An Upward Revision Of Our HP Price Estimate To $30

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We have recently revised our price estimate of Hewlett-Packard (NASDAQ:HPQ) from $25.04 to $29.79. Despite this price revision, our stock price estimate is 28% below the current market price of $38. The company 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 stagnation in 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 has reinvigorated its product lines by launching new products and increasing its R&D efforts. We believe that a product refresh has augured well for the company as its share in both PC and printer hardware industry has improved. Based on the initiatives taken by HP, we have upgraded our price estimate for the company to $29.79.

See our full analysis on HP

Short Term Revenues To Fall

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Due to a weak macroeconomic environment, a stagnant PC market, a slowing printer hardware industry and restructuring efforts, the company expects a marginal decline in revenue across most of its divisions. Based on these parameters we have revised our estimates to show that revenues for HP will be flat for 2014. While we expect revenues from the PC hardware division to increase marginally by 2.8%, we project low-single-digit decline in revenues for some of the other divisions. We forecast that HP will report $111 billion in net revenues for 2014.

Restructuring To Boost Bottom Line

The company announced significant restructuring plans in May 2012 as it planned to simplify business processes, and lower its sales and marketing expenses. CEO Meg Whitman stated that 2014 will be a year in which HP would see recovery and expansion. According to its plans, the company is slated to reduce its workforce by 41,000 by the end of 2014, resulting in projected savings to the tune of $3.0-3.5 billion annually. Furthermore, its likely that the total reduction is expected to reach 45,000 to 50,000 by 2015 (i.e. an exodus of another 4,000 to 9,000 employees). The company expected this to create additional run-rate savings in fiscal 2016 of approximately $1 billion per year on top of what it previously laid out ($3.0-$3.5 billion). We have factored this cost saving in our projected cost for 2014 and 2015. 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 2014, HP increased R&D spending to introduce a new line of printers, Windows tablets, PCs 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 due to negative industry headwinds (price pressure from competition) and increased R&D spending, we expect software and services division margins to decline marginally for our forecast period.

Key Drivers to Our $30 Price Estimate

Focus on High-end Printer and Supplies Market: The printer and ink cartridge division is HP’s second largest division and makes up 22% of its value. According to IDC, global demand for printers is on the rise and the number of units shipped has increased over the past three quarters. [1] HP is focusing on the high-end ink market and commercial hardware rather than low-end consumer hardware.

In the first half of 2014, HP benefited from the ink advantage program that targets enterprise customers, which also led to stabilization in supplies revenue and growth in profitability. Additionally, newly launched color 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. The ink advantage 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 to Bolster HP Services Division: 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 the Moonshot server platform will power cloud computing by seamlessly integrating big data analytics and security. HP announced several new cloud services and cloud professional services based on its technology 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. Furthermore, the company has recently bolstered the HP Helion Network with several new cloud products and services. The HP services division contributes nearly 31% to its estimated stock value. Within this division, the three verticals (i.e., technology services, infrastructure outsourcing, and application and business services) provide cloud related services. This division and its three sub-divisions are expected to drive revenue growth for HP going forward, primarily due to the adoption of cloud services such as as the expanded Helion network by its clients. [3] While we expect HP services to continue to weaken in the remaining half of 2014 and report 5% year-over-year decline in revenues, converged cloud services will be the key revenue driver in the future.

Moonshot Servers and 3PAR Storage To Bolster Revenues: The Enterprise Group is HP’s third largest business division and makes up 20% of its value. Notably including HP’s Industry Standard Servers (ISS), the division reported 9% year-over-year growth in revenues to $3.09 billion in Q2 2014. The primary driver for this growth was average unit prices, which grew double digit year-over-year. However, the company continued to experience decline in its business critical systems division as revenues declined by 18% year over year to $233 million.

HP’s revenues from its industry standard  server segment continue to increase due to growing popularity of its x86 servers and its strong share. HP continues to lead the global server market in terms of number of units shipped in Q2 2014. However, continued macro pressure and an intensely competitive pricing environment will continue to temper revenue growth in the short term. HP launched its ultra-dense Moonshot server platform to bolster its hyperscale server sales. 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 2014, revenues from 3PAR exceeded a $1.4 billion run rate. We expect 3PAR converged storage solutions to drive growth in revenue at storage division in the coming quarters.

Tablet and New Line Of PCs 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 11% of its estimated value. Weak PC demand, which has plagued computer manufacturers in recent years, appears to be abating; PC sales in the recently reported quarter were up 12% year to year with the retirement of XP-based systems.  While we expect that the stagnation in the global PC market could continue to affect HP as the upgrade wanes, 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 new variants of its tablets. 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 one of the largest PC hardware manufacturers and has a huge institutional client base, it can cross-sell its tablets as a productivity tool to 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 and hybrids sales. If HP were to capture only 1% of the expected tablet shipments share, it can sell nearly 3 million tablets in 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 Maintains Its Growth Trajectory in the First Quarter of 2014, According to IDC, June 4 2014, www.idc.com []
  2. 8-K []
  3. Read more about how converged service will impact HP services division here []