Revising HP Price Estimate Upward To $23

by Trefis Team
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Hewlett-Packard (NASDAQ:HPQ) is in the middle of restructuring its business to realign itself with the emerging trends in the technology sector. It has taken a number of steps to ensure that it bucks the declining trend in the PC hardware industry. While HP’s restructuring efforts will negatively impact revenue growth in the short-term, its focus on cutting costs by reducing redundant workforce will significantly impact the bottom line. Additionally, HP is reinvigorating its product lines by launching new products and increasing its R&D efforts. We believe that a product refresh will augur well for the company. Based on the initiatives taken by HP, we have upgraded our price estimate for the company to $23. Post this upgrade, our stock price estimate stands slightly below the current market price.

See our full analysis on HP

Short-term Revenues To Fall

Due to a weak macroeconomic environment, a slowing PC market and restructuring efforts, the company expects a marginal decline in revenue across all divisions. Based on these parameters we have revised our estimates to show a 9% y-o-y drop in revenues for HP. While we expect revenues from the PC hardware division to decline by over 13%, we project mid-single-digit decline in revenues for other divisions. We forecast HP to report $112 billion in revenues for 2013.

Restructuring To Boost Bottom Line

The company announced significant restructuring plans in May last year as it planned to simplify business processes and lower its sales and marketing expenses. CEO Meg Whitman, stated that while 2013 would be a year in which HP will fix its business, 2014 will be a year in which HP would see recovery and expansion. Since its restructuring announcement, HP has reduced its workforce by 18,800 employees, resulting in $2.2 billion savings in labor cost in 2013. The company plans to reduce its workforce by 27,000 by the end of 2014, resulting in projected savings to the tune of $3-$3.5 billion annually. We have factored this cost saving in our projected cost for 2013 and 2014. As a result, our stock price estimate for HP has increased by $1.

Increase in R&D Spend To Affect Margins

In the first half of 2013, HP increased R&D spending to introduce a new line of printers, Windows 8 tablets and cloud computing platforms. We are also forecasting an increase in R&D and IT spending in the near term. While we expect margins for the PC and printer division to shrink rapidly due to negative industry headwinds and increased R&D spend, we expect software and services division margins to decline marginally for our forecast period.

Key Drivers To Our $23 Price Estimate

Focus on High-end Printer and Supplies Market

The printer and ink cartridge division is HP’s third largest division and makes up ~20% of its value. According to IDC, global demand for printers is waning and the number of units shipped has declined over the past three quarters. [1] However, HP is focusing on the high-end ink market and commercial hardware rather than low-end consumer hardware.

In the first half of 2013, HP’s newly launched Multifunction Printers (MFP) for the commercial segment continued to gain traction with enterprise clients, and we expect MFP to bolster the printer division’s profitability going forward. Additionally, HP introduced its ink advantage program that targets enterprise customers in Q1 that led to stabilization in supplies revenue and growth in profitability. We expect HP to launch a similar ink advantage program for home and small businesses in the coming quarter. These programs not only increase sales, but also increase the average selling price of each hardware unit. We expect that these ink advantage programs will gain traction and the average selling price of supplies to decline at a slower pace in the future.

Focus On Converged Cloud Services

HP continues to report double-digit growth in revenues of its strategic enterprise services such as cloud, mobility, security and big data. [2] We believe that cloud services are potentially the biggest new revenue source for HP in 2013. The HP Cloud is based on OpenStack and is a direct competitor to Amazon Web Services. Some of the services are HP Cloud Compute, HP Cloud Object Storage and HP Cloud CDN. These services are based on pay as you go pricing. Converged cloud infrastructure built on technologies like converged storage, software-defined networking and Moonshot server will power cloud computing by seamlessly integrating big data analytics and security. HP announced several new cloud services and cloud professional services to bolster its cloud presence and feed business into its channel. It continues to work closely with its channel partners to improve their cloud go-to market and delivery capabilities.  While we expect HP services to continue to weaken in the remaining half of 2013 and report 5.5% y-o-y decline in revenues, converged cloud services will be the key revenue driver in the future.

Moonshot Servers and 3PAR Storage To Bolster Revenues

HP’s revenues from its industrial server segment continue to suffer in H1 2013 due to poor demand across all major geographies, continued macro pressure and an intensely competitive pricing environment. While HP continues to lead the global server market in terms of number of units shipped in Q2 2013, it is losing market share. However, HP recently launched its hyperscale Moonshot server to bolster its reeling industrial standard server division. We expect Moonshot to drive revenue growth at HP’s server division going forward.

HP acquired 3PAR in 2010 and this acquisition is beginning to bear fruit for the company. The converged mid–tier storage solution from 3PAR is in high demand. In H1 2013, revenues from 3PAR exceeded a $1 billion run rate. We expect 3PAR converged storage solutions to drive growth in revenue at storage division in the coming quarters.

Tablet Offering To Bolster PC Hardware Revenues

HP’s PC and workstation division is the fourth largest division, which contributes near 30% to its revenue and makes up 10% of its estimated value. Weak PC demand across the world continued to plague computer manufacturers as shipments declined. While we expect that the decline in the global PC market will continue to affect HP, we believe HP has taken some prudent steps such as the launch of new advanced thin clients at lower prices, to ensure that it maintains its market share.

Additionally, HP recently launched two variants of its tablets. The $169 7-inch Slate Tablet that is powered by an ARM processor and runs on Android, and the $699 11.4-inch Elite-pad that is powered by an Intel Atom processor and runs on Windows 8. The successful launch of tablets is important for HP as it not only addresses one of the biggest emerging opportunities in the hardware space, but also fills the missing product offering in its product portfolio. As HP is the one of the largest PC hardware manufacturers and has a huge institutional client base, the more powerful Elite-Pad is likely to be popular as productivity tools with institutions. HP can leverage its network to push sales of its tablets. We expect HP’s revenues for PC division to get a boost from tablets sale. If HP were to capture only 1% of the expected tablet shipments share, it can sell nearly 3 million tablets in 2013-2014. This could translate to around $600 million in revenues and $30 million (at EBITDA margins of 5%) in EBITDA for HP.

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Notes:
  1. Worldwide Hardcopy Peripherals Market Sees Year-Over-Year Decline in Both Units and Shipment Value in the First Quarter of 2013, May 15 2013, www.idc.com []
  2. 10-Q []
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