HPQ - Hewlett-Packard Company

[bmichaud]

It pains me to admit that I am associating myself with such an egregious violator of proper capital allocation, but at its current price and today's capitulation, my hand was forced. 1) Unlike RIMM, HPQ generates cash flow that one can reasonably project past a year, and 2) Unlike MSFT or CSCO, HPQ is small enough where activists could become involved, and given that the BOD is in shambles, there is a decent chance activists could get involved, push for a break-up, and sell off the pieces to private equity or strategic partners.

 

Discounting its cash by 100% and giving a 50% haircut to the Personal Systems Group, I can pretty conservatively get to $40 per share (see spreadsheet attached).

HPQ_Break-up_Analysis.xls

HPQ_Break-up_Analysis.xls

[Uccmal]

That seems reasonable.  HPQ has to be the poster child for bad management specifically at the BOD level.  They have done little right since just before the Compaq acquisition.  Why would Meg Whitman want to do this to herself?

[bmichaud]

It's a great question. Maybe sees it as a good challenge to fix it up. As Ackman says, I'm not sure it would be worth the return (or lackthereof) on invested brain power. The culture throughout the "old economy" tech co board rooms is truly nauseating. It's ashame MSFT has gotten too big for activism, because the opportunity to unlock value is so obvious.

 

Perhaps we can start a "reform old tech co" consortium on the Corner and get these board rooms to treat shareholder capital with some respect!

 

[bmichaud]

It's too big for PE in current form but not too big for an activist(s) and/or current shareholders to push for a break-up, which IMO would free it up for PE to get involved.

[eclecticvalue]

Hey here is my sum of parts valuation. I checked yours out and the intrinsic is on the lower end than what I had, also you do yours a little bit differently. I would like to get feedback on mine.

hp_charts.xlsx

[17thstcapital]

Are these models pro forma for the Autonomy acquisition and the related financing costs?  Not suggesting that it would change the thesis but it does appear to be an expensive acquisition at first blush. 

[bmichaud]

Hey here is my sum of parts valuation. I checked yours out and the intrinsic is on the lower end than what I had, also you do yours a little bit differently. I would like to get feedback on mine.

 

We differ on the following:

 

1. Corporate costs - the "corporate" category for HPQ fluctuates between positive and negative each year (at least per Capital IQ), so I assume its a wash and ignore it.

 

2. Pension - Probably to a fault I assume the "cost" of the pension plan is taken into account in SG&A, so I do not include in total debt.

 

3. Debt - I use total debt as oppose to just long-term debt (as it appears you do) or net debt.

 

Probably the biggest difference between our models is the use of an EBIT multiple. I'm not entirely sure what an appropriate EBIT multiple would be without looking at comps, so I generally try to come up with either a fair value PE multiple of earnings based on ROE and retained earnings, or a fair value TEV multiple of NOPAT based on a Company's WACC. The TEV/NOPAT approach ignores potential growth (i.e. it's similar to an EPV multiple of net income based on the cost of equity) thus I believe it is more conservative than coming up with a multiple containing a growth assumption. I would assume in a negotiated sale HPQ's cash flows would command a higher multiple than I'm assigning given the leverage a PE firm would employ or the synergies a strategic partner would realize.

 

Coming up with the various scenarios for EBIT margins is probably smarter than taking the 2010 margins at face value as I do, but I try to compensate for that by giving the PSG business a 50% haircut, not including cash, and using the above-explained no-growth TEV multiple.

[bmichaud]

Are these models pro forma for the Autonomy acquisition and the related financing costs?  Not suggesting that it would change the thesis but it does appear to be an expensive acquisition at first blush.

 

I took Autonomy into account by not giving HPQ credit for its cash.

[eclecticvalue]

Thank you for the feedback bmichaud. Also I am interested in hearing other peoples comments about the valuation. Are there any other ways of doing sum of parts valuation?

[bmichaud]

Thank you for the feedback bmichaud. Also I am interested in hearing other peoples comments about the valuation. Are there any other ways of doing sum of parts valuation?

 

Not sure if this helps, but another common SOTP valuation method would be to use comparable multiples from transactions for like businesses or multiples currently being assigned in the marketplace to like businesses.

[S2S]

Not to piss on others' parade but I've seen analysts touting HPQ stock based on pie in the sky SoTP valuation for years, periods where the stock traded in the 40s included. Given the dearth of buyers possessing both the scale and the desire to acquire a segment(s) outright, one has to wonder whether using "comparables" is merely an intellectual exercise.

[bmichaud]

That's exactly why I don't use comps - I hate comps. They have never made much sense to me.

 

HPQ, IMO, is in a valuation sweet spot where it's trading well below EPV based on current earning power, whereas buying MSFT at or above EPV subjects investors to leaning on growth to realize excess return.

[Josh4580]

http://www.bloomberg.com/video/76982346/

 

Ackman Says HP `Looks Cheap' But He Won't Invest

 

New financial metric- "return on invested brain damage"...interesting Sir Ackman

[tombgrt]

Seems like it is official now.

 

http://www.reuters.com/article/2011/10/27/us-hp-pc-idUSTRE79Q6VH20111027

 

Citing deep integration of the PC group in HP's supply chain and procurement, recently appointed Chief Executive Meg Whitman said the company was "stronger" with the unit.

 

Imo she is right but sjeez, what a bunch of idiots they have there. Wonder if they lost a lot of business and trust from customers.

[cmattporter]

Does anyone notice their Goodwill is $38,772 and their Total Equity is $38,823? A whopping 99.87%!

[rkbabang]

 

HP moves to revolutionize computing

 

"This would suggest HP is actually on the cusp of a revolution similar to the transistor. If properly executed, the new paradigm could put the company at the heart of an intense technology storm."

[SI]

I have been following this board for awhile and thought it was finally time to post an idea to get some feedback on a stock i bought yesterday.

 

HPQ has been very publically struggling following a bad acquisition and an accompanying CEO transition last fall which slowed their sales cycle. The morale interruption and capital destruction was incredibly painful for HPQ but has brought on the seeds of change with a new CEO and importantly an activist investor (whitworth) appointed to the board who can help steward capital allocation – an investor I have successfully co-invested with on prior occasions. HPQ is trading at 5.5x 2012 earnings or just 40% of the market multiple. It isn’t just a low multiple on earnings that we think is vulnerable to good news but also the earnings themselves. Today’s earnings are being generated off operating margins that are materially below historic levels which gives HPQ a target of earning 3% more off every dollar of revenue. As the company works to repair their margins, there are a few industry reasons to believe that their income statement can regain some footing with the easing of the Hard Disk Drive supply bottlenecks and the launch of Microsoft’s Windows 8 slated for this fall. So while this is a different type of investment than what I typically make as the company looks to rebuild its competitive position, I am comforted by the fact that their end markets are growing and that HPQ is throwing off $4.38 in FCF/share which is a 19% free cash flow yield.

Any thoughts?

 

[Guest valueInv]

Tablets threaten both of their biggest businesses: PCs and printers. People will not have a big need to print since tablets make documents, etc more portable. On the other hand, Windows 8 might give them a chance to get marketshare in the tablet market.

 

Also, I don't have a lot of confidence in Meg Whitman. She made some pretty big mistakes at Ebay at the tail end of her tenure.

[vinod1]

If you can assume that management is competent and motivated, then HPQ is cheap. I am not sure if they are either competent or motivated enough.

 

1. I do not know if Meg Whitman is really competent but I do not think there is enough motivation for her. She has billions, she tried her hand in politics, and she took a job that allows her to maintain high social status. I do not think she would have enough fire in her.

 

2. The same board that allowed all the bungled decisions to be made by Apotheker is there. They are provably incompetent and are still there at the helm.

 

3. Turnarounds take 3-5 years and HPQ has just begun this journey. So we might have lots of opportunities in future so it might pay to be patient.

 

That said, I have a very small amount of call options (bought before Leo's genius came to light) and watching the company and share price.

 

Vinod

[SI]

Good points but let me add a few things:

(1) The FCF I reference is Goldman's avg estimate for the past two years and the next two years.

 

(2) You say, "Everyone knows that turnarounds take 3-5 years and HPQ has just begun this journey." The words 'knows' is a funny thing.  It is almost price agnostic. In April 2010, the stock was $54. The price of risk assets are obviously up since then while those waiting for the turnaound have gotten impatient enough to move the stock into the $22s yesterday despite FCF of over $9Bn last year and next year according to neutrally rated goldman and a $45Bn mkt cap despite a balance sheet which is not at risk. In fact after the closed, they actually upped the dividend.

 

(3) Yes printing is worse but we got an ugly disruption when the world moved from desktops to laptops and also when the PC bundle ended. This business nor PCs is going to marvel the world but if you study history leaded gasoline at the end was a great business, just ask Nalco.

 

(4) As far as mgmt goes, I am no Whitman fan but I successfully coinvested with Whitworth in Genzyme, Home Depot and most recently CVS so i'll take my chances at a 19% fcf yield that we get more announcements like we did tonight. 

[Guest hellsten]

ValueLine projects 22-31% annual returns:

http://www3.valueline.com/dow30/f4341.pdf

 

Seth Klarman has a small, maybe 1-2%?, position in HPQ:

http://www.dataroma.com/m/stock.php?sym=hpq

 

There's another thread where HPQ is discussed, including a break-up analysis:

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/hpq-hewlett-packard-company/

 

HPQ is similar to DELL. Morningstar likes HPQ more than DELL:

http://quote.morningstar.com/Stock/s.aspx?t=HPQ

http://quote.morningstar.com/Stock/s.aspx?t=DELL

 

DELL has better management, almost twice as much cash (15 billion), and less debt:

http://financials.morningstar.com/balance-sheet/bs.html?t=HPQ&region=USA&culture=en-us

http://financials.morningstar.com/balance-sheet/bs.html?t=DELL&region=USA&culture=en-us

 

Both companies seem to understand that they need to increase their earnings from software and enterprise customers. IMHO, Dell understands this and the software business a lot better than HPQ.

[vinod1]

 

(2) You say, "Everyone knows that turnarounds take 3-5 years and HPQ has just begun this journey." The words 'knows' is a funny thing.  It is almost price agnostic. In April 2010, the stock was $54. The price of risk assets are obviously up since then while those waiting for the turnaound have gotten impatient enough to move the stock into the $22s yesterday despite FCF of over $9Bn last year and next year according to neutrally rated goldman and a $45Bn mkt cap despite a balance sheet which is not at risk. In fact after the closed, they actually upped the dividend.

 

 

You are making up words that I did not say.

 

Vinod

[SI]

Vinod - It was punctuated poorly, I apologize. You said, "turnarounds take 3-5 years and HPQ has just begun this journey." It is my point that it is a truism worth examining.

 

Regarding the comparison to dell which is trading at a hefty premium to hpq. Yes, dell has a better balance sheet but...

 

-Recurring revenue is 30% of sales at HPQ, much higher than dell.

-Dell is trading at a ~30% premium.

-It's businesses aren't as well positioned as HPQ.

-It has more public sector exposure than HPQ.

-Dell is later in its turnaround but its leverage to PC/peripherals/support is much higher than HPQ.

-Dell's turnaround took many years as did IBMs but Cisco's stock flashed into the 13s this year and its stock is now 50%+ higher than it was. It was a turnaround that people said the same thing about(For full disclosure I had owned both DELL & CSCO).

-Dell's turnaround was arguably much harder given it was solely a build-your-own PC company, this should be easier. Dell's supply chain/cash flow model/brand and go to market were all derived from that model. It's brand was primarily Michael Dell and PCs. HPQ means more. It is a brand that once meant innovation, we don't have to have people believe that again for the stock to have been a good investment.

-Last point, everyone knew M. Dell wouldn't sell the company. HPQ isn't going to sell to Dell(but at just a $15bn mkt cap spread it isn't insane that we could see a bid like MLM is making for VMC) but ORCL has had interest according to the New York Post and HPQ thought it was a real enough risk they hired Goldman to defend themselves. I am sure HPQ isn't interested in selling in the low $20s but it probably provides some downside support and with a figurehead CEO and an activist on the board - there is no entrenched mgmt like we saw at Yahoo. The other point the regarding the Oracle bid was that former CEO Mark Hurd(now president at ORCL) had a standstill in his severance agreement that prohibited such a move. That standstill period was reported to have expired last month.

[west]

Huh.  Not to create confirmation bias, but Klarman has a little more than 14% of his portfolio in HPQ.  Almost a 50% heavier weighting than his MSFT position, and a pretty concentrated bet for Klarman.  Now, given, I haven't looked to see if he's reduced his MSFT position from a larger initial stake since it's gone up, but still...

 

I still don't like the company, but maybe it's worth a second look.

[vinod1]

Huh.  Not to create confirmation bias, but Klarman has a little more than 14% of his portfolio in HPQ.  Almost a 50% heavier weighting than his MSFT position, and a pretty concentrated bet for Klarman.  Now, given, I haven't looked to see if he's reduced his MSFT position from a larger initial stake since it's gone up, but still...

 

I still don't like the company, but maybe it's worth a second look.

 

That 14% is only calculated for the publicly traded and reported portfolio. It is around 2% of his AUM.

 

Vinod