How Will Aruba Acquisition Impact HP’s Stock?

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Hewlett-Packard (NYSE-HPQ) announced on Monday, March 2nd that it was acquiring the wireless networking company Aruba (NASDAQ-ARUN) for $3 billion in equity value ($2.7 billion net of cash and debt). [1] This translates into $24.67 per share for the company, a 1% discount to Aruba’s close price on Friday. This is the largest acquisition that HP has made since it acquired Autonomy for nearly $12 billion in 2011. Aruba Networks will be integrated into the proposed new HP Enterprise Company once HP completes the split of its PC and printer business from its corporate hardware, software and service business later this year.

Aruba, based in Sunnyvale, California, is a leader in the wireless networking and makes Wi-Fi networking systems for shopping malls, corporate campuses, hotels and universities. The company had revenues of $729 million in fiscal 2014, and has reported compound annual revenue growth of 30 percent over the last five years as more people are using mobile devices at work, school and elsewhere. In this note, we explore the opportunity this deal offers HP in the Wireless LAN (WLAN) Market, which is currently dominated by Cisco.

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The Global WLAN Market

Wi-Fi networks market has taken off in the past five years as the rapid proliferation of wireless devices has impacted the number of users who go online. As a result, Wi-Fi has become a necessity in the work space as well as at home. This has translated into a high growth rate for the sales of Wi-Fi hardware equipment. According to IDC, the global wireless LAN market has been growing over the past few years. In Q3 2014, Cisco with about 48.3% share dominated the market. [2] Aruba, with a market share of 11.5%, was a distant second. Despite the acquisition of Colubris in 2008 and 3Com in 2010, HP has not been able to capitalize on its wireless technology portfolios, and its market share has been a paltry 4.5%.

From a geographic perspective, the enterprise WLAN market is witnessing robust growth in Latin America (with 27.3% year-over-year growth) and Europe, Middle East, and Africa (EMEA) (15.0% year over year) in 3Q14, while enterprise WLAN market in the Asia/Pacific region grew more modestly at 4.5% year over year. However, North America, which witnessed a decline in 2Q14, grew 7.5% year over year in 3Q14.

Going forward, as companies are transforming their internal business processes and improving employee productivity through WLAN-enabled cloud and multimedia applications, enterprise WLAN demand is expected to increase. The transformation in Enterprise IT is further accentuated by  the adoption of cloud, mobility, big data analysis and social media that have increased both network density and the requirement for advanced Wi-Fi technologies such as 802.11ac.

Furthermore, public-facing enterprises such as government agencies, malls, retailers, etc., are realizing the importance of improved customer engagement through the wireless access and are investing to install WLANs. These factors are leading to a robust stream of brownfield (network upgrades) and greenfield deployments. These deployments are not only affected by the increase in number of smart mobile devices that can be connected, but also by the increase in the number of wireless endpoints such as printers, scanners and beacons. We expect that these trends will continue to play out for the foreseeable future.

The HP-Aruba Deal

While Aruba is a leading provider of next-generation network access solutions for the mobile enterprise, HP’s legacy networking solutions business has not been doing well, and its market share in WLAN has shrunk to 4.5% in Q3CY14. Through this acquisition of Aruba, HP hopes to create a leading competitor in the $18 billion campus networking sector, so as to become a significant player in the fast growing WLAN market.

Aruba has a highly regarded innovation engine and specialized sales, marketing and channel model, complementing HP’s leading networking business and go-to-market breadth. Under the deal, Aruba is to become part of the HP Networking business within HP’s Enterprise Group. The enterprise networking division posted $2.62 billion in revenues for FY14. HP could leverage its Helion services and Converged systems portfolio (servers, storage and networking) to bring new clients to the Aruba’s fold. Furthermore, HP can use its global exposure and presence in various industry verticals such as education, healthcare and financials to expand Aruba’s business globally. If the combined entity could capture 20% of the WLAN market, which is 5% more than the current combined shares of each, the wireless networking revenue for HP can increase by over 100%, due to the synergy offered by each business. As a result, the Networking division’s contribution to HP’s estimated stock price would increase to 10% and should lead to 12% upside to our current price estimate.

The new combined organization will be led by Aruba’s Chief Executive Officer Dominic Orr, and Chief Strategy and Technology Officer, Keerti Melkote, reporting to Antonio Neri, leader of HP Enterprise Group. With this move, HP will be uniquely positioned to deliver both the innovation and global delivery and services offerings to meet customer needs worldwide. The transaction is expected to close in the second half of HP’s fiscal year 2015, subject to Aruba stockholder approval, regulatory approvals in the US and other countries as well as other customary closing conditions.

We presently have a $31.33 price estimate for HP, which is 10% below the current market price.

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Notes:
  1. HP to Acquire Aruba Networks to Create an Industry Leader in Enterprise Mobility, March 2 2015 []
  2. Worldwide WLAN Market Shows Sustained Growth in Third Quarter of 2014, According to IDC, 25th November 2014 []