Friday, June 13, 2014

HP's Business Risks

The "Risk Factors" section of a company's 10-Q is almost always a cover the waterfront, throw in the kitchen sink list that, once drafted at the behest of corporate counsel, is too rarely refreshed.  According to the securities regulations, however, it must bear some relationship to reality.  In that spirit, we looked at this section in the company's most recent quarterly for Q2 2014.

If we are unsuccessful at addressing our business challenges, our business and results of operations may be adversely affected and our ability to invest in and grow our business could be limited.
Three broad categories are discussed:

  • Dynamic and accelerating market trends, but especially "the market shift to cloud-related infrastructure, software, and services, and the growth in software-as-a-service business models. After all, the CEO has said that this is the single most significant business development she has seen in her career. 
  • Major competitors, e.g. IBM and Cisco, are expanding offerings of integrated products and solutions.
  • Business specific competitors are targeting specific areas of HP's portfolio and going after new markets.
  • Emerging competitors are introducing new technologies and new business models
  • The final set of challenges "relates to business model and go-to-market execution."
The reference to business models is interesting: what does it mean?  It surely cannot refer to Software-as-a-Service, as this has been bandied about for a decade or more.  It also appears in relation to outside competition, and in the final bullet point as an internal challenge.  I believe that this could refer to the antiquated sales model in a large organization like HP, where sales forces are organized by consumer versus enterprise, by product, by customer size, geography, public versus private enterprise, and by product versus services.  Sales force effectiveness is often referred to in CEO code as "execution," which we have often heard from the CEO of IBM and the CEO of HP recently.  

Competitive pressures could harm our revenue, gross margin and prospects.
 "We have a large portfolio of businesses and must allocate resources across all of those businesses while competing with companies that have much smaller portfolios or specialize in one or more of these product lines. As a result, we may invest less in certain areas of our businesses than our competitors do, and these competitors may have greater financial, technical and marketing resources available to them than our businesses that compete against them. Industry consolidation also may affect competition by creating larger, more homogeneous and potentially stronger competitors in the markets"

This seemingly boilerplate paragraph addresses some of our repeated concerns.  HP's CFO has repeatedly made reference to decisions about share repurchases and other investment decisions being "returns based." HP's portfolio has some businesses that are being obsoleted by technological developments or changing customer requirements, e.g. UNIX based servers, developer reluctance to write new software for Itanium products, or lower demand for hardware being switched to cloud-based configurations. There is little reason to invest in these businesses from a returns standpoint.  The market will prune these parts of the HP portfolio.

There are other parts of the portfolio that HP should probably prune itself, like portions of Enterprise Services. 

HP has invested $1.4 billion through the first six months of fiscal 2014 for share repurchases.  There is no reason to make the suggestion that HP is at a disadvantage compared to competitors because it has to invest across a broader portfolio.  If "more homogeneous" competitors are potentially stronger, then surely HP can become more homogeneous, if the numbers and the customers will support this.  This shouldn't be a risk, nor should it be an excuse.  

Research and development expenditure of $873 million in 2Q 2014 increased 7.1 % year-over-year. Should it increase faster?  A big acquisition at this point, beyond the financial and integration risks, seems like it is unlikely to be successful because if the target had an entrepreneurial culture, it would have a difficult time maintaining that spirit in a behemoth that is in a continuing human capital restructuring that has just been extended.  

The post about 2Q 2014 is our jumping off point for this post, so have a look back. HP's evolution from this point forward has to move beyond quarterly guidance and forecasts.  The company is on a stable footing, and the financial risk has been sharply diminished, at great credit to the management.  However, from here it really has to be about a much more focused and clear picture of the future portfolio and investment requirements going forward.  

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