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Hewlett-Packard Company (HPQ), Dell Inc. (DELL): A Closer Look at Three Global PC Makers

Hewlett-Packard Company (NYSE:HPQ) experienced a significant rise of nearly 14% in after-hours trading, to nearly $24.20 per share, after it reported earnings results that beat analysts’ estimates in the second quarter. Since the beginning of the year, Hewlett-Packard’s return on the market has been quite juicy, rising more than 68.2%. Should investors buy Hewlett-Packard at its current trading price? Let’s find out.

A quarter earnings that beat estimates and rosy outlook

Hewlett-Packard Company (HPQ)In the second quarter 2013, Hewlett-Packard Company (NYSE:HPQ)’s revenue decreased a bit, from $30.7 billion in the second quarter last year to $27.6 billion this year. The company’s net income came in at more than $1 billion, or $0.55 per share, which was much lower than its net income of $1.6 billion, or $0.80 per share, last year. However, the company’s non-GAAP EPS was $0.87, which was $0.06 higher than analysts’ expectation of $0.81 per share. Hewlett-Packard Company (NYSE:HPQ) also reported in the second quarter that it has returned around $1.1 billion to its shareholders, including $797 million in share buybacks and $283 million in dividends.

Looking forward, the company expected its non-GAAP EPS to stay in the range of $3.50 to $3.60 for the full year. Meg Whitman, the company’s President and CEO, commented that the company’s balance sheet strength had improved for the fifth consecutive quarter. She set the goal of reducing net debt to around zero, with the net debt being decreased below pre-Autonomy level by the end of the 2013 fiscal year. As of April 2013, the company had $23.9 billion in equity, $13.2 billion in cash and as much as nearly $26.8 billion in both long and short-term debt.

Still record large goodwill and intangible assets

The Autonomy scandal has made Hewlett-Packard Company (NYSE:HPQ)’s share price fall to more than $12 per share. In the fourth quarter of 2012, the company had to record as much as $8.8 billion in write-downs, which was around 80% of the $11 billion that it paid for Autonomy. Interestingly, of the $8.8 billion impairment charges, $5 billion was due to accounting improprieties and misrepresentations. What I worry about with Hewlett-Packard is still the huge amount goodwill and intangible assets it holds. In March 2013, the company reported more than $35 billion in goodwill and purchased intangible assets, or 146% of the total equity. If these amounts were written down, they would wipe out the total equity of the company.

Dell is no exception, but a buyout deal could drive more value

Another global leading PC manufacturer, Dell Inc. (NASDAQ:DELL), also had quite a high amount of goodwill and purchased intangible assets. While Dell had $10.76 billion in equity as of May 2013, the amount of goodwill and purchased intangible assets stayed at nearly $12.5 billion, or 116% of its equity. Jim Chanos commented that Dell Inc. (NASDAQ:DELL) and Hewlett-Packard Company (NYSE:HPQ) had basically “bought” their R&D via many acquisitions. Consequently, the goodwill and purchased intangible assets rose significantly and the percentage of R&D expenses to total revenues was quite small. Trailing twelve months, R&D expenses accounted for only 1.88% of the total revenue in the case of Dell Inc. (NASDAQ:DELL) and 2.87% in the case of Hewlett-Packard.

Dell’s two biggest shareholders, South Eastern Asset Management and Carl Icahn, seem to be bullish about Dell at its current price. Both of them proposed the offer so that Dell Inc. (NASDAQ:DELL)’s current shareholders could have the right to continue being Dell’s shareholders. Moreover, shareholders could choose to receive $12 per share in cash or $12 in additional shares valued at $1.65 per share. With the assumption that 20% of total outstanding shares will not receive cash, the remaining stub earnings might be ranging from $0.50 to $0.89 pre-tax per share. A value of $1.98 to $5.35 would be realized with a multiple of 4 to 6.

A good play on Chinese PC maker

Lenovo, the Chinese PC maker, has also spent very little for its R&D. In the past twelve months, Lenovo generated $32.55 billion in sales. However, it only spent $153 million in R&D activities, accounting for only 1.68% of the total sales. It has a much stronger balance sheet than the other two companies I’ve mentioned, though. It had nearly $2.4 billion in equity in September 2012, nearly $4 billion in cash and more than $3 billion in intangible assets.

Lenovo seems to have the advantage because it is also the leader in the most populated country in the world, China. Dated back to 2005, Lenovo acquired its personal computer business from International Business Machines Corp. (NYSE:IBM) for around $1.25 billion. Liu Chuanzhi, the former chairman of Lenovo commented on the acquisition

We benefited in three ways from the IBM acquisition. We got the ThinkPad brand, IBM’s more advanced PC manufacturing technology and the company’s international resources, such as its global sales channels and operation teams. These three elements have shored up our sales revenue in the past several years.

Recently, Lenovo also entered talks with International Business Machines Corp. (NYSE:IBM) for IBM’s x86 server business. The talk has been placed on hold for now, however, due to the disagreement on pricing. According to the Wall Street Journal, Lenovo offered less than $2.5 billion for x86 server business which had generated $4.9 billion in sales in 2012.

My Foolish take

With the fast-deteriorating global PC environment, I would not consider all of those three giant PC makers to be in my long-term portfolio. Among the three, I like Dell Inc. (NASDAQ:DELL) the most and consider it a speculative play on the buyout transaction. Hewlett-Packard Company (NYSE:HPQ), with the largest amount of goodwill and intangible asset on the balance sheet, is quite vulnerable to the future write-down which could negatively impact on its stock price.

The article A Closer Look at Three Global PC Makers originally appeared on and is written by Anh HOANG.

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