How Will HP Look After The Proposed Split?

-35.04%
Downside
29.94
Market
19.45
Trefis
HPQ: Hewlett logo
HPQ
Hewlett

Hewlett-Packard (NASDAQ:HPQ) announced on Monday that it is splitting itself into two public companies, HP Inc and HP Enterprise. The spinoff has been fueled by the idea that companies with a narrower focus perform better. On news of the announcement, HP’s shares increased by almost 5% and the stock is up nearly 32 percent since the beginning of this year.

While HP Inc will focus on personal computer and printing operations business, HP Enterprise will focus on corporate hardware and IT services. HP Inc will be headed by Dion Weisler (current Executive Vice President of HP’s Printing and Personal Systems), while Meg Whitman will continue to head HP Enterprise division. [1] The company hopes to unlock value for shareholders by delivering products and services at competitive price points. In this note, we will look at the two proposed business units.

See our full analysis on HP

Relevant Articles
  1. Up 5% In A Fortnight, Can HP Inc. Stock Continue Outperforming The Market?
  2. What’s Next For HP Inc. Stock After Dropping 5% Last Week?
  3. Buy HP Inc. Stock For 25% Upside?
  4. Has HP Inc. Stock Peaked At $17?
  5. Here’s Why Hewlett-Packard’s Stock Could Touch $10
  6. Why Did HP’s Stock Price Grow 60% Between 2016 And 2018?

The HP Enterprise Unit

According to HP’s announcement, HP Enterprise unit will consist of its server, storage, networking, converged systems, cloud, software and financial services divisions. Currently, these divisions map onto HP Services, Server & Storage, HP Software, HP Networking and Financial Services divisions in our model. Together, these divisions make up 64% of HP’s estimated value. However, they contributed 53% ($59 billion) to total revenues and 56% ($6.1 billion) to earnings from operations in 2013.

One of the key objectives behind the split is to make HP’s different units more nimble, according to CEO Meg Whitman. These divisions are on the forefronts of technology in areas such as Cloud computing, big data, mobility and security, and require continuous investment, both organic and through M&A, to bolster existing product portfolios and innovate new products. However, governance issues with a large company make it difficult to drive innovation across so many verticals. For example, in the last decade, HP made numerous acquisitions worth tens of billions of dollars but failed to realize the synergies. As a result, these acquisitions haven’t had a significant positive impact on the company’s top line. By having a business unit that is less encumbered by debt, HP hopes to accelerate investments across key areas of the portfolio by realizing synergies  with existing and potentially new assets.

The HP Inc. Unit

HP Inc. division will consist of its imaging and printing group and personal systems group, and also retain the iconic blue and white logo of HP. Currently, these divisions map onto our Printer and Ink cartridge, and PCs, Workstation & Others division. Together, these divisions make up 35% of HP’s estimated value, and contribute 50% ($56 billion) to its total revenues. However, they have lower operating profit margins (8.7%) and contribute only 44% ($4.9 billion) to total earnings from operations. By clubbing PCs and printer businesses together under one unit, HP hopes to achieve synergies by cross selling its products to clients.

One of the key trends in the PC industry has been a decline in average selling price (ASP) of desktops and laptops over the past few years that started with the slump in demand of PC. As demand (both replacement and new demand) faltered, manufacturers engaged in price wars, that drove ASP lower. Since hardware is commoditized (i.e., it is difficult to distinguish amongst manufactures as similar laptops have similar technical specs), customers buy the cheapest option available. By hiving off its PC hardware into HP Inc., the company aims to drive innovation not only in the PC Industry, where it is second behind Lenovo, but also enable workers to seamlessly connect over multiple devices.

Printer division was a major source of profit for HP last year, as it implemented ink advantage program for medium and small companies. This division contributed nearly 80% to operating profit of the proposed HP Inc in 2013. Printing business has been stagnant for the past two years as more people are storing photos and files online, and view them increasingly on their phones and tablets. However, it has received a reprieve in the last quarter, buoyed by pent up demand in the commercial segment. HP has been innovating in this segment by launching low-cost multi-function printers (MFP), which enable a user to do multiple tasks such as copy, scan, print etc, that require less ink.

Furthermore, the company plans to cut costs by rationalizing resources in  the two divisions. We believe that the major cost saving for this unit will come from the consolidation of manufacturing relationships and distribution channels, which have fragmented over the years due HP’s policy of outsourcing manufacturing to contract manufacturers. [2]

The transaction will be effected through a tax-free distribution to HP shareholders, and is expected to complete by the end of FY15. The precise ration of new to existing shares has yet to be determined  as does the date.  We currently have $29.79 price estimate for HP, which is approximately 15% below the current market price.

Understand How a Company’s Products Impact its Stock Price at Trefis

Global Large CapU.S. Mid & Small CapEuropean Large & Mid Cap

More Trefis Research

 

Notes:
  1. HP Announcement []
  2. HP Shows How to Outsource Production While Keeping Control Over Suppliers []