First, the CEO quoted a statistic about the amount of information that mankind created since the primordial ooze until 2000, which I frankly don't remember; today, that amount of raw data is produced in one year. This theme was echoed by other executives, including by George Khadifa who heads HP's Software businesses. The context here would be that corporations need to store, protect, analyze and extract value from data mountains that are running on IT infrastructures patched together from the sixties through the eighties.
Within this lies the second theme, namely that IT is being reinvented in its mission, strategic importance, and in the way customers use it, pay for it, and in the way they select partners. Again, the "new IT" theme was consistently echoed by all the executive presenters. This all seems eminently plausible.
Meg Whitman's PresentationIn this five year turnaround, the first year was spent diagnosing the patient and building the foundation for the turnaround. After that, her focus was on fixing and rebuilding the company, especially the executive team. She characterized a good team as having the "right people in the right places with the right attitudes." That's an interesting triad, but it doesn't mention the right incentives, which are especially important in a large, sprawling organization like HP. The good news is that the CEO said that the current group of executives are a team, for the first time, and it is made up of the right players. That is no mean accomplishment and would seem to bode well for the future.
Meg Whitman said that FCF of $7 billion through nine months of FY13 and net debt reduction of $8 billion both exceeded the guidance ranges provided at the Analyst Day one year ago. The management team had done all they could to achieve the corporate financial goals, and to exceed some; she was happy with the performance, but she was now looking forward into the back half of the turnaround.
The CEO repeatedly talked about sales forces and their interactions with their customers. She has formed her opinions from, among other things, personally meeting with 1,000 major customers of HP, Overall the sales teams lacked focus, metrics, and the technology infrastructure to sell effectively to their corporate customers and partners. Increasing the quality of HP's interactions with its customers was overall the number one goal for everyone in the corporate leadership down through the next level of executive client-facing management.
She told a story about being with a top tier corporate IT buyer who said that she told her HP leader about some IT problems for which she was seeking a solution. The HP account leader said that she would go back to corporate and get some ideas. Before HP responded, the customer told the CEO that she had already received emails from two competitors asking to set up meetings with their senior technical people to talk about solutions. It was a small story, but it seemed to speak volumes about the inertia and bureaucracy within HP.
Execution, particularly in sales, both growing within accounts, and quickening new product introductions will be critical to fulfilling the shareholder value part of the turnaround.
The other big, recurring theme echoed by all the executives was that HP's future was going to built around four areas: Cloud, Security, Big Data, and Mobility. She felt that by offering devices, infrastructure, software and services HP was one of the very few players that could provide the new IT buyer with the whole spectrum of products, tools and services to help their businesses.
The CEO reviewed the major businesses. Enterprise Services, a $17.5 billion business (based on nine months, YTD), accounts for 21% of the YTD revenues but only 5% of the non-GAAP operating income. Whitman cited the inconsistent leadership, strategy, lack of EDS integration, and inadequate internal systems as the biggest reasons for its historically poor performance. This business needs some portfolio pruning, in my opinion, but the CEO said that there would be no major restructurings in fiscal 2014. The segment's non-GAAP operating margin was said to be at the high end of the outlook given at last year's meeting, but that doesn't change the fact that this is an albatross that needs to take flight. It clearly has the CEO's attention.
Whitman cited a pretty extensive list of new leadership within Enterprise Services, including executive promoted from within and new hires from Bain, Accenture, Microsoft, and Elastic Intelligence/BMC. The leadership group has pretty easy comps to have a strong 2014, let's hope that they get there.
Turning to the Enterprise Group, the CEO noted this is the group that this groups focus is to exploit the industry trend and customer need to build and support a converged infrastructure driven by servers which are increasing dramatically in power, with smaller profiles and lower power consumption. The Enterprise Group comes to the customer with products like the Moonshot server line, 3PAR storage solutions, networking, security, and data center management tools. Instead of selling a grab bag of discrete products, HP has reset their offerings into a platform called HAVEn for analytics. The two different capabilities are provided by Vertica for structured data and by Autonomy for unstructured data. For the nine months of the current fiscal year, Enterprise Group revenues are about $20 billion, with non-GAAP operating income of $2.8 billion. Enterprise Services, at some point after the ship is righted and the portfolio pruned, should probably be integrated into the Enterprise Group.
Talking about the competitive landscape, Whitman noted the growing population of single technology startups, along with the well known established players. Partners like Microsoft and Intel are now competitors both on devices, servers and services. Although she "likes" the assets at HP, she again mentioned the word "execution," which she said will determine HP's degree of success in monetizing those assets. She again reiterated the point that revenue opportunities were being missed at existing large accounts and with partners. Some of the customer feedback she received is that HP isn't attentive to the customer's thinking and slow to respond.
The response has been to arm the sales organizations with better tools, including Salesforce and Workday. Company-wide, everyone has a Top 40 pairing of opportunities by country, a Top 30 desired innovations for 2014, and a Top 15 growth markets in IT. All prospecting and market development work, whatever the business segment, will work of the same playbook, and these are expected to have the most financial impact on the CFOs goals.
George Khadifa's presentation on Software was a lot more sober and a little less energetic than the one he did upon joining last year. It is about a $4 billion on an annual basis this fiscal year. IT operations management is about 39% of the Software segment, applications delivery management about 22%, Autonomy about 23%, Security about 15%, while Vertica is about 1%. 51% of their business is built around software that supports and maintains IT infrastructure: it is recurring revenue. He characterized HP as a large SaaS player, noting that their business is larger than those of Workday and Splunk.
It sounds as if he is quite excited by Vertica, but it is tiny. It seems that Khadifa has his arms around Autonomy, in terms of getting them to focus their sales and product development efforts around fitting into the HAVEn platform instead of selling the next personal innovation of an engineer. Khadifa talked more like a corporate insider this time, and he seemed a bit weary from all the infighting and pruning he probably has to do to get this business as a real growth engine, given its relatively small size. I assume that Khadifa continues to report to the CEO as was announced at last year's Analyst Day.
I continue to believe that Meg Whitman needs more support around her if she isn't going to burn out on this turnaround. With the repeated reference to execution and the mediocre performance of sales teams, that's too much micro work to land on the CEO's desk, especially if she continues to interact with customers, partners, investors and the board. A stronger board could provide some counsel and support here, notwithstanding the two new members who are good for the long-term direction.
Overall, she describes HP as growing at GDP rates. Assuming little inflation, that could be 2-3%. Lest you think that's pessimistic, she also made repeated references to a balancing act of managing declining or stagnant business lines while feeding and investing in in the future growth drivers. That is very difficult for the managers of these empires to carry out, unless they think like a CFO or CEO. So again, if this lands on the CEO's desk, this balancing act of portfolio unwinding and growing is not easy at this scale, espcecially with the business segments being more inter-connected than discrete.
The research and development budget will be about $3 billion next year. There will be lots of back office upgrading of systems to manage the diverse portfolio, and these kinds of expenditures were cut off during the Hurd tenure.
Getting back to the GDP-like growth concept for the HP top line, the CEO said that this should be consistent with a 7-9% operating margin and an ROIC of 15-25%. With limited information and not a lot of effort, it's hard to see how one gets there with the current portfolio.
According to the slides from the CFO's presentation, Printing and the Enterprise Group together comprised 45% of the YTD revenue of $83.2 billion, and 77% of the non-GAAP operating profits. Enterprise Services and Personal Systems together, account for 49% of revenue and a paltry 14% of operating profit. Software is very profitable but only about 3% of revenue.
The CFO noted that the reduction in force announced over a year ago was stated as being from 29,000 employees plus or minus 15%; the final RIF will be at the upper end of the range. To date, 22,000 employees have left the company, worldwide. 2014 earnings will get an incremental $1.1 billion of benefit compared to fiscal 2013.
FCF for 2014 is projected at $6-6.5 billion, down from the nine-month pace of the current fiscal year.Earnings per share were projected in the $3.55-$3.75 range.
So the the stock appears to be selling at 6-7x its forward, adjusted EPS level, which is certainly distressed. The company could just continue to do what it said, and it could show significant gains from multiple expansion alone. A distressed P/E for tech companies at similar turning points would have been 10-11x.
The consensus which seems to have been a great guide for contrary action on this stock, is Neutral or Hold. I do wonder about the continuing focus on returning 50% or better of the FCF to shareholders through dividends and buy backs. Now that it's clear HP is not a distressed investment, why continue to act as if it's in liquidation? If there are investments to be made in 64% of the revenue that can be fed by businesses that generate 36% of the operating profit and are stagnant, why not invest what's needed to get out of the gate faster? Make the shareholder cash return a true residual. Invest in your growth, unless you really don't have clear projects or you don't believe in them. It may be splitting hairs, but I think not.
Whether one believes it or not, it is easier to understand what this company is doing and where it's trying to go than it is for that giant ball of yarn in Redmond. Congrats to HP for trying to be transparent without being blustery or self-congratulatory, like people in blue shirts at Microsoft.