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A Shrinking Giant - Analysis of HP's fourth fiscal quarter business results

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INDUSTRY TRENDS

Updated 11/23/09, 9:00PM HIT

Analysis of Hewlett-Packard's Fourth Fiscal Quarter Results

A Shrinking Giant

Services Only Major Line of Business That Appears to Grow; Like Gerstner, Like Hurd?

HAIKU, Maui, Nov 23 – The largest IT company in the world is getting...well, smaller!  For a fourth quarter in a row, Hewlett-Packard has been a shrinking giant.  Revenues dropped in double digits in all of its major product lines except for services (HPS).  And even though HPS grew ostensibly 8% to $8.9 billion in the last quarter, the 2008 fourth period included only two of three months' worth of EDS revenues.  So on an apples-to-apples basis, we figure that the latest HPS revenues actually declined about 11%.

As it turns out, even such a drop was actually better than the results of the rest of HP's major product lines.  Enterprise Storage and Servers (ESS) reported revenues of $4.2 billion, down 17%.  HP Software revenue declined 16% to $967 million.  Personal Systems Group (PSG) posted revenue slide of 12% to $9.9 billion.  Imaging and Printing Group (IPG) revenue dropped 15% to $6.5 billion.

It was not a pretty picture.  Yet HP's CFO Cathie Lesjak, called the results “solid.” She said the market in the United States, particularly in the consumer business, was recovering. She added the strength of a recovery next year was largely dependent on demand in Europe, which remains weak.

Undaunted by negative FACTS, Wall Street seems to be buying the self-serving executive OPINIONS lock stock and barrel.  The HP shares have been soaring over that of the larger markets and of the main rivals' in the last three months, as you can see from the chart (left).  In fact, HP just set a new 52-week high ($51.47, Nov 17), and are near a two-year high.  Evidently, investors are seeing something we don't.  Or are not seeing the things we've noticed about this shrinking giant.

Steep Cost Cuts, 3Com Deal: Like Gerstner, Like Hurd?

Yet HP somehow managed to grow its quarterly net profit by 14% to $2.4 billion.  How is that possible?  Steep cost cuts.  They are becoming a hallmark of the Mark Hurd administration, just as they were in the mid-1990s at IBM when Lou Gerstner was a the helm of Big Blue.  "Like father like son?," as they say.  Maybe like Gerstner, like Hurd...

And it's not just the cost cuts, nor the Gerstner-style "financial engineering," such as the miraculous HPS operating profit that went up by 53% since a year ago (click here for a detailed analysis).

Another thing that makes Hurd look more and more like Gerstner is the tripling of HP's stock buybacks.  The company raised its share repurchase plan today by $8 billion to $12 billion. About $4 billion remained of an $8 billion share buyback program approved in September 2008.

And again like Gerstner, who acquired Lotus in 1995, kicking off Big Blue's acquisitive binge, HP also expanding through acquisitions.  After gobbling up EDS last year, it announced earlier this month a $3 billion deal to acquire 3Com Corp.  As competition in the corporate data center is heating up and industry consolidation continues, HP is obviously trying to lower its cost of network solutions and beef up its offerings in a new market, yet one that will also help HP’s services business and not just hardware. 

"The No. 1 thing we get back from customers is they'd like us to do more, they'd like us to have a broader portfolio with more capabilities," Hurd said today.

Also, 3Com’s strength in China complements HP’s.  HP just reported a 20% surge in China revenues, a stark contrast to a sea of negative growth signs elsewhere around the world.  However, China also poses some new risks for HP now.  The country has its own very successful multinational networking company – Huawei.  China is very proud of Huawei.  And with good reason.  We have visited the company's HQ in Shenzhen and were impressed by Huawei's capabilities and global ambitions.

For example, Huawei had also tried to buy 3Com but was reportedly blocked by U.S. government on national security grounds. There is a possibility now that China may retaliate in a similar manner against this HP deal, given 3Com’s large R&D staff and business in that country. 

By the way, that's really something, isn't it, when a communist country lectures the self-appointed "leader of the free world" on free trade, as has just happened during President Obama's recent visit to China.  Furthermore, the Chinese might take a page out of the American playbook and go on the offense.

If we were in Huawei's shoes right now, for example, we’d be also looking for a Sugar Daddy with deep pockets and a global reach.  Big Blue comes to mind first and foremost.  The two companies already have a close business relationship.  Huawei is one of IBM’s major global accounts.  And the two have collaborated on some bids, even within China.  So maybe HP's China business won't be quite as quick and easy in the future as it has been in the past.

Business Segment Analysis

Services. HP Services revenue increased 8% to $8.9 billion. Infrastructure Technology Outsourcing reported revenue of $4.1 billion while Technology Services, Application Services and Business Process Outsourcing posted revenue of $2.5 billion, $1.5 billion and $778 million, respectively. Operating profit was $1.4 billion, or 16.2% of revenue, up from $945 million, or 11.4% of revenue, in the prior-year period.

Enterprise Hardware. As for HP hardware, storage revenue declined 20% with the midrange EVA product line down 23%. Industry Standard (Wintel) server revenue dropped 10%.  Business Critical Systems (Unix) revenue declined 33%, while blade revenue was down 8%.  Operating profit was $481 million, or 11.4% of revenue, down from $705 million, or 13.9% of revenue, in the prior-year period.

And it looks like things aren't going to get any easier for HP from now on.  IBM has just reduced the memory prices on its Power System p (Unix) servers by 28% to 70%.  This price action will bring the overall System p prices down by over 40%.  And even before that, IBM has been cleaning up in the marketplace against HP and Sun. 

As it announced the memory price action, Big Blue also said that "last month alone, 235 customers moved critical business workloads to IBM servers and storage systems from Sun and HP."  If such a mass exodus continues, Larry Ellison may end up with a nearly empty hardware shell after his acquisition of Sun in which Oracle outbid IBM last spring.

Personal Systems.  HP PCs posted revenue slide of 12% to $9.9 billion.  PSG Notebook revenue for the quarter was down 8%, while Desktop revenue declined 16%. Commercial client revenue was down 15%, while Consumer client revenue decreased by 8%.  Yet despite all of these PC lines pointing south, HP claims to be gaining share against its main rival - Dell.  But as usual, market share gains come at a price.  PSG's operating profit was $460 million or 4.7% of revenue, down from $616 million, or 5.5% of revenue, in the prior-year period.

Imaging and Printing. IPG revenue declined 15% to $6.5 billion. Supplies revenue was down 8% while Commercial hardware revenue and Consumer hardware revenue declined 32% and 17%, respectively.  Printer unit shipments decreased 20%, with Commercial printer hardware units down 38% and Consumer printer hardware units down 14%. Operating profit was $1.2 billion, or 18.1% of revenue, versus $1.2 billion, or 15.3% of revenue, in the prior-year period.   So HP's "cash cow" is still producing milk, but it needs a bull or two if it is to grow again.

Software.  HP software revenue declined 16% to $967 million. Business Technology Optimization revenue declined 16% and Other Software revenue declined 15% over the prior-year period. Operating profit was $234 million, or 24.2% of revenue, up from $211 million, or 18.4% of revenue, in the prior-year period.

Summary & Outlook

HP estimates full fiscal year 2010 revenue will be approximately $118 billion to $119 billion, up from its previous estimate of $117 billion to $118 billion. Full fiscal year 2010  EPS is expected to be in the range of $3.65 to $3.75, up from its previous estimate of $3.60 to $3.70.

For the first fiscal quarter of 2010, HP estimates revenue of approximately $29.6 billion to $29.9 billion and the EPS in the range of $0.90 to $0.92.

These estimates do not include the potential impact of the acquisition of 3Com Corporation that HP announced on Nov 11. 

Happy bargain hunting!

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