Why Hewlett-Packard Company (NYSE:HPQ)’s Troubles May Not End With Breakup

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Hewlett-Packard Company (NYSE:HPQ) and Dell, long-time rivals battling challenges of disruptive technologies, are taking different routes to the future or so they appear to suggest. While Dell recently inked a deal to consume enterprise storage giant EMC Corporation (NYSE:EMC), Hewlett-Packard is about to split into two companies – both publicly traded.

In Hewlett-Packard’s case, the enterprise division will be separated from the personal computers and printer business and named HP Enterprises (HPE). The remaining business will become HP Inc (HPI). The breakup will formally happen on November 1.

The split of HP is aimed at increasing focus on core competencies, mitigating disruption from emerging technologies and tapping into the emerging technologies for new growth.

HPQ mocks Dell’s deal but still wants it to happen

Hewlett-Packard (the united entity) has already mocked Dell’s turnaround strategy, terming it a deal to nowhere. Dell is paying $67 billion to get hold of EMC, together with 80% stake in VMware, Inc. (NYSE:VMW), a more valuable system virtualization business.

According to HPQ’s CEO, Meg Whitman, who will head HP Enterprise post-breakup, things will not get better for Dell after the tie-up with EMC. Instead of Dell becoming a market taker, Whitman sees it turning into a market giver, and that could actually reward HP Enterprise.

At Hewlett-Packard, officials are hoping to complete its breakup of HP Enterprise and HP Inc in time to take advantage of the disruption in Dell that could trigger customer defection, especially in the storage division.

If Dell’s strategy isn’t fine, is HPQ any better?

The perception that has been created is that Hewlett-Packard Company (NYSE:HPQ) would reinvent itself into two stronger, independent companies after the November 1 split. While the breakup will certainly trigger some benefits, it is unlikely that HP Enterprise and HP Inc will suddenly sidestep all or most of the challenges they are currently battling as unified entities.

Cloud is one of the disruptive technologies affecting HPQ. Pressure from cloud will likely hang around even after HPQ’s enterprises business separates from the Printer/PC business. Perhaps for a short while, HPE and HPI may delay great disruption from cloud and other emerging technologies, but they will nonetheless stick around for some time.

PC/Printer noise

For a long time, Hewlett-Packard has looked to its PC and printer division for free cash flow. Although growth may be limited in the printing segment, it is likely to remain a cash cow.

However, the PC business is at far greater risk of growth deceleration and shrinking profitability, potentially hurting its cash flow contribution. First, PCs usually have longer replacement periods, which can adversely impact free cash flow from the business. Additionally, the rise of phablets (larger screen smartphones) and tablets is cannibalizing PC sales. In the enterprise scene, once a key PC domain, tablets are driving displacement. A confluence of these unfavorable factors in the PC market will likely live on in HPI and impact HPE post the separation because HPE will initially largely look up to HPI for cash.

The chart below shows HPQ’s annual cash position in the past four years:

1

Exposure to emerging markets

Hewlett-Packard Company (NYSE:HPQ)’s exposure to emerging markets, such as Asia-Pacific, is larger than its peers. On a good day, Hewlett-Packard generates above-corporate profit margins through its engagement with customers in emerging markets, especially the Asia-Pacific region.

However, on a bad day, weaknesses in the region can take a heavy toll on the company’s revenues and margins. Problems in Asia-Pacific could be compounded for Hewlett-Packard given that its breakup is coming at a time when the situation in Asia-Pacific borders on the negative thanks to China’s economic woes that are spreading abroad.

Impact of cloud on storage

Hewlett-Packard generates about 3% of its consolidated revenues from the storage market. However, its storage business is unlikely to escape cloud disruption, at least in the medium term. The rise of cloud and the transition to all-flash systems are likely to displace Hewlett-Packard’s 3PAR storage solution in the enterprise storage equation.

Threat of cloud to software application business

Sales of software applications contribute about 3.5% of Hewlett-Packard’s revenue. The rise of cloud services such as SaaS and PaaS don’t bode well for Hewlett-Packard’s legacy software application business. Enterprises are shifting to the cloud at a rapid rate, ditching legacy software solutions for more nimble, flexible and affordable solutions in the cloud.

Acquisition risks

Post breakup, there is a fair chance that the resulting HP companies will acquire to compensate for their various shortcomings. While acquisitions might add some important assets (technology and talents), any kind of acquisition comes with a certain level of risk. Integration is one of the challenges that companies meet after they acquire a new asset. History shows that many of Hewlett-Packard’s past acquisitions never happened smoothly, a problem that may carry into the resulting entities.

The other risk is that acquisitions predicated on desperation to catch up with the competition could fail to live up to expectations, be costly or unnecessarily disruptive. The two resulting HP businesses may not stay clear of these acquisition risks.

Acquisitions can also introduce higher headcount and factory operating expenses, thus neutralizing whatever revenue benefits achieved.

Possible routes to safety

Solid server/storage gains: Hewlett-Packard Company (NYSE:HPQ) could mitigate its pressure post-split if its servers and storage business successfully sidestep disruptions coming from cloud.

Resurgence of PC/Printer market: Hewlett-Packard could also avoid more pressures if its PC/printer business manages to defy pressures to a greater degree.

Avoid risky acquisitions: Hewlett-Packard could also sidestep troubles if it avoids rapid and large acquisitions that might suck its resources and live it high and dry.

International exposure: Because the economic cold in China is one of the sources of pressure in HP’s business, a faster economic recovery in China could see Hewlett-Packard escape intense pressure abroad, especially in Asia-Pacific.

Takeaway

Hewlett-Packard Company (NYSE:HPQ)’s move to break up may be bold, in the medium term it doesn’t look beautiful or brilliant.

Disclaimer: The opinions and data expressed herein by the author are not an investment recommendation and are not meant to be relied upon in investment decisions. The author is not acting in an investment advisory capacity, nor is this an investment research report. The author’s opinions expressed herein address only select aspects of potential investment in securities of the company or companies mentioned and cannot be a substitute for comprehensive investment analysis. Any analysis presented herein is illustrative in nature, limited in scope, based on an incomplete set of information, and has limitations to its accuracy. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings, and consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

Neha Gupta

Neha Gupta has been in the financial space for over six years now. Gupta earned her MBA degree from Symbiosis Centre of Distance Learning in 2009 and her passion for finance led her to pursue Chartered Financial Analyst (CFA) course. She has successfully completed Level II of her CFA. She is a veteran in article writing, which is depicted in her numerous pieces published on SeekingAlpha, Nextiphonenews, InsiderMonkey, MarketWatch, and Techinsider. Her crisp and eloquent writing finds its best place in Researchcows, where emphasis is given on developing rich content for various websites, products, business plans, trainings, and book writing.

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