Arik Hesseldahl

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Ahead of Big Meeting With Analysts, Another “Sell” Rating Appears on HP Shares

With less than a week to go before Hewlett-Packard CEO Meg Whitman sits financial analysts down for an update on her efforts to turn the company around, another analyst has chimed in with a negative “sell” rating on HP shares.

HP shares are trading lower by more than 2 percent in premarket action in partial response to the downgrade note by Peter Misek of Jeffries and Co. Misek lowered his target price for HP shares to $14 from $17, and maintained his already low estimate on its per-share earnings for fiscal year 2013 of $3.58, which is far below the consensus estimate of $4.22.

He has lots of reasons: For one thing, Misek is worried about HP’s intentions in the tablet and smartphone arena. After failing to capitalize on the acquisition of Palm and shutting down the webOS hardware business after sales of the TouchPad tablet failed to gain tractionand a subsequent $3.3 billion write-off for goodwill and inventory — Whitman has promised to try again with another smartphone. Misek sees that “makes sense strategically,” but it carries with it a lot of risk: “On top of adding costs and working capital burdens to an already stressed balance sheet, there could be additional write-offs.”

Meanwhile, HP already has significant trouble with its bread-and-butter PC business. Overall demand in the PC market is slowing, while Microsoft’s Windows 8 doesn’t yet appear to be much of a catalyst, at least if you look at the slow demand for PC microprocessors from Intel.

On top of that, the transition to a renewed emphasis on higher-value IT hardware and services is sputtering. Documents revealed in the lawsuit with Oracle over the Itanium chip — HP won the first round, but Oracle has promised to appeal — laid bare the fact that HP has long been relying heavily on revenue-derived service-and-support contracts with customers who buy Itanium-based servers. Referring to the Business Critical Server unit that sells the servers, Misek writes that his conversations with its customers don’t bode well for HP: “Our conversations with BCS customers indicate a lack of confidence in the longevity of the product platform. While migration off of BCS is not lightly undertaken, we expect continued weakness in BCS hardware and related Services revenues.”

Then there’s the printer business: Inventories of printer ink have built up because they’re selling more slowly than before. The correction, Misek argues, will take several quarters to resolve. He thinks tablets are cutting into demand for printed pages.

Finally, there’s software: The one still-unfinished bit of messy business left over from the 11-month service of former CEO Léo Apotheker is the $11.7 billion acquisition of the British software firm Autonomy, announced 13 months ago. Misek says he expects HP to write off some of the value of Autonomy. This would follow the massive $8 billion write-off announced Aug. 22, related to the EDS acquisition from 2008. After that first big write-off, HP hinted strongly that more goodwill write-offs are in the offing, probably in Software, Misek says. “After Autonomy’s poor performance the last couple quarters, we think HP will write off half of the $6 billion goodwill from the Autonomy acquisition, which will put further pressure on its debt to equity ratio.”

Which brings us to HP’s debt situation. Misek notes that HP has $1 billion in debt payments due in the fourth quarter of this year, and another $5.5 billion due in fiscal 2013. While not unusually high for HP historically, it doesn’t exactly help the already-strained balance sheet. Investors in debt markets have certainly noticed as credit default swaps on HP bonds experienced a textbook case of “blowing out” over the summer, though in all fairness it wasn’t the only PC maker they worried about.

Misek isn’t the first to place a “sell” rating on HP shares. Chris Whitmore of Deutsche Bank Securities was notable for placing a “sell” on HP in August of 2011, and has remained bearish on the shares since then. The bearish case is strong, indeed, and many investors are working it: Short interest in HP shares — an indication of sentiment that the share will fall further — has increased substantially in the last year.

As markets opened for trading in New York, HP shares fell by 15 cents, or a little less than 1 percent, to $16.96 on the New York Stock Exchange, after closing yesterday at $17.11. If HP shares fall to the $14 price target that Misek has set, it would constitute their lowest price since April of 2003.

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