, as did finance chief Cathie Lesjak. Other executives have been explaining the move to customers, employees and retailers. Mr. Apotheker plans to travel to New York Monday to meet investors in person, and will hold meetings in London on Wednesday, said Bill Wohl, H-P's head of communications.

H-P is getting out of the PC business because it can't afford to invest in the consumer devices the unit made while also building out its portfolio of products for businesses, Mr. Apotheker said Thursday.

One problem the company faces is that splitting the PC arm away from the rest of H-P will likely make the PC division a less attractive business than when it was attached to H-P, said analysts, investors and tech-industry executives.

Many of the PCs H-P sold went to corporate customers who bought the computers as part of big bundles that included tech services and server systems, said Rob Cihra, an analyst with Caris & Co. On the consumer side, Mr. Cihra said, H-P got favorable deals with retailers because it also sells printers and ink through them. Without those ties, he said, the separate PC company may have a tougher time competing with low-cost vendors like Taiwan's Acer Inc.

Another difficulty has to do with component pricing: H-P gets bulk discounts on microchips and other items because of the scale afforded by its combined server and PC purchases. Without being tied to a larger company, the new company "may face higher component prices," said Bijan Dastmalchi, whose company, Symphony Consulting, advises tech companies on their supply chains and purchasing. As a result, he said, the PC division may be most attractive to a buyer already in the computer industry.

An H-P spokeswoman said the company may consider options to allow the spun-off PC maker to continue bulk purchases and collaborative marketing with H-P.

H-P's overhaul plan crystallized in recent days, said people familiar with the matter. The company had long discussed getting out of the PC business, but only started discussing it in earnest in the spring of this year, these people said, when it hired advisors to review the company's businesses.

In recent months, said a person familiar with the matter, Mr. Apotheker and other board members have been concerned that H-P shares "traded at a discount." They attributed this in part to confusion by investors about H-P's identity: Was it a consumer-focused PC maker or a vendor of corporate software?

Still, as recently as early spring, Mr. Apotheker was inclined to keep the PC business, said people familiar with the matter. But PC price declines and the newfound popularity of tablet PCs—an area where H-P failed to compete with Apple Inc.'s iPad—made it clear that staying in the PC business would push H-P "in a commodity direction," said a person involved in the discussions.

The board decided to get out of the PC industry, and members felt a spinoff would be "the easy move" to make, said a person familiar with the matter. The company could also sell the PC unit to a private equity firm or another tech company. The challenge, said two people briefed on the matter, is that H-P executives felt they had to announce the decision right away to comply with SEC rules, even though the announcement may make it harder to sell the unit.

In addition to being concerned about what a potential spinoff could mean for their jobs, some employees Friday criticized Mr. Apotheker's decision to kill H-P's tablet effort, which was based on software called webOS acquired last year when H-P bought Palm Inc. H-P introduced its first webOS tablet less than two months ago. "It takes the wind out of your sails when you throw in the towel after only 49 days," one H-P employee said.

COMMENTARY:   In a previous blog post dated August 20, 2011, I shared my views on HP's sudden and unexpected decision to dump their new TouchPad tablet computer.   In spite of the fact that the TouchPad received excellent reviews, and HP provided the TouchPad launch with a huge marketing push, the new tablet could not overcome several problems:  

• HP entered the tablet market dead last among major computer brands
• The TouchPad had only 8,000 apps compared to Apple 150,000 for the iPad. 
• HP was having problems convincing developers to develop more apps for the TouchPad's WebOS which came with the acquisition of Palm in 2010.  

The handwriting was on the wall when HP began discounting the TouchPad from $499 to $399 in early August, but this apparently didn't do much to increase sales, so the company pulled the plug and cut its losses. A sorry ending, but I agreed with the decision. 

HP executives and members of its Board of Directors apparently had apparently discussed the possibility of spinning off the PC business prior to the release of the TouchPad, but held off until the sales results for the TouchPad came in.  Truth be told, HP has experienced a steady decline in PC market share and profitability in the PC side of the business since 2009.  The bad news of the TouchPad was the final nail in the coffin.  Let's look at some numbers.    

• HP's global PC market share peaked at 19.3% at the end of 2009, but by the end of the 2010 it's market share had dropped to 17.9%.  HP's PC market rebounded to 18.9% in the 1st quarter ending March 31, 2011, but declined to 18.1% in the second quarter ending June 30, 2011.  HP has lost most of its market share to Toshiba, Acer and Lenova, and probably Apple.    
• For the fiscal year ending October 31, 2011, HP generated total revenues of $126.033 billion.  HP's computer systems group (PC's) generated revenues of $40.741 billion or 32.32% of that total, a 15% increase from the prior fiscal year.   However, out of HP's seven business groups, the computer systems group contributed only $2.032 billion in operating profits or 5.0% of the total ($14.4 billion).  Between fiscal year 2010 and 2009, HP's computer systems group operating profits grew by only 3/10th's of one percent.  
• For the 1st quarter ending January 31, 2011, HP generated total revenues of $32.3 billion. HP's computer systems group generated revenues of $10.449 billion or 32% of the total, but were revenues were down 1% from the same quarter 2010.  The group's operating profits were only $672 million or 6.4% of the company's total operating profits.
• For the 2nd quarter ending April 30, 2011, HP generated total revenues of $31.632 billion. HP's computer systems group generated revenues of $9.415 billion or 29% of the total, but revenues were down 5% from the same quarter 2010.  The group's operating profits were only $533 million or 5.7% of the company's total operating profits.   
• For the 3rd quarter ending July 31, 2011,HP generated total revenues of $31.189 billion. HP's computer systems group generated revenues of $9.592 billion or 31% of the total, but revenues were down 3% from the same quarter 2010.  The group's operating profits were only $567 million or 5.9 of the company's total operating profits.

Hewlett Packard - Global PC Market Share and Financial Highlights

 

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HP has been the victim of a slow recovery from the Great Recession, consumer frugality and a very crowded PC market characterized by a lack of product differentiation, product commodization and competition based solely on price.  Apple has first-mover advantages in the tablet segment with the iPad, and it has been next to impossible to unseat them.  

HP has always prided itself on the quality of its products and generally high profit margins, but the intense competion in the PC market has significantly grinded down its PC profit margins where they don't contribute much to the bottom line, although HP still leads in overall global PC market share. 

Although HP's stockholders are not very happy with HP's decision to spinoff the PC business, it's really a no-brainer when you review the numbers as I just have.   It's now a question of how much can they fetch for the PC business and who is willing to acquire a business with very low profit margins in a highly competitive marketplace.      

It's fun trying to determine a valuation for the HP's PC business, but I am willing to give it a shot.  

• Price Based On Earnings - Dell's market cap ($26.4 billion) is presently 10 times Dell's earnings ($2.635 billion).   HP's PC business generated earnings of $2 billion for the fiscal year ending October 31, 2010, and is on track to do $2.4 billion for the fiscal year ending October 31, 2011.  At a multiple of 10 times earnings, HP's PC business would be worth $24 billion. 
• Price Based on Revenues - HP's PC business generated revenues of $40.741 billion for the fiscal year ending October 31, 2010, and is on track to do about $39.5 billion for the fiscal year ending October 31, 2011.  Dell's generated revenues of $61.5 billion for the fiscal year ending January 31, 2011.  HP's PC business revenues are two-thirds those of Dell, so if you valued HP's PC business at two-thirds $40 billion, this works out to a valuation of $26.6 billion.  This is pretty close to HP's PC business valuation of $24 billion based on revenues.   

If you took an average of the above valuations, this works out to about $25 billion.  However, I don't think the PC business is worth that high a premium, so I am guessing more along the lines of $18 to $20 billion.  Let's see if there are any takers at that price range. 

In summary, HP's key executives and board of directors are making the right decision spinning off the PC business.  If HP is lucky enough to get $25 billion for the PC business, this will more than offset what they paid for Autonomy ($10 billion).  

Technology businesses are based on developing valuable IP, controlling industry standards, attaining first-mover advantages and developing disruptive technologies.   The PC market is fully matured with no differentiation, and economies of scale for a company like HP have hit the critical inflection point where there are no real advantages.  It's time to sell the PC business and as quickly as possible.   

Courtesy of an article dated August 20, 2011 appearing in The Wall Street Journal Technology