On October 5, the financial media was abuzz with the news that Hewlett-Packard (NYSE:HPQ) would split itself into two companies. HP announced it would separate its faster-growing corporate services business, which will be called HP Enterprise, and its more sluggish computer and printer businesses, which will be called HP Inc. This move will be accomplished through a tax-free spin-off, and should be completed next year.
HP stock rose 5% immediately after the announcement, implying a sense of optimism on the part of its investors. While it's customary to see a stock rise in value after announcing a plan such as this, it needs to be stated that the split does not actually represent a meaningful change of direction. Splitting the company into two pieces will not change the core problems HP is facing. It's seeing its hardware-focused businesses, primarily printers, seriously deteriorate. A corporate split does not change this at all.
Moving the pieces around does not change the story
HP can shift around its various pieces all it wants, but the company's woes will remain even after the split is completed. Investors should not be lured into thinking that this will instantly cure all that ails the company. After all, in the same announcement, HP also revealed it would cut another 5,000 jobs. This brings the total number of layoffs under current Chief Executive Officer Meg Whitman to 55,000 in all. That is not exactly indicative of a company in good shape.
HP's fundamentals also bear this out. Over the first nine months of 2014, HP's revenue is down by less than 1%. Diluted earnings per share are up 2%, which is far from impressive growth. And, it's worth noting that HP only managed this growth because of its aggressive share buybacks, which helped reduce the company's share count.
The rationale for these types of splits is that the parts, taken separately, are often worth more than the whole. HP is hoping that once its higher-growth businesses are free to operate as an independently-traded entity, they will be awarded with a higher valuation than the current company holds. The problem with this notion is that once the "bad" business trades by itself, that stock will likely see its valuation compress because of its poor fundamentals. All else being equal, this will probably net out.
HP expects just 5% earnings growth next year, at the midpoint of its forecast. This will be once again accomplished mainly through share buybacks and job cuts to boost profitability. It's clear that there are bigger fish for HP to fry.
The problems facing HP are exactly the same as they were before the announcement, which is why investors should be skeptical of the move. The split does not change what is weighing the company down.
The story remains the same
Hardware is the problem for HP, as it is for many other technology companies. HP's printing revenue is down 3.4% over the past three quarters, year-over-year. For years, companies reliant on printers and the personal computer have been trying to shed their hardware businesses to varying degrees of success.
One company that has been particularly successful with this is Microsoft (MSFT). That is because Microsoft has been able to meaningfully branch out into higher-growth areas away from the PC, particularly when it comes to the cloud. Microsoft recently concluded its fiscal year and gave very good results. Total revenue grew 11.5% versus the prior year. Free cash flow totaled $26 billion, which increased 8% year-over-year. Much of this was due to Microsoft's cloud-based initiatives. For example, commercial cloud revenue soared 147% to a more than $4.4 billion annual run rate. Its Office 365 was a major contributor to the company's devices and consumer segment's 42% revenue growth.
HP is trying to do this as well, but it doesn't seem that these initiatives are gaining much traction. During HP's most recent conference call with analysts, the company made some bold promises, saying "Over the next several months, you can expect to see the introduction of game changing products in personal systems, servers, cloud and printing, that are going to bring some real excitement to these markets." Management said that HP is making progress with HP Helion, its cloud product offering, but did not give specifics.
Essentially, HP will simply be moving around the parts with its planned split. This caused some excitement and the stock rose after the announcement, but the fundamental problems still remain. Printing continues to be a poor business, as sales of toner and ink remain very weak. If HP gains traction in its cloud-based products, investors should be excited. Until then, the spin-off should not be considered a game-changer.
