Should HP Break Up or Stay Together?
Neil Sedaka or Jack Johnson? Honestly, this is all beginning to sound a little too much like a bad mix from a lite-FM radio station. But here it is: Should Hewlett-Packard be broken up into parts, or should it stay together?
It’s an old question, dating back more than a decade, but it was raised anew today in a note by analyst Steven Milunovich at UBS Investment Research. His vote: Break it up.
Milunovich initiated coverage on HP today, after a break of several years, opening with a “sell” rating and a price target of $16, which would amount to a drop well below its current 52-week low, and would represent the lowest price that HP shares have seen in nine years. He then prefaces his argument with a history lesson: Way back in 2002, HP, under then-CEO Carly Fiorina, closed the $25 billion acquisition of Compaq Computer. Within a few years, HP leapfrogged Dell to become the largest PC vendor in the world, but the deal also gave HP some key assets it was missing in the enterprise hardware world. “Although historians likely won’t be kind to the merger, it’s not clear that HP would have been better off without Compaq,” he writes.
By 2004, Milunovich was arguing that HP should break itself into two companies: One focused on the enterprise, the other on consumers. On the enterprise side of the house, HP’s best course of action, he thought then, was to become an alternative to IBM.
No such breakup occurred, and now, 10 years after that enormous acquisition, HP finds itself “stuck in the muddy middle.” Of course, one CEO — Léo Apotheker — sought during his 11-month tenure to spin off the PC division; though, when combined with the costly $11.7 billion acquisition of the British software firm Autonomy and three consecutive quarters of results that came in below expectations, it wasn’t long before he was pushed out of his job.
New CEO Meg Whitman quickly undid Apotheker’s plan, arguing that HP is “better together,” a view she reiterated to AllThingsD in an interview in June. Instead, Milunovich argues, they might be “smart apart.”
With the printer business, a onetime cash cow now in a state of possibly permanent decline, and with PCs under attack by slowing growth generally and tablet substitution in the notebook business, HP’s strongest suits lie in the enterprise: “If HP is able to take advantage of cloud and big data trends, it should see modest revenue growth and margin expansion in ESSN, which is critical to offsetting the likely deterioration in printing,” he writes, referring to the old Enterprise Server, Storage and Networking group. A boost in software revenue would also boost profit margins.
And with HP shares currently trading at about four times estimated earnings for both 2012 and 2013, he compares its different segments and concludes they would trade at higher prices relative to competitors. The PC and printer groups could trade at six to seven times forward earnings; software and enterprise at 10x and services at 11x. Basically, break it all up and it could be worth between $27 and $34 a share, Milunovich writes.
But is it really that easy? The primary reason that Whitman gave for undoing the plan to spin off PCs was that HP’s scale alone gives it the ability to negotiate aggressively with suppliers of components used in other parts of the business. But she has also praised the unit’s overall return on invested capital. And there’s also a big batch of savings expected from this year’s combining of printing and PCs under Todd Bradley.
Much of it is a matter of time. Shareholders seem willing to give Whitman a certain amount of time to get the turnaround she has promised under way, and she has even taken to managing expectations by saying it will take years to get done. But if HP’s share price doesn’t respond, they may get impatient and start demanding a breakup. As Milunovich puts it, it would be interesting to see an activist investor like Carl Icahn or Bill Ackman get involved, though HP already has one of those on its board — Ralph Whitworth — and he has a history of lobbying for corporate breakups.
For now, it’s all an academic discussion. Whitman has made zero moves toward any kind of a breakup, and is clearly in the “better together” camp. My prediction is that Milunovich’s argument today is the starting gun to a broader discussion about how best to fit HP, and that the calls for a breakup are only going to get louder.