Arik Hesseldahl

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HP Is Swimming Upstream as Turnaround Efforts Falter

salmon-upstreamShares of the computing giant Hewlett-Packard opened lower by more than nine percent this morning after the company reported third-quarter earnings that fell short of consensus expectations, and as CEO Meg Whitman said the company doesn’t expect to grow revenue in 2014, as previously expected.

After trading down by more than $2, or more than eight percent, in pre-market trading, HP shares opened at $23 Thursday, down more than two dollars from Wednesday’s closing price of $25.38. It amounted to the most significant decline in the shares this year.

HP’s earnings for the third quarter, at 86 cents a share, were in line with expectations, but sales of $27.2 billion fell slightly short. It was close enough for Whitman to declare victory on a conference call, where she said that HP “achieved the financial performance we said we would.”

But Whitman also admitted for the first time that a key plank of her multiyear recovery plan isn’t likely to materialize. She said that year-on-year revenue growth during the 2014 is now considered “unlikely.”

Previously, 2014 had been pegged as the first year during which “real growth” would occur, when Whitman and CFO Cathie Lesjak outlined their recovery plan at a meeting with financial analysts in San Francisco last year. Even so, Whitman closed Wednesday’s conference call by saying, “I feel like we are on track and things are headed in the right direction.”

She still has the credibility to say so. Other metrics, including cost cuts, restructuring and the reduction of HP’s once-overpowering debt load, all appear to be running according to plan, but the market realities in its key lines of business continue to weigh on HP’s performance. Personal computer sales continue to decline at a historic rate. Printing continues to decline, though it appears to have stabilized. And the IT spending environment for servers and networking gear remains uncertain around the globe.

In a barrage of research notes to clients today, analysts took a mixed view of the results and outlook. The most negative came from Brian Marshall of ISI. Previously bullish on HP’s turnaround prospects over the long term, he argued that a corporate breakup might be the only way to recover any of HP’s lost value. “… The only remaining material catalysts for HP shares going forward would be the break-up of the company,” he wrote in a blistering research note to clients this morning. “Even the great Carl Icahn would likely have difficulty creating value here should he choose this as his next ‘tech play.’”

Chris Whitmore of Deutsche Bank Securities wrote that he wasn’t surprised at HP’s disclosure that it won’t grow in 2014 as planned. “Due to the widespread exposure to declining businesses like PCs and printers, persistent structural headwinds and growing pricing pressure, we expect ongoing revenue declines to translate into continuing pressure on earnings and cash flow,” Whitmore wrote in a note today. “Furthermore, HP is now roughly three-quarters through its current restructuring program, which creates added risk to earnings in future periods.”

With the benefit of savings from restructuring and operational cost cuts starting to take hold, most analysts began to wonder if HP could cut enough fast enough to arrest the continuing decline in overall sales. As Rob Cihra of Evercore Partners put it in a note this morning: “We appreciate that without its latest round of big restructuring and headcount cuts, HP’s quarter and guidance would look substantially worse. But we also have a tough time thinking it can cut costs faster than revenue structurally erodes, particularly for a company built on massive scale.”

Others focused in on HP’s specific lines of business. A key plank of Whitman’s recovery plan has been to boost sales to large corporate and enterprise customers, particularly as they rebuild and restructure their data-center operations. Poor sales results in the sprawling $30 billion Enterprise Group (2012 sales) spurred Whitman to reassign that group’s head, executive vice president Dave Donatelli, on Wednesday, in a move first reported by AllThingsD, and to replace him with COO Bill Veghte. Whitman said in a subsequent interview with AllThingsD that she was “disappointed” by the results, and wanted “fresh eyes” on that business.

It’s in that line of business that one of HP’s biggest challenges lies, said Patrick Moorhead, analyst with MoorInsights and Strategy, a boutique research firm focusing on the IT industry. “HP has some really differentiated and forward-looking designs like Moonshot for the data center market, but it’s really a long-term play, so naturally revenue hasn’t kicked in yet,” he said.

HP’s rivals — Dell, in particular — have been hurting HP with aggressive price cuts. “Dell has really been the shark in the water in the rack and scale-out server business, increasing market share considerably. As Dell goes private, HP will need a strategy to counteract this, as I expect Dell to get even more aggressive.”


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