Bears Stalk HP Shares Ahead of Analyst’s Meeting
Next week, Hewlett-Packard will hold an analysts meeting in San Francisco, the main purpose of which will be to offer its forward-looking guidance for the coming fiscal year. Also, CEO Meg Whitman, CFO Cathie Lesjak and other senior executives will probably open the corporate kimono a bit and give a peek inside the financial situation, providing more detail than HP usually does.
The big looming question is whether HP can legitimately turn itself around. Having already set plans to reduce its headcount by 29,000, its restructuring is still getting under way.
There are many betting that Whitman may be in over her head. In a research note issued to clients today, ISI’s Brian Marshall considered — and then rejected — the bearish case against HP. Short interest in HP — a key indicator of market sentiment that a stock’s price is going to fall — has increased substantially in the last year: About 3.7 percent of HP shares were short, as of Sept. 14, up from less than 1.5 percent a year ago. And the short bets have paid off: HP shares closed Tuesday at $16.71, a level they haven’t seen since about 2002.
Marshall summarizes the bearish case thusly: HP is a broken company, and will experience annual revenue declines of about 5 percent forever. With the enterprise value amounting to about 8 times free cash flow, the company is not generatng enough free cash flow to be an attractive investment. Add to that about $20 billion in net debt, and you get a company that has little flexibility to make big acquisitions or invest in new initiatives. Conclusion: HP’s hopes for delivering $4 a share in annual per-share earnings just aren’t tenable.
But Marshall is not a bear himself. In his view, HP should saw itself in half — one part that generates cash, and one that requires cash investments in order to grow. The “growth group,” as Marshall sees it, would combine the Enterprise Servers, Storage and Networking business unit and HP’s IT Services group. The “cash group” is the new Printing and Personal Systems Group, which amounts to about 51 percent of overall sales. Marshall argues that HP Executive Vice President Todd Bradley, who runs the PC and printer group, will be an effective steward of that unit’s contribution to HP’s overall cash flow, allowing the excess to be reinvested in the “growth group,” and to rebuild the balance sheet.
“While we expect HP to continue to post revenue declines of about 5 percent year-on-year for the next 18 months before the company becomes a GDP-like grower, we believe annual earnings power can be maintained at about $4 per share during this transformation period,” Marshall writes.
How will HP maintain its earnings while revenues slide? Reducing headcount further — Marshall sees another 15,000 jobs on top of the 29,000 already announced — plus further reductions in the overall share count. Add to that a further tightening of operating expenses, and HP, he argues, can maintain profits at or near $4 a share through 2017.