HP Analyst Day 2013: Sober Optimism

HP's 2013 Analyst Day 2013 disappointed the worst skeptics, including those who boldly called for the stock to move to the mid-teens. Hopefully, that analyst's research director is asking some tough questions about the analyst methodology and model.  It was a solid presentation that raised as many questions as it answered. The management team's presentations were well drilled, and everyone hewed to the CEO's key themes.

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 Presentation

In 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.

The IMF Pulls the Rug from Under the Greek Government

I thought that it would take longer than a day after yesterday's post for the IMF to show its fecklessness as a global economic institution, but here it is from the Wall Street Journal. 

The Greek government, based on a projection from those clueless prognosticators at the IMF, will only hit a 2014 primary budget surplus of 1.1% of GDP compared to the 1.5% contained in the terms of the first bailout.  40 basis points projected difference and the Greek government and people will be thrown to the wolves and not receive a next round of funds from the troika, which in turn will freeze any other creditors from acting also.  Meanwhile "negotiations" with the troika over how to solve this problem will begin in the next few weeks.  

The Greek government has done more than any the French or U.S. governments have ever done: the Greeks have actually cut wages and spending and decreased the primary deficit in the here and now, not at some future time.  Addressing the collapse in tax revenue collections and longer term issues of economic and administrative reform haven't gone as well as could be hoped, but surely none of the core EU countries can point to the Greeks and say, "Let's show you how we slashed our central government budget and reformed our economies in two years."  

The Greeks are being very circumspect in their statements, but their frustration is very clear in the short quotes reported in the Journal. 

“The Greek government does not comment on reports from international organizations like the International Monetary Fund,” it said, adding that it refrained from commenting “even when this organization (the IMF) accepted [it made] wrong assumptions and wrong estimates in the drafting of the first Economic Policy Program for our country.”  Let's remember that the Managing Director of the IMF admitted they "had no clue" that economic fundamentals in Greece would deteriorate so quickly after the first bailout.

Yet, the Greek government committed itself to the austerity program and suggests that it might consider more measures, even with likelihood that the IMF's 2014 forecasts for the EU will prove to be too optimistic.  

What this set of announcements does is to raise the specter of another Franco-German confrontation about solutions to the Greek debt crisis, casting the Germans again as the bad actors for not agreeing to have their taxpayers contribute to the "solution." Here we go again. 

Revisiting the Euro and the Grexit

Less than a year ago, we expressed our doubts about the scenarios for Greek austerity.   We said, "It's hard to see a scenario continuing where the Greek government keeps wearing sackcloth and ashes, begging for more relief.  They can never achieve the 4.5% GDP target even in 2016.  What is the point of this two year long multinational charade?"

Now we know that the Directors at the International Monetary Fund, when they implemented the Greek bailout in May 2010 knew that it was a charade, based on minutes of meetings viewed by the New York Times.  According to the Times, one-third of the forty voting Directors worried about the "immense risks" of the bailout, and the consensus was that it would not be feasible without demanding concessions from the creditors.  This demand was never put on the table.  Why?

French banks, like BNP and SocGen, and German banks like DB and Commerzbank were among the largest private creditors to Greece and didn't want to take the balance sheet hits at a time when capital adequacy and the need for bigger equity cushions might be demanded of the banks.

So, Dominique Strauss-Kahn opined, according to the Times, that there was "no doubt" that the Greek bailout would succeed.  He was not available for comment. Christine Lagarde, the IMF's Managing Director since 2011, had her eyes on that prize and needed to have a public success, even if was doomed to fail. When asked about the failure today she notes, "We had no clue that the overall economic situation was going to deteriorate as fast as it did."  It's nice to admit that you were clueless, but it's also hard to believe.

The Greek GDP has contracted by 20% since 2007, according to the Economist.  The austerity programs took the primary budget deficit (w/o interest payments) from 10.5% of GDP in 2009 to 1% of GDP in 2012. The revival of the economy can't come from the consumer sector, as the Greek unemployment rate of 27.2% is the highest in Europe.  Exports can't make up the difference, nor can increased direct private investment because of an antiquated Greek legal system that doesn't offer adequate protections.  The Greek bureaucratic logjams in the ports has been relieved, but it's still not on a par with those of the core countries.

As reported in the Wall Street Journal, Citigroup's economic forecasts for Greece are disheartening, and on another planet from those of the IMF, the ECB and the EC.  Citigroup sees the Greek GDP contracting by 11.8% in 2014.  They may be directionally correct, but let's hope that they are being too pessimistic.  There will be political blood in the streets under this scenario.

What are some of the reality bytes from all this?

• The European monetary system still has fundamental design and execution flaws that make it unstable in most environments;
• It offers peripheral members few real benefits except access to easy credit; 
• Unless the peripheral countries undertake real economic reforms, the austerity medicine may make the patient better, if it hasn't killed him first;
• French, European and Italian banks need to take their medicine and acknowledge the diminished economic values of sovereign debt on their balance sheets;
• The continuing struggle for EU power between France and Germany is very analogous to the struggle between our two sides in Congress.  Despite all the nice rhetoric and the ECB posturing, their divergent interests still limit the effectiveness of the monetary union. 

Checking In With Tech's Four Horsemen: HP

Let's recap in broad strokes how we got were we are.  Meg Whitman takes over as CEO, gets a brief honeymoon.  She eventually produces not only a clear, new strategic plan and resets expectations for a multiyear horizon.  From the fourth quarter of 2012 until recently, the stock goes on a tear from $12ish to $27ish, before pulling back testing the $20 support level.

The initial guidance strategy, depending on your viewpoint, was to take investor expectations to the sub-basement.  Another way of looking at it would be to say that management told it "like it was."  A multi-year turnaround.  Lots of industry and macro headwinds.  Lack of innovation and commitment to deliver new products.  Sales organization problems.  Executives in the wrong spots on the roster.  And so on, and so on.

The promised staff reductions came quickly, and the ramp up of this program caught some skeptical analysts by surprise.  Along with some one-time factors, good tax planning, and cash flow management, debt was paid down faster than expected and the share repurchases continued.  What was not to like about this?

We believe that the dysfunctional culture within HP and the organizational discouragement precipitated by the reigns of the imperial and imperious Mark Hurd and the clueless Leo Apotheker have gained traction and buy-in within the rank-and-file.  The new board members, given their stature and experience would certainly not have come on ship if they didn't fully vet the longevity and outcome of the turnaround.

So, here we are, but where is that?  The consensus view of analysts for the Analyst Day outlook revisions are that the company, which has already cautioned about no 2014 revenue growth, will revise this outlook down sharply, for both the revenue and earnings lines.  In other words, "No Expectations."

Targets have been lowered, and some analysts have projected a price decline to the mid-teens, post the revised outlook.

In the meantime, the company seems to have introduced both Windows and Android tablet lines aimed at the corporate accounts.  So, their stated intention of being the best, platform-agnostic supplier of hardware, software and services to global corporate accounts seems well underway.  That's pretty encouraging.

As we've said before, there is still some significant portfolio optimization to be done, e.g. on corporate technology services.  Lowering expectations would give good cover to announce this now, but I'm not sure that it's on the radar at the moment.  Not a big deal.

Given that Dell has shot itself in the thigh with its acrimonious deal that couldn't have given its customers or employees much comfort, HP's visibility with corporate accounts should continue to increase.  That's good.

So, we definitely go into Analyst Day, with "No Expectations," which is okay, and we return to the Stones for a closing serenade,

Bill May Return to Microsoft, or Not.

With all the hot news stories--like the budget deal and the Middle East--cooling into sludge, it's the moment for the New York Times to opine about the "widespread fascination" about the future role of Microsoft Chairman Bill Gates.  The story tries desperately to titillate the reader about Mr. Gates' increased presence at product introduction meetings.

On the other end of the spectrum, I have to applaud two institutional shareholders who, according to the New York Times, approached the company to have it consider having Mr. Gates relinquish his Chairman's position because it would inhibit a new CEO from adopting radical changes from the existing strategies that have cemented the company's role as a tech follower, and a mediocre one at that.

I don't believe that either of the above two events will come to pass.  Mr. Gates is having too much fun with his philanthropic projects in education and global health to return to the drudgery of extracting this company from the mud and getting its culture jump-started again.  As a co-founder and large owner, he wouldn't countenance losing face by relinquishing the Chairman's role without some future bridge-building to a CEO whom he respects and who has produced some results.  Too early for this.

The CEO of Ford makes the current short list of successors to Steve Ballmer.  Sell the stock on the announcement of Mulally's appointment as Microsoft CEO.  Watch the exodus begin on the servers and tools sides of the business.  Damage control all around, because it makes no sense.  Nothing else looks new, except that people like former Motorola Mobility CEO Sanjay Jha don't appear on today's list.

On the Microsoft Surface side, it's interesting to hear some different views about the Surface RT.  About a year ago, writing about the launch, we made a couple of key points:

1. "The question now becomes, can they act like a consumer products company and tell their story to the customer?
2. "The cost of making every buyer happy is a better investment that buying back shares.  That cost is just another form of advertising and brand rehabilitation."  Can they commit to making buyers happy?

Unfortunately, the answer to both these questions has been "No."  We know that the company took a write-down, forget that.  Some British IT users call Microsoft's marketing of the Surface RT "absolutely shocking," which in American English would translate into a profane phrase.  Why?

We've written before that most people still use their iPads as photo albums, video cameras, and places to find maps or restaurant reviews.  They are not productivity tools, and far from it.  The British buyers don't care about the shortage of "rubbish apps that you download and never use again."  Rather, they do like being able to use Office for document work and to connect easily to printers.  This indeed is productivity.  So Microsoft produced something better, but they didn't communicate to users what they had produced and why it was better.  

Now, they're going to cut prices and release Windows 8.1. Okay, but what about those people who took the risk first and got hosed?  Bill Gates should send everyone of them a computerized, hand written note saying, "You took a bet on us, and we let you down.  We've learned and I promise you that it won't be at your expense.  Come to a Microsoft Store, let us swap you out to a new machine, transfer your data to Sky Drive, and we'll give you a coupon for the price difference that you can use at the app store. Bill"  Let the accountants get busy. No one will care, except for consumers who would be shocked by a show of customer care, strength and confidence. It won't happen, but it should. 

Warren Buffett Follows Up With Michael Dell

Dear Michael,
I wanted to follow up on my last letter about your cramming down the SilverDell deal on your shareholders.
Listen, I know that you're very busy, and now that you're in bed with the private equity types you will truly see what "hell on earth" really means.  You'll long for the days with your fawning analysts and compliant public shareholders. Good luck with that project.

I wanted to follow up on the Goldman deal that I made, as I'm sure that you don't keep up with our picayune business.  To reiterate, I threw Goldman an expensive life line during the crisis, and this was to people who really understand what "expensive" means.  If I've learned one thing, it's that markets retrace from overshooting both ways.  You just have to be there with dry powder, make your deal and be patient.

Anyway, not to lecture.  Berkshire invested its $5 billion into the preferred shares and picked up $1.5 billion in dividends before Goldman redeemed the paper, paying us an additional $500 million.  Since the stock was about $160, well above the warrant strike price of $115, they came to Berkshire to offer us a deal for fewer shares without splashing out the cash.  The accounting treatment will be sweet, and the tax treatment even better, not to mention all the cash that's already rolled in.

Berkshire now owns 3% of the premier global investment bank, and I know that if they ever get their shorts in a knot again, the Feds will bail us all out again.  For all my railing about executive pay and CEOs paying more taxes, Lloyd Blankfein ,who like you knows how to pay himself well, works for me!  How sweet this capitalism is.  My shareholders love Charlie and I, while Llloyd's love him, and it's a love fest with Wall Street.

Which gets me back to Dell. Are your assets, namely your people, walking out the door as all the bureaucratic machines grind through getting your deal approved?  Was this mess really the best thing for your company? If you ever come back to the market to sell a public deal, wait three to five years so they won't remember who you are.  Wall Street is fickle and forgetful.

Unfortunately, I don't see Berkshire being interested in anything you're doing.  It's a pity.  But, you see I a make 8,000 meter mountains of money investing in things like banks, railroads, insurance, machine tool makers, candy and ketchup makers.  It's not as highfalutin as your tech world, but more profitable and more fun!

I'll look for you in the pages of Barron's, Michael.

My best,

Warren Buffett

Checking In With Tech's Four Horsemen: Microsoft

As the whole CEO succession debacle continues to unfold at Microsoft, I continue to be amazed at their inability to deal with longstanding, loyal, zero resource demanding customers like myself in a way that makes me feel good about our relationship.

I somehow got signed on for a trial subscription to Office 365.  I want to cancel and to find out how this subscription was initiated.  Emails, after a lengthy delay, generated a support incident link; clicking on the link in my Chrome browser generated nothing by a little X in the center of the white screen.  Lots of attempts to figure out how to change Chrome's settings to display the Microsoft page failed.  "Aha," I said to myself, "of course, the geniuses at Redmond want to thumb their noses at Google and at me to make me use Explorer as my browser."

Reluctantly, I open the resource hogging, hacker inviting, slow as molasses IE, and it too cannot display the message from Microsoft support!  More emails to Microsoft, using the address header eventually send instructions about going to "Internet Options," and authorizing Microsoft support twice as a trusted site, one on the support site, and a separate authorization for the secured support page.  Ridiculous, right?  This is their own browser and their own communication!  After doing this a few time, Explorer still can't display whatever it is Microsoft is trying to tell me.

A couple of times, the site displays, flashes suddenly and then displays an error about frames not being able to be displayed.  All of this because I want to cancel a subscription that I didn't intentionally order, if I ordered it at all.  The last thing in the world I want to be doing is to be figuring out browser settings on my time.

After no communication to resolve my issue.  I actually got a customer satisfaction survey about their support, without ever having resolved anything.  It is the first time in my life I ever filled out a survey with every answer being the most unsatisfactory level possible.  "How would you like to hear from us?"  Smoke signals would suffice.  A post card?  Weeks have gone by and nothing from the company that Steve Ballmer has led into the brave new world of technology.

It is going to be a great supplier of technology hardware, software and entertainment to the masses.  I don't think so because they have no idea what this involves.