HP Is Worth $20 Despite Tempered Outlook Due To Its Turnaround Strategy

by Trefis Team
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In the Securities Analyst Meeting last week, Hewlett-Packard (NYSE:HPQ) provided a detailed turnaround strategy and 2013 outlook. CEO Meg Whitman laid out a plan, extending to 2016, to improve efficiency, make the business segments lean, cut costs and transform the company to a leading technology company. The company expects a marginal decline in revenue across all segments in 2013 except the software division. The Enterprise Services business is expected to have revenues of up t0 13% lower and significant margin pressures as well. [1]

The company expects to increase R&D expenses and IT spending to make its products competitive and simplify business processes and sales and marketing expenses is expected to reduce in the future as it rolls out CRM across the organization by implementing Salesforce.com’s products and services. The market reacted to this turn around and lowered outlook by punishing the stock which fell from $17 to $14 in a day. We have revised our outlook based on the outlook provided and have revised our estimates from a near $30 valuation for the stock to $20.68 based on reducing revenues, tighter margins and increasing costs. However, this estimate is still nearly 45% higher than its current market price and we explain our rationale below.

See our full analysis on HP

HP has been performing well in the hardware division, especially with the Envy Ultrabook and Sleekbook range and has entered into some high growth markets such as the tablet market with its Windows 8 tablets and most notably its entry into cloud services that compete with Amazon. It has regained its top spot as the largest PC seller in the world and hopes to maintain that position with the Windows 8 tablets aimed at institutional buyers. The company also plans to reduce its workforce by 27,000 that will save it $3-$3.5 billion annually. We believe the market is undervaluing HP, and we expect its performance to improve, provided the current CEO Meg Whitman’s efforts to restore stability to the company pays off.

Model Changes

Based on the outlook provided in the Securities Analyst Meeting 2012, we have revised our estimates to show a 12% y-o-y drop in revenues for the Enterprise Services division and a slight drop between 1% to 3% for all other divisions except Software. The model is revised to show a reduction is revenues and an increase in expenses for the next two years after which we show slight recovery till 2016.  We are also showing an increase in R&D and IT spending in the near term as per the guidance provided by the company. It is increasing R&D spending to introduce a new line of printers, Windows 8 tablets and cloud computing platforms. HP also expects restructuring costs to increase owing to the reduction in workforce via voluntary retirement and expects IT spending to grow as it implements a CRM system and simplifies business processes. We detail key drivers of our estimate below:

Key Drivers of Our $20 Price Estimate

1) Ultrabooks

The Envy Ultrabook and Sleekbook line of HP will drive its PC division in 2012 and beyond as the company launches the SpectreXT, the latest Ultrabook in the popular Spectre line. Currently this division constitutes just over 15 percent of the current Trefis price estimate of HP.

With HP regaining its top spot as the largest PC seller in the world, these ultra-thin PC’s can arrest dropping hardware prices and margins as these are high margin, premium laptops. It has also adopted the Ultrabook design to run AMD chips and its line of Sleekbooks are priced significantly lower, starting at $599. This is cheaper than the Ultrabook range for similar configurations. With a range of cheaper ultra thin laptops, it can potentially gain a much larger market share than expected as its competitors have lesser options in this range.

2) Windows 8 Tablets, Enterprise Tablets And HP Thin Clients

HP has announced that it will resume production of tablets running the Microsoft Windows 8 OS. This is its second foray into the tablet market as the TouchPad based on the WebOS was suspended last year due to poor sales. Restarting the tablet line is a strategic move to ride the tablet growth wave. The new range of tablets will run on Intel’s x86 processor powered by Windows 8 Pro, and the ARM processor based Windows 8 RT tablets will not feature in this lineup.

As HP is the world’s largest PC hardware manufacturer and has a huge institutional client base, the more powerful x86 format is likely to be popular as productivity tools with institutions and HP can leverage this network. The ARM tablet space is dominated by Apple with the iPad and HP is sticking to its strength by making productivity focused tablets. [2] The company also has plans to make a line of tablet based thin clients. It will depend extensively on cloud storage and will enable content sharing between devices. This is probably aimed at better serving enterprise customer that already use its line of Windows 7 based tablets, specifically hotels, hospitality and medical industries. This move will help HP gain market share in tablets without directly competing with Apple iPad, which is more consumer-centric. [3]

3) Merged Printing and PC Business Entity

The combined printing and PC business of HP is worth $65 billion and the company sees a significant cost saving opportunity by combining the two entities and managing a lean, centralized work force for sales and management. HP is the world’s largest printing solutions provider and it plans to leverage this by introducing new, cutting edge multi-function printers and high yield printing accessories. It is a slow growth business, but its leadership position, strong product portfolio and intellectual property will help its profitability and cash flows. Multi-function printers are becoming popular with enterprises as they provide combined multiple functions such as printing, fax, photocopying, scanning etc. and as companies upgrade to the new line of printers, we can expect this division to maintain profitability.

4) Cloud Services

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. This will have a pay as you go pricing. Cloud services are potentially the biggest new revenue source for HP in 2012. HP also announced that it is expanding its Converged Cloud portfolio with Microsoft solutions that could simplify a customers transition to the cloud. The Joint Private Cloud initiative would provide pre-integrated solutions based on joint technology development, and will be a one-stop-shop for sales and support. The HP Converged Cloud solutions will feature Windows Server 2012 and provides customers with a clear path to go beyond virtualization and accelerate their cloud transformation. HP Services constitute 40 percent of our current Trefis price estimate of HP. It currently competes with Amazon (NASDAQ: AMZN) in this space. [4]

6) HP webOS Ecosystem In The Making

HP has released an open source version of the webOS in beta mode. The beta release consists of 54 webOS components and half a million lines of code under the Apache 2.0 license. Releasing the webOS as an open source software is likely to draw third party developers to the platform and help develop a healthy app environment for HP. [5] It is releasing two development environments with the desktop development platform and mobile framework. The desktop development platform is the primary environment for improving the webOS experience and runs on Ubuntu Linux. The mobile framework is for users who want to deploy webOS on new devices. It includes an ARM emulator that can run core webOS services. HP is also working on a future release that includes the full webOS experience. This is, however, unlikely to be a bid to revive the HP Touchpad tablet range.

We currently have a $20.63 Trefis price estimate for HP, which is around 40% above of the current market price.

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Notes:
  1. HP Details Turnaround Strategy, http://h30261.www3.hp.com, October 3, 2012 []
  2. Hewlett-Packard To Shun ARM At Debut Of Microsoft Windows 8, www.bloomberg.com, June 30, 2012 []
  3. HP restarts tablet manufacturing, Bangkokpost.com, May 11, 2012  []
  4. HP Expands Converged Cloud With Microsoft Services, echannelline.com, Sep 9, 2012 []
  5. HP Releases webOS In Beta, blog.openwebosproject.org, Aug 2012 []
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