How the Enterprise May Help Save Hewlett-Packard
Today’s earnings report, which is expected after the markets close for trading in New York, will be the first since the end of HP’s worst year ever. The list of its woes is well known. There was the Autonomy acquisition, which contributed more than $5 billion of an $8.8 billion write-down that shocked shareholders. That write-down came on top of another write-down, this one worth about $8 billion, on the 2008 acquisition of the IT services firm EDS. During 2012, HP’s shares traded at levels not seen since 2002, going back to the days immediately following its mammoth acquisition of Compaq Computer.
That acquisition made HP the world’s biggest vendor of personal computers, a market that is now in decline, but which affords HP a certain amount of scale that helps it in other businesses. Combined, PCs and printers, another declining market, amount to about half of HP’s revenue, and more often than not get most of the attention from shareholders. And for that reason it’s not exactly difficult to find Wall Street analysts who have rated HP shares with a “sell” or equivalent. Though likely untrue, persistent rumors that say a breakup or sale of a significant business unit is coming continue to goad HP shares higher. “Talking to investors, the biggest story on HP these days isn’t about its business fundamentals but whether the company will split itself in two or more pieces,” analyst Shaw Wu of Sterne-Agee wrote in a research note today.
The consensus of analysts polled by Thomson Reuters calls for HP to report a per-share profit of 71 cents on sales of $27.8 billion. The bar, however, is relatively low: A year ago, HP reported per-share earnings of 92 cents.
CEO Meg Whitman has made a persistent case that, despite all its recent troubles — and calling them “troubles” feels like describing World War I as a case of bad vibes — HP will not only be saved, but will remain whole. She has also characterized 2013 as the year during which the arduous work of repairing and rebuilding will begin in earnest.
Whitman has been hinting publicly that signs of the turnaround are coming, though they’re not yet visible. The narrative at HP lags reality, she said at The Wall Street Journal’s CIO Network conference last month.
For the moment, Whitman seems to have earned the trust of HP shareholders impatient for more positive results. She has been on the job 17 months, and on her watch, HP shares are down about 25 percent, while the S&P 500 has risen by 32 percent. By that benchmark, Whitman compares favorably with former CEO Carly Fiorina, who, at the 17-month mark, presided over a 46 percent drop in HP shares, while the S&P 500 was down only 6 percent. But at the same point in the Mark Hurd era, HP shares were up by 66 percent, well ahead of the S&P 500, which was up only 11 percent. (Whitman’s immediate predecessor, Léo Apotheker, never made it to 17 months.)
If that’s true, then there’s a good reason to expect that the turnaround she anticipates will be visible first in HP’s enterprise-facing businesses. In this, HP has a new weapon upon which rests a great deal of hope. It’s called Project Moonshot. Announced late in 2011, it is a fundamental rethinking of a server.
I saw an example of one during a meeting last month with Dave Donatelli, HP’s executive vice president and head of its enterprise business, during a recent visit to the company’s headquarters in Palo Alto, Calif.
It’s about the size of a trade-paperback book — and not a very thick one, either — yet it’s a full-blown server. It comes in flavors running Intel’s low-power Atom chip, but also ARM-based chips, and can be outfitted with many of them. For storage, it can be configured with a conventional spinning hard drive, or a flash-memory-based solid-state drive. It can also be tricked out with a lot of system memory, and with a graphical processor unit (GPU) like those from Nvidia, which are increasingly being used to give computers some extra oomph on certain kinds of computing jobs.
The case Donatelli makes is simple, and can’t help but resonate with customers, especially with those building large data centers: When compared to a mainstream HP server currently on the market, one built using the Moonshot approach consumes 89 percent less power, and requires 94 percent less physical space. “We imagine a world where you can fit thousands of these servers in a single rack,” he says. “It really is a fundamental revolution in how servers work.” And no one, Donatelli says — not Dell, not IBM, not Oracle — makes anything quite like it. And it will begin shipping soon.
Moonshot will be an important piece of HP’s strategy, especially as many big companies seek to build massive data centers running hundreds of thousands of servers at once. Large companies increasingly want to get the same economies of scale that smaller ones get by farming out their IT infrastructure to cloud companies like Amazon Web Services and Rackspace, but they don’t always want to let go of their IT infrastructure entirely. And then there are the cloud service providers themselves. “Many of the large cloud providers run 250,000 or maybe even a half a million servers. Within three to five years we’ll be talking many times that amount,” Donatelli says. “Those data centers will get very expensive, and they won’t be very environmentally friendly.”
And there are other important pieces on HP’s chessboard. HP’s cloud services business — which will presumably be a big consumer of Moonshot hardware, Donatelli says — is already a multibillion-dollar business. And its 3Par enterprise storage business — a company HP acquired in 2010 after a bitter bidding war with Dell — reported record sales in its most recent quarter. Then there’s enterprise networking, a business built primarily out of 3Com, a company HP acquired in 2009. Only Cisco Systems is bigger in that business, Donatelli says, and, yes, it’s a lot bigger, comprising about two-thirds of the addressable market, leaving HP and everyone else to fight over the remaining third. But that’s a fight that HP is winning, beating out, in the reckoning of research firm IDC, players like Alcatel-Lucent, Juniper and Huawei.
And what of Business Critical Servers, the unique HP business built on Intel’s exotic Itanium chip? Long a source of beefy profits derived from services supporting Itanium’s finicky customers, HP’s BCS business suffered from an injection of doubt about its future, whipped up in no small part by Oracle, which insisted that HP intended to kill the platform. Oracle said it would stop making software that supported it. That prompted a lawsuit from HP, which argued that Oracle had agreed to continue supporting Itanium, and was bound by that agreement. HP won, but it hasn’t helped HP sell more Itanium servers. That’s because, Donatelli says, Unix-based servers are fundamentally a business in decline. “That marketplace is in secular decline,” he says. “Although you and I will be here five years from now, and will still be talking about it, it is a shrinking market. We will drive as much revenue as we can from it and, over time, it will disappear.”
HP recently updated its line of Itanium servers with a machine that’s three times faster than its predecessor. But there’s also a solid business capturing recovering Unix customers and helping them move to more mainstream platforms running Linux and traditional Intel chips. HP does offer a “mission critical” server that contains a mainstream Intel Xeon processor. Expect more like that.
And what of those declining service revenues related to BCS? The good news is that they will decline slowly. Itanium customers aren’t exactly known for moving fast or swapping out their machines that often. The better news is that HP’s 3Par storage line carries with it an interesting service profile that’s kind of similar to what has been the norm with Itanium. “There is a backfill coming to replace what is being lost,” Donatelli says.
And while he couldn’t get specific — HP will be more specific when it reports its results later today — Donatelli said 2013 looks like it may be an important transitional year for HP customers, and thus for HP itself. “We see more and more customers starting to rethink how they run their operations, and how they can change them significantly,” he said. “We think that’s a big opportunity. The enterprise doesn’t move like a light switch. It moves gradually. But when it starts to move, it really moves.”