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Is a Hewlett-Packard Turnaround Shaping Up?

Hewlett-Packard Company (NYSE:HPQ) announced its second quarter earnings on September 10, which were down 29.7 percent year-over-year. The company indicated that it will be cutting 29,000 jobs by the end of 2014 for a savings of $3.5 billion yearly after the cuts are complete. About 8,000 positions are expected to be cut in the all-important enterprise division, which, as we have indicated before, houses HP’s greatest potential for growth. The company has drawn criticism from a number of hedge fund managers, including Philippe Laffont and Jim Chanos.

Jim Chanos puppeteer

Hewlett-Packard has wasted a lot of money in trying to determine what its strategy as a company is.  The company has spent nearly $37 billion since 2007 to acquire companies like Palm, EDS, and Autonomy, acquisitions that were followed by write-offs, restructurings, and revenue drops. Last month, the company reported an $8 billion write-down of EDS, which HP bought for $14 billion in 2008. Luckily, management has recognized its chronic lack of talent in this area and intends to halt acquisitions for the time being. In the recent past, some like Jim Chanos have claimed that this activity has masked the “real growth” of the company.

The following relatively common-place phrase appears in HP’s 10-Q: “The rate at which we are able to invest in our business and the returns that we are able to achieve from these investments will be affected by many factors, including … operational execution.” A slide from Chanos’ presentation in June called “A Search for Global Value … Traps” notes that true “value plays” do not rely on superior management in order to succeed. The underlying business should have long-term viability, solid finances, and a decent brand to back it up and give management some slack. So I am wary about a supposed “value” company who needs “superior management”—opinions about Meg Whitman aside.

That said, global shipment of mobile products increased 79 percent year-over-year in 2011. This compares to a 2.9 percent increase in PC sales year-over-year. The following graph, pulled from Chanos’ presentation (Source: IDC via Bloomberg), puts the picture together:

This entire set of data implies what has been popularly called the “post-PC thesis”: secular growth of smaller devices will eventually dwarf that of larger ones. Hewlett-Packard management noted in its 10-Q that it wants to enter into higher margin “higher growth industry segments.” Consider that, for instance, Apple Inc.’s (NASDAQ:AAPL) iPhones rake in a 49 percent gross margin compared to 23 to 32 percent for iPads. In turn, iPads have a bill of materials 40 percent below that of PCs. Though it sounds like the annoying post-PC rejoinder, we are skeptical about a hardware company that wants to enter “higher growth industry segments” but that is, nevertheless, not making headway in mobile solutions. Who would turn away the opportunity to make money on the “hotcakes” of the technology world—a metaphor that holds for both sales and margins?

[Note that Hewlett-Packard intentionally, notes Whitman in the company’s 2011 Annual Report, did not spin off the Personal Systems Group (PSG), thus solidifying the company’s intention to remain a player in (dying?) hardware spaces like PCs. Printers would still have remained in HP’s lineup—another eyesore.]

This need for mobility does not stop at the consumer market—it is a fact in the enterprise market as well. HP Slate, the present tablet solution from HP, has an enterprise tagline: “The Right Business Touch.” John Solomon, senior VP at Hewlett-Packard, notes that the enterprise market is “under-penetrated.” It is also a market that Apple is not pursuing heavily. New product releases are trying to hit the right tone with consumers by developing convertible tablets—devices with the functionality of a laptop when connected to a dock and the portability of a tablet when separate. Apple’s CEO Tim Cook compared a convertible tablet computer to “a toaster and a refrigerator” combination appliance, so this is one space that is safe from Apple for now (if it pans out). However, HP is yet to prove itself in the mobile market. If you take a look at’s tablet ratings, you will find that Asus, a successful pioneer in the netbook space, has already come out with a very successful cross-over machine. HP’s name is conspicuously absent from every major tech rating site I checked.

All-in-all, buying HP shares amounts to a speculation on management execution and the ultimate sales potential of new enterprise hardware and software products. HP has bowed out of the consumer tablet market after Microsoft Corporation (NASDAQ:MSFT) announced the Surface, though it has redesigned its desktop PCs to be all-in-one devices for Windows 8. Maybe there is room for the “do one thing, well” strategy in the enterprise world populated by desktop PCs, convertible tablets, and specialized software solutions. In HP’s case, that is the hope, at any rate.

Disclosure: Brian is long Apple and Microsoft.

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