Reviewing HPE’s Performance in 2016

It has been an eventful year for Hewlett Packard Enterprise (NYSE:HPE). In its first year of operations as an independent company, the management has divested non-core businesses into joint ventures. Additionally, it continues to focus on building out its core portfolio of services to serve the hybrid cloud infrastructure vertical. In this note, we review HPE’s business performance in 2016.

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Improving Focus On Server, Storage And Converged Solutions

During the last twelve months, the company rolled out new strategy for its enterprise group to focus on profit rather than market share. As a result, HPE’s enterprise group revenue declined by 2.72%. However, this decline is lower than the decline in underlying server, storage and networking industries.

During the last twelve months, HPE’s server business witnessed 1.42% decline in revenues. The decline in core industry standard servers, which are facing intense competition from white-box servers that are manufactured to design by Asian ODMs,  was offset by the growth in high-performance and mission critical servers. However, the company continues to launch new products such as the Synergy line of servers to compete in the Blade segment for its server vertical to shore up its share in the server industry. We believe that 2017 will be an eventful year for the company with HPE reporting higher margins for its server division.

HPE’s storage revenue declined by over 5.8% as contraction of its legacy portfolio continued in the year. However, the higher-margin converged storage portfolio was up 1% and it’s now 55% of the total storage mix. Furthermore, 3PAR solutions, which cater to small and medium sized companies, continued to report growth and all-flash 3PAR revenue grew nearly 100%.

HPE’s networking revenue grew by over 78%, primarily due to acquisition of Aruba. Going forward, we expect the growth in Aruba to accelerate in coming  quarters as installations for network solutions ramp up, especially for virtualization, cloud deployment and security.

Disinvestment In HP Enterprise Services Takes Center Stage In 2016

In the last twelve months, HPE’s services revenues have declined by 4.72%.  However, considering the breadth of the portfolio, the company announced that it was spinning off its enterprise services unit into a separate entity. This entity would be merged with CSC (NYSE: CSC) through a Reverse Morris trust to create a $26 billion pure-play, global IT services company.  The transaction is expected to be completed by the end of March 2017 and HPE shareholders will own 50% shares of the new company.

The company expects to unlock $8.5 billion in value for its shareholders through this transaction, which includes $2.5 billion in debt and pension liabilities and $1.5 billion in dividends in addition to $4.5 billion stock consideration (50% stake in new entity).

Shift In Focus Towards Software Defined Infrastructure  

Prior to its split from Hewlett-Packard, HPE had acquired some of its software assets through the controversial acquisition of Autonomy in 2011.These businesses included Application Delivery Management, Enterprise Security, Information Management & Governance and IT Operations Management. This primary reason for this has been a shift towards Software as a Service (SaaS) and growth in virtualization. Furthermore, with software defined infrastructure over cloud, the need for IT operations management has also declined. As a result, the software revenues for HPE have declined in the last twelve months. As reported with year-end results, HPE’s software business has declined by 11.9% in the last fiscal year.

To ensure that the company has laser like focus on hybrid IT, which is increasingly adopted in today’s data centers, the company has spun off and merged its non-core software assets into Britain’s Micro Focus International Plc (MCRO.L). This deal is expected to close by May 2017. Nevertheless, the company will continue to have a sizable software business, both through its interest in Micro Focus and through its focus on software-defined infrastructure. Under the terms of the deal, HPE’s shareholders will receive a cash payment of $2.5 billion, while retaining a 50.1% ownership of a newly-formed company, a stake valued at $6.3 billion. The newly formed entity is expected to be world’s largest pure-play enterprise infrastructure software company. The combination of HPE’s software assets with Micro Focus is expected to create a business with annual revenues of approximately $4.5 billion.

Strategy Post Disinvestment From Non-Core Businesses

The management believes that HPE will be able to sharpen its focus on the next generation Software Defined Infrastructure that leverages the breadth of its portfolio, including its servers, storage, networking, and converged infrastructure, as well as its Helion cloud platform and core software assets like HPE OneView.

Currently, HPE generates over $28 billion in revenues from its server, storage, networking and technology services business.  However, with the divestment of non-core businesses, HPE can improve not only improve its margins but also emerge as an industry leader in delivering secure hybrid IT solutions.

We currently have a $23.72 price estimate for the stock, which is inline with the current stock price.

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