Unless you’re Apple (NASDAQ:AAPL), you’re probably going to have a hard time earning good profit margins on consumer hardware. As Dell (NASDAQ:DELL) can attest, the PC business has been experiencing a shift from desktops to notebooks over the last few years and declining PC price points have squeezed margins. This has been part of the calculus that has led HP (NYSE:HPQ) to evaluate options for its PC business including a possible sale of the business.
While the PC business may be the focus now, the lucrative HP printing business may be another sale candidate in the not too distant future. Creative destruction, in the form of tablets like Apple’s iPad and e-readers like Amazon’s (NASDAQ:AMZN) Kindle, may curtail printing demands faster than people anticipate.
We recently revised our Trefis price estimate for HP to about $42 (still significantly above the market price) in the wake of recent developments at the firm. Below we provide some background on HP’s PC business, why HP is thinking about getting out of PCs and highlight the important trends that may lead HP to eventually get out of printers as well.
PCs Are HP’s Largest Source of Revenues
HP’s Personal Systems Group (the PC business in the Trefis model shown above) generated sales of $9.6 billion for HP during the past quarter accounting for over 30% of HP’s revenues and constituting HP’s largest revenue source. In addition, HP’s PC business was the only hardware business in which HP reported an improvement in operating margins while both the printing and server businesses showed sharp declines in operating margins.
But HP Still Wants Out of PCs
Despite the fact that HP is the largest PC maker in the world and generates more revenues from its PC business than any of its other business segments, the PC business is by no means the most valuable business for the firm. In fact, the PC business is not even the most valuable hardware business for HP, contributing less than both the Imaging and Printing Group (printers & ink cartridges division) as well as Enterprise Servers, Storage and Networking business segment (servers & storage and HP networking divisions combined).
This is primarily because the PC business has low margins. In addition, the entire PC market faces a modest future as growth in PC demand is weakened by demand for mobile computing devices like tablets and smartphones.
Printers & Ink Cartridges Are HP’s Hardware Jewels (for now)
Of all its hardware businesses, HP earns highest margin on sales of printers and ink cartridges – thanks to very high margins (shown below) that HP generates on ink cartridge sales. Thus, while smaller than HP’s PC business in sales, printers & ink cartridges is worth 25% of HP’s firm value – way ahead of PCs.
But Digital Storm Clouds May Be Gathering in the Distance
HP’s Q3 results indicate that the printers & ink cartridges business needs a little more of management’s attention. The division’s revenues declined 10% sequentially and operating margins fell by a very sizable 2.3 percentage points. Despite HP’s innovative ink cartridge and toner developments that help it maintain significant margins, the company may be facing strong technology headwinds in the printing business that may curtail demand for traditional printing hardware faster than anticipated.
6 Trends that Can Hurt Printer Demand
- Color tablets (iPads, Xooms, PlayBooks)
- E-Readers (Kindle, Nook, Sony eReader)
- Web presentations (GoToMeeting, WebEx, Adobe Connect)
- Higher prevalence of notebooks rather than desktops (everyone has their PC at the meeting)
- Wi-Fi networks and more easily shared printing resources (one printer for the whole office)
- High cost of ink and toner
These trends make it more important for HP to succeed on either diversifying its business into fast growing new hardware technologies (tablets, smartphones) or rapidly transitioning into software and services via the IBM playbook.
What do you think? Are you ditching your printer any time soon?
