Sunday, October 5, 2014

HP Comes Full Circle

The whisper wire says that "Hewlett-Packard Plans to Break In Two." The stock has done well off its lows, and shareholders have been returned significant free cash flows through dividends and share buybacks, while corporate bondholders have also been satisfied with their holdings, despite some concerns about bondholder unfriendly payments from free cash flow.

So, we have gone all around the mulberry bush. In the first half of 2012, bearish analysts were calling for the sale of the company in parts, which they claimed would be worth more than the consolidated corporate equity's value at the time. This made no sense. Fortunately, neither the board nor management bit on the fire sale scenario.

The bullish analysts believed in the single powerful vendor selling the full line of hardware, software and services for the enterprise and for the consumer.  It wasn't obvious to us that sophisticated buyers would build their IT infrastructures on this "one stop shop" model, either.

It made more sense to us to focus on the financial stabilization, improvement of core metrics, and pruning the portfolios of marginal businesses, and focusing on faster innovation, even as the CEO touted HP Labs.

In the first quarter of FY13, we wondered if the realignment of some sector reporting pointed to future divestitures. But during the same conference call, we also noted that,
"The CEO clearly rejected any conversation on the call about breaking the company into pieces or divesting large businesses like Personal Systems and Printing."
In between these points, there were also regular allusions to the need for significant acquisitions, despite the colossal failure of the Autonomy acquisition.

So, today, coming full circle, HP has leaked the news that it will split itself into two companies: a PC/Printer business and an enterprise company, with the PC/Printer business being dividended to shareholders through a tax-free distribution.  Well, it isn't technically a divestiture. And, this way, the management of the PC/Printer business can continue to improve its business using the large free cash flows from printers and supplies, while eventually selling itself at a much higher price than would have been the case in 2012.

What is surprising is that the SEC/IRS would have agreed that the two businesses had been operating separately and distinctly from each other before the transaction.  The company itself said that HP was calling on global IT companies with one voice and one product portfolio.

Who gets the debt? Are bond covenants conveniently renegotiated?  What is the most important factor in the success of this deal going forward.?  The inter-company agreement must be thousands of pages long.  The settlement of the power struggle in the terms of the agreement will give important clues as to which company gained at the expense of the other.

The Journal's reports of customer comments like these are a sad commentary,

  • “What I really noticed is that they had not evolved their products, and they were not necessarily involving their customers, who wanted to help them.” Senior Data Architect, Coach, Inc.
  • HP has been slow to embrace the cloud, and it lacks certain capabilities of rivals.
  • "slow to react to market forces"
Selling the company for parts wasn't the right strategy.  Improving the company has paid off.  This latest announcement says that continuing the current operational plan would be a long slow grind. It will be interesting to hear management talk about how the two companies will work together, post the spin off. 

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