Annex Bulletin 2005-12                      April 7, 2005



Four Recommendations to Hewlett-Packard’s New CEO

Up Mount MarketCap

Rich Rewards Await Brave Visionaries at the Summit: Breaking-up HP Could Yield $27 Billion in Hidden Value, But It’s Not Only Way to Go

PHOENIX, Apr 7 – As Hewlett-Packard’s new CEO gets set to climb Mount MarketCap, it may be helpful for him to review some clips from our past expeditions.  We took them with Lou Gerstner and Dick Brown, former IBM and EDS CEOs in the 1990s (see “Gerstner: The Untold Story,” Dec 27, 2002).  Along the way, Mark Hurd may also consider some (not so) new ideas.

Does anyone still remember that in 1990 HP replaced IBM as the “most admired corporation in America,” according to the Fortune magazine?  If not, it’s worth recalling that.  Not so that now that HP is only seventh among its peers, it can lament lost past glory (see the Fortune chart; noting that NCR is two notches below HP!).  But to realize that as of 1990, IBM had already laid the seeds of its future success and comeback – services (see Industry Stratification Trend, Mar. 30, 1990).  There is no reason why Mark Hurd’s HP can’t do that, too.

Text Box: FORTUNE’s “Most Admired” 2005 Rankings
Industry Rank	Previous Rank	Company	Overall Score
1	1	IBM	7.61
2	2	Dell	7.46
3	4	Apple Computer	6.84
4	3	Xerox	6.67
5	8	Pitney Bowes	6.52
6	6	Canon	6.49
7	7	Hewlett-Packard	5.91
8	9	Sun Microsystems	5.81
9	10	NCR	4.92
10	5	Gateway	4.86

But it took more than a decade for the old HP to get that the ground was shifting.  The world was changing while HP was not.  And that is a mark of a follower.  “The scenery only changes for the lead dog,” any Alaskan musher will tell you.  The new HP CEO, would want to turn HP into a leader once again.  We suggest he make it his goal line.  So that’s our first piece of advice. 

Create New Winning Culture

Which means creating a new winning culture.  And what culture is that?  Well, if you go by the media reports, the HP culture has always been described as “collegial.”  Which means mutually respectful, collaborative, according to the dictionary.  But also uncompetitive.  And that is a problem in a highly competitive industry. 

How do you create a winning culture?  You start by letting all HP employees know that you have an open mind and that they won’t be punished for speaking up.

If there had been a problem with Carly Fiorina’s management style, it was that she, like IBM’s John Akers 15 years earlier, had thin skin and developed a “bunker mentality” in the last year or so, after she was pronounced one of the nation’s “worst CEOs” (see “Delivering Value Horizontally,” June 2004).  She proved it by firing summarily three HP executives in August of last year.  Only two months earlier, however, she paraded them in front of analysts and consultants as valued members of her executive team (see “HP Savaged by Wall Street,” Aug 2004 and “Carly’s Fickle Fans,” Feb 2005).

So the new CEO will have to let the HP people know that he won’t be playing the “blame game;” that he knows that there is no such thing as a wrong idea; only wrong facts; and that all new ideas are welcome and needed.  For, a winning strategy usually results from a competition of ideas. 

So “uncompetitive” is out; “open-minded” is in – should be the new business motto inside HP.

Stop Stock Buybacks

While our first recommendation – changing the HP culture – is a long and arduous process, our second one is a “no brainer” that can be implemented in an instant. 

Our Nov 2004 report, “HP Hits Home Run,” showed how much goodness there is still left in HP, and how Wall Street continues to miss the mark in finding and seeing the value inside HP.  But this report also pointed out some pretty wasteful HP practices, such as stock buybacks.  Any company that spends more money bribing Wall Street than on investing in its business deserves to see its stock flounder.  Because Wall Street will take your money and spit in your face, too.  So the fastest and the easiest way for Mark Hurd to become a real shareholder hero is to stop share repurchases  - immediately (also see “Corporate Cabbage Patch Dolls,” Nov 1998 and “Dell: King of Fluff,” Dec 1999).

Increase Shareholder Value

Increasing the shareholder value was the last on the list of attributes the HP board was looking for, according to what Patricia Dunn, Chairwoman of the Board, said as she introduced Mark Hurd as the new CEO.  We think it should be first, or close to first.  The reason is that HP’s is one of the most undervalued stocks in the IT industry.

Here’s what we said about it in “An Upside-Down View” (Mar 2005), a report on the Top 16 IT companies in the industry: 

“The value is there; plenty of it as it turns out in HP’s case.  But Wall Street is blind for looking.  Or it’s looking but not seeing the wheat for the chaff.  Either way, the HP shareholders are taking it in the chin.  Which makes this stock probably the most undervalued among the top 16.”


(An excerpt from “An Upside-Down View”, Mar 2005)

So how do you go about increasing shareholder value?  By forcing Wall Street to value your strengths, and by reducing or eliminating your weaknesses.  And how do you do that?  By breaking up the company and spinning off various units is one way.

If this sounds familiar to our old clients and friends, it ought to be.  It is the same recommendation that we made to IBM when its stock was badly undervalued, just as HP’s is today (see "Break Up IBM!", Mar 1996).  The main difference is that the break-up scenario in HP’s case in a little less compelling than was IBM’s nine years ago.  Back then, we said IBM’s market cap would double (it actually increased more than three-fold in the next three years – thanks to stock buybacks).

If valued at price/earnings and price/ revenue ratios relative to its peers in various industry segments, we figure that a broken-up HP could add about $27 billion or about 44% to its current market cap (about $63 billion).  That would move it up from dead last – as the most undervalued stock among the top 18 IT leaders (see the charts) – to No. 10, sandwiched between Microsoft and Oracle (not a bad place to be… J).

In terms of overall market cap, the broken-up HP would be the No. 4 company among the IT leaders, behind Microsoft, IBM and Dell.  Both Wall Street market rankings are about what you would think a No. 2 company in the business deserves, instead of being at the bottom of the stack.

But as we said earlier, breaking up the company is not as compelling an option at HP as it was with IBM in 1996.  The relatively modest (44%) stock price gain may be attainable by other means, too, while keeping the company together.  What’s important, however, is that the new CEO is willing to consider all options, including the break-up.  If for no other reason, that would be good for reinforcing the message that he is open-minded and welcoming of new ideas.

Reform “Schizophrenic” Board

As we said when we made our recommendations to Lou Gerstner back in 1993, firing a board of directors that hired you can be a challenge.  But it can be done.  Within three years, most of the John Akers-era IBM directors were gone.  Gerstner had his new board.

Dick Brown, on the other hand, did not follow that recipe.  So within six months of his first misstep, he was gone.  Carly Fiorina evidently misjudged the support she thought she had on the HP board.

We hope that Mark Hurd takes to heart these CEO history lessons.  For, “those who deformed us, cannot reform us,” read a hand-painted slogan on a Prague wall in 1989, during that country’s “velvet revolution” against communism.  IBM, EDS and HP boards were there when the CEO they picked and applauded made momentous judgment errors.  These directors were every bit as culpable, therefore, as were the CEOs whom they dumped so unceremoniously at the end.

“We’ve flogged this horse enough,” an exasperated President Dwight Eisenhower once quipped.  “Let’s get a new one.”

And now, the HP board has picked its new horse.  Here’s how Patricia Dunn, the chairwoman, described the qualities they were seeking in the new CEO:

“These criteria included operational strength, focus on execution and accountability, global experience, leadership ability, ability to lead high performance teams, technology knowledge, investor credibility, shareholder value creation (and) orientation, and ability to ‘hit the ground running,” among others,” she said during the March 30 Mark Hurd announcement teleconference.

What’s left?  Walking on water? 

The first thing that struck us as odd was that the HP board’s CEO wish-list read like a litany of Carly Fiorina’s (operational) shortcomings, as least as the board saw it when she was ousted (there was supposedly nothing wrong with strategy, only with her execution, we were told). 

That’s like closing the barn door after the horse has gone.  Modeling a job description after a person’s faults narrows the scope of possibilities and the range of candidates.  The new CEO will bring his own baggage that is different from that of his predecessor.  What if the new CEO were all operation and no vision?  (We are not implying that about Mark Hurd, whom we do not know… just pointing out the risk of allowing the pendulum to swing too far).  The HP board wanted a candidate who can walk on water but only gave him a bathtub in which to practice.

Hurd said during the March 30 introductory teleconference that there were no conditions imposed on him by the board.  He implied that he was free to choose any strategy that he sees fit, including an eventual break-up. 

If true, this is another turn-about-face by the HP board.  No wonder the Fortune magazine observed that the HP board acted “schizophrenically” – first zigging, then zagging – when it praised then fired Fiorina (see “How the HP Board KO'd Carly”).

Given such erratic behavior, the sooner Hurd gets some fresh new blood on the board, the better… both for him and for the HP shareholders.  Gerstner proved you can fire your bosses.  In the next 12 months, we’ll see how Hurd hurtles over such hurdles on his hike up Mount MarketCap.

Happy bargain hunting!

Bob Djurdjevic

For additional Annex Research reports, check out... 

2005 IT:  HP CEO: Up Mount MarketCap (Apr 2005);  EDS Booster Club Fees Rise (Mar 2005);  An Upside-Down View (Mar 2005);   The Worst of Both Worlds (Mar 2005);   Octathlon 2005: Accenture Wins (Mar 2005);  IBM Global Services: Smaller, Shorter - Better? (Mar 2005);  IBM 5-yr Forecast: Quality over Quantity (Mar 2005); Rumor Lifts EDS', Fujitsu's Shares (Mar 2005); Capgemini: Turning the Corner (Feb 2005);  IBM Servers to Grow Again (Feb 2005);  Carly's Fickle Fans (Feb 2005);  CSC: Gearing Down on Purpose (Feb 2005);  EDS: Grossly Overpriced Stock (Feb 2005);  IBM Historical Update: 2004 Shot in the Arm (Feb 2005); New HeadTurners Series #1 (Feb 2005); IBM: A Crescendo Finale! (Jan 2005); Accenture: Strong Finish, Better Start (Jan 2005); Annex Coverage 2004: IT Services Dominate (Jan 2005)

2004 IT: EDS: The Titanium Stock (and other Wall Street tales) (Dec 2004); IBM PC: Good Riddance (Dec 2004); Fujitsu: Recovery Continues (Nov 2004);  IBM Server Renaissance (Nov 2004);  HP Hits Home Run (Nov 2004); Capgemini: Revenue, Stock Soars (Nov 2004); EDS: Jordan's Swan Song? (Nov 2004);  To Russia with Love and $ (Oct 2004); IBM: Slow Quarter No Longer (Oct 2004); Accenture: Revenues, Profits Up, Stock Down (Oct 2004); Capgemini: A Takeover Target? (Oct 2004); Sellout of America (Oct 2004); Spy Wars (Sep 2004); Outsourcing Boomerang (Sep 2004); EDS to Cut Up to 20,000 More Jobs (Sep 2004); Capgemini Stock Plummets on Unexpected Loss (Sep 2004); HP Savaged by Wall Street (Aug 2004); Moody's Lowers the Boon on EDS (July 2004); HP: Delivering Value Horizontally (June 2004); Accenture: Revving Up a Notch (June 2004); Beware Your CFO! (May 2004)IBM: Changing of the Guard (May 2004); Capgemini: Texas-size Home Run (May 2004); Following the Money (May 2004);  EDS: On a Wink and a Prayer (Apr 2004); HPS Wins by a Nose! (Octathlon 2004); Accenture: Burning the Track (Mar 2004);  IGS: "Crown Jewel" Restored? (Mar 2004); HP: Still No Cigar (Feb 2004); Cap Gemini: Another, Smaller Loss (Feb 2004); CSC: Good Quarter Gets Boos (Feb 2004); EDS: "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); IT Industry: Whither Goeth It? (Jan 2004); Cronyism Is Alive and Well at EDS" (Jan 2004)

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Volume XXI, Annex Bulletin 2005-11
March 28, 2005

Bob Djurdjevic, Editor
(c) Copyright 2005 by Annex Research, Inc. All rights reserved.

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