Chief executive officers, particularly new ones, are supposed to create shareholder value, not destroy it.
So it is with understatement that we say the brief tenure of Léo Apotheker at the helm of Hewlett-Packard has been underwhelming. The company, worth about $90-billion (U.S.) when he was appointed at the end of September, 2010, dipped below $50-billion earlier this month at the latest news of the company's evolving strategic plan.
Simply put, the market consensus is the once-revered HP is now the gang that can't shoot straight – anything the company announces is met with distrust and disdain.
Investors willing to bet that the pessimism has gone too far, and that Mr. Apotheker is setting the course for a new era at the company, can make that wager remarkably cheaply, as the company is now trading for less than six times forward earnings.
To be fair, HP provided investors a number of surprises earlier this month. The company plans to review strategic options for its personal computer business, which provided nearly a third of the stunning $126-billion in sales it made in the most recent fiscal year. HP said it will scrap its webOS system, effectively killing its new tablet computer offering after just 48 days on the market. And it said it would pay $10-billion for a U.K. computer services company called Autonomy, thereby paying about 20 per cent of its market capitalization for a concern that will provide about 1 per cent of HP's revenue going forward.
Are these signs of confusion, or clarity? I suggest the latter.
While Mr. Apotheker has said there's value to HP operating in both the consumer and business segment, it was widely noted at the time of his hiring that he came from business software company SAP, and could be expected to emphasize that element of HP's business.
HP's "personal systems group" – the PC business – has an operating margin that, at 5.9 per cent in the third quarter, is one-half to two-thirds that of every other line of business at HP. Now, ask yourself this: If either the "cloud computing" trend or the tablet phenomenon change the PC business as much as the futurists say they can, will HP's margins in that division head higher or lower?
The Autonomy deal, at somewhere around 10 times revenue, is indeed expensive. At the same time, it's a clear step toward HP competing in the enterprise software business. Contrast that with HP a decade ago, when then-CEO Carly Fiorina made a run at buying the consulting arm of accounting firm PricewaterhouseCoopers; when that failed, she turned around and bought low-margin PC business Compaq Computer. That, it can easily be said, reflects less strategic clarity than the current set of HP moves.
The Bear Case
Let's take a minute to review a well-articulated bear case from A.M. (Toni) Sacconaghi of Bernstein Research, who recently cut his HP target price to $39 from $60. (Given that HP stock has tested the low $20s recently, he still has an "outperform" rating.)
Mr. Sacconaghi says the Autonomy acquisition is "value-destroying" in part because the money would be better spent on share buybacks. He compares HP to IBM, which has driven roughly 12-per-cent annual earnings-per-share growth over the past decade despite averaging 2-per-cent revenue gains. HP, he says, has potential to deliver high single-digit EPS gains with just 3 per cent sales growth.
"The purchase of Autonomy represents a fundamentally different approach to running HP with a different set of capital allocation priorities, which we do not believe is appropriate for HP," he says. "It worries us significantly, and we believe that the time may be ripe for activists to become involved with the stock, forcing change."
One of the problems with value investing is that sometimes you're catching a falling knife; I wrote an article for Globe Investor nearly a year ago saying HP shares looked cheap at $43 because people were too pessimistic about the changes at the company. Sentiment has gotten considerably worse, evidenced by Needham & Co. analyst Richard Kugele saying he senses HP's "dramatic moves are being made from a position of weakness and not strength, and have an air of desperation to them."
At least half of that is true; if HP were strong, you couldn't buy it at a P/E of less than six, as you can now. But what the market takes for desperation, and even hopelessness, may instead be the first sign that Mr. Apotheker is moving decisively toward growth and higher margins. It is cheaper than ever to bet he will be right.
David Milstead