The Pressure Is on HP to Stand and Deliver in 2013
Today marks the end of what has been without a doubt the worst year in Hewlett-Packard’s corporate history. You could argue that 2011, marked by the brief period that Léo Apotheker was CEO, was worse in many ways, and that the difficulties the company struggled to correct in 2012 were created in the prior year. But by all the metrics that count, the year now ending was a whopper: Sales on an annual basis fell by more than 5 percent to $120.4 billion, and on a GAAP basis it swung from a $7 billion profit to a $12.6 billion loss.
Much of those losses can be attributed to a combined $17 billion in write-downs taken during the second half of the year. The biggest was the $8.8 billion write-down announced on Nov. 20, of which $5.7 billion was attributed to Autonomy, the British software firm HP acquired for north of $11 billion in 2011. Another $8 billion was the result of an impairment charge related to EDS, the IT services concern HP acquired in 2008 for $14 billion.
If 2012 was the year that HP sought to package up all the toxic accounting and financial disclosures it could find, then 2013 either will or won’t be the year where it starts down the path toward recovery and turnaround. While HP is technically shut down now for the holidays, people I’ve talked to there in recent days tell me that the internal message being broadcast to employees at all levels is consistent: This year, everyone has to deliver.
Investors frustrated by the decline in value in HP’s shares in 2012 — at $13.68, as of Friday’s close, the shares are down nearly 49 percent this year — have largely come to terms with the notion that HP had to suffer through a horrible year in order to begin the arduous process of rebuilding its business and balance sheet, though the company and its CEO, Meg Whitman, have essentially exhausted their indulgences.
At a meeting of financial analysts in October, Whitman portrayed 2013 as a “fix and rebuild” year, and so the fixing and rebuilding will, a year from now, have to be apparent. The problem with that is that in the very same speech, Whitman projected profit declines in 2013.
The difficulty is clear in nearly every single line of HP’s business. While each line of business remains profitable — take out the combined $20.3 billion in impairment and restructuring charges on HP’s financial statements, and you see a $7.7 billion operating profit — sales in practically all of them declined by a range of 2 percent (services) to 10 percent (PCs). That’s unlikely to change in the face of an uncertain global economy. HP makes about 65 percent of its sales outside the U.S., and has historically had the widest exposure to Europe of all the major tech companies.
So, if 2013 goes according to Whitman’s recovery plan, what does it look like? For one thing, expect a boost in research-and-development spending. Whitman has made it clear that she thinks that R&D spending as a percentage of sales has been trimmed further in recent years than it should have been. In 2004, R&D spending at HP amounted 4.5 percent of sales. By fiscal 2010, it was 2.3 percent. In 2012, it was 2.8 percent. CFO Cathie Lesjak has said spending will be boosted in 2013, along with increased spending on internal IT infrastructure.
Also, expect more restructuring. The bulk of the 29,000 jobs cut at HP will take place during 2013, which will incur about $1.5 billion worth of restructuring charges.
All in all, it’s going to make 2013 a tough year for HP, though if it has any good luck at all, it will be less difficult and drama-filled than 2012. Analysts expect HP’s sales in its 2013 fiscal year (ending in October) to decline again to just north of $112 billion and, on average, they expect per-share profits on a non-GAAP basis to be $3.31.
By October it should be clear if the repair work undertaken is having any effect. Costs will be decreased. Most of the restructuring will be complete and, with luck, the global economic picture will have improved, if only slightly. If HP’s official guidance for fiscal 2014 doesn’t begin to look optimistic, that’s when talk of an endgame — really only speculative now — will begin in earnest.
So far, Whitman’s argument has been that HP is stronger as a combined unit than it could ever be if split into two or more pieces. If results and guidance aren’t looking up by late 2013, shareholders will start looking for alternatives, and a breakup will be at the top of their list.
One person who might lead that discussion is director Ralph Whitworth. An activist investor with a history of pushing companies into breakup strategies, Whitworth’s Relational Investors LLC owns about 34.5 million HP shares. That investment is about $318 million under water as of Friday’s closing price. Late in 2013, a two-year agreement he has with HP not to seek a breakup or sale of any significant assets will expire. If his patience with HP’s management and strategy wavers at all, expect the breakup conversation to get serious quickly, and to dominate media coverage about it into 2014.