HP, Dead or Just Resting?
HPQ

September 6, 2011

(At the time this is written)

HP, as the Hewlett Packard Company likes to be known, (NYSE: HPQ), is on its last legs, if you judge it by its stock price. It is selling for less than six times earnings. It has become a symbol of technological failure lately, mainly because of the failure of its tablet computer offering and its lack of presence in the smartphone market. Also, it announced it wanted to sell or spin off its personal computer (PC) business, but apparently no one with that kind of bucks wants to buy the division.

But suppose the pundits and investors arranging for a funeral are reading the symptoms wrong. In that case it possible this is a buying opportunity for those who get an accurate view of the situation. After all, a PE under 6 means trailing earnings are about 17% of the stock price. That strikes me, on the surface, as a much better deal than 2% annual returns on loans to the United States.

The most solid evidence that things are not so bad are actual GAAP results from fiscal Q3 2011, as reported on August 18, 2011. True, revenue was up only 1% y/y, and while GAAP net earnings were $1.9 billion, up 9% y/y, non-GAAP net earnings were $2.3 billion, down 11.4% y/y.

A company with $1.9 billion in GAAP earnings in a quarter is not on death's doorstep. So the low stock price must be based on opinions about something more fundamental than mere profits: technology trends.

I have been around long enough to see a lot of companies go out of business, especially in the PC space. I know it can happen. Margins are brutal when differentiation from competitors is difficult. That is why IBM turned over its PC business to Lenovo. On the other hand, Lenovo has done quite well since then, so maybe IBM's strategy was not so brilliant.

The main theory is that tablets and smartphones are going to eat PCs, just like PCs ate up minicomputers back in the 1980s. To buy that argument you have to include servers in the PC category, because what PCs ate up was dumb terminals. Servers, based on technology similar to PCs, are what actually killed minicomputers.

Digging deep into history, recall that PDAs were going to replace PCs. Instead MP3 players replaced PDAs, because more people wanted to listen to music than wanted to carry around a tiny crippled business tool. HP was a leader in PDAs, and a failure in MP3 players, yet it did not die from the experience.

HP has several segments; the future does not look the same for each segment. The printer segment does not seem to be disappearing. The business hardware segment, excluding PCs, includes servers, enterprise-level storage, and other datacenter components like switches, routers, and the software needed to enable and manage racks of equipment. Because people are increasingly relying on mobile information, these datacenters, aka the cloud, continue to expand. Competition with IBM, Dell, Cisco, Oracle and many other companies is fierce, but so far HP has competed rather well. Services for enterprise computing are also a major source of revenue and profit.

So if the consumer PC division is seen as a weakness, the worst case scenario should be that it gets spun off. Stockholders get the enterprise and printer gravy in one tray and the consumer business in another.

If HP is making a mistake, it is not seeing the further possibilities of the PC business (with PC broadly defined). Every few years since the PC was born it has been declared to have all the computational power it needs. I have made that mistake myself. These days the new AMD A-series chips can run a pretty good game without the need for a discrete graphics card. They can put HD video on a big screen. The end of innovation must be near, except for smartphones. And tablets.

If you think PC innovation is coming to an end, you have not talked to the visionaries at Microsoft, or AMD, or even at Intel. Amazing things are just beginning to be computationally possible. A good example is the Kinect device for Xbox 360 games. There is no reason similar technology can't be attached to PCs running 60 inch displays. In fact, hackers are doing that already, with Microsoft even offering a software development kit (SDK) to help.

Yes, you will be able to wave your hand in the air, talk a bit, and do everything from altering an accounting spreadsheet to running a tractor to manipulating DNA from the comfort of your chair.

You are going to want the latest smartphone when you are on the road. But in your den or office, you are going to want a PC with a big screen, input devices more intuitive than touchscreens, and a hairy advanced processing unit to make it all work in real time.

If Leo Apotheker is too dull to see the potential of HP's PC division, it is still going to be profitable for the foreseeable future, even if it is just a commodity manufacturer of innovation spun elsewhere. A spin off suits me fine. Wish I would run it, wish I could own it. In addition I would get shares of the enterprise segment, a gold mine in itself.

Wait, I can own a piece of it. That is the great thing about stocks, you don't have to buy the whole company all at once.

Disclaimer: As I write this I own no HPQ, but it is on my wish list to buy. I do own AMD and I do occasional subcontracted work for Microsoft. I also own an HP competitor, SGI, that specializes in technical computing.

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