Five Steps HPQ Could Take To Be A Leader Again
A new CEO should be a catalyst for HPQ. The shares have languished in
a trading range - around $18 to $22 - since the Compaq merger, due to lack of
investor confidence in
strategy and execution.Â
HPQ stock's valuation is
more attractive than it has been the last two or three years. Turnaround
potential could propel the stock higher; new leadership could generate improved
top line growth and operating leverage. That said, realizing this potential will
take time. The key business for HP is enterprise hardware, which, if the company
can execute substantially better, could boost revenues and profits. It's
possible HP can end up doing "a
Motorola", "a Xerox", and even "an Apple" -
whereas before Fiorina's departure, HP looked like it might do "a DEC" or "a
Unisys".
But for me to feel
confident that HP can execute a turnaround, I'd need to see a leaner and clear
business strategy, more and more visible senior management accountability,
considerably better execution (particularly in the enterprise business), more
cost cuts to improve operating leverage, and a specific end-market-driven sales
focus.
HP shares currently trade
at just
13 times the consensus' 2006 EPS estimate, a significant
discount to the hardware peer group.
I can see the multiple expanding to $25 on turnaround
potential, which would imply a price of around $25.
Although I don't see more than
around 15 to 20 percent appreciation this year, the stock's downside risk seems
to be limited.
HP needs a
coherent strategy
A key issue for HP since the
mid 1990s has been lack of strategic focus. Chairman Patricia Dunn’s, in
describing the recent leadership change, stated the
need for better "hands-on" management and also
implied the problem at HP was one of execution rather than strategy. But I
disagree.
Hewlett-Packard needs to do a
lot, both strategically and tactically, to move from being a mediocre company to
an industry leader. HPQ was range bound for the last couple of years with no
catalyst to propel it higher. The company suffered from soft demand across most
of its product segments, as well as ongoing distractions from operations as a
result of reorganization of its structure due to fundamental changes and significant
cost-cutting initiatives. Although HP has significant technology assets and a
solid base of stable profitable revenue from both its printing and supplies
segments, these positives were offset by ongoing pressure from increased
competition, commoditization, ongoing execution challenges particularly in the
enterprise business, and lack of strategic focus. All within the context of a
weak economy, continued softness in overall IT spending, and competition that
has executed considerably better than HP.
Some have suggested
splitting the company into two (or more) parts. But I’d rather streamline HPs
operations and spin-off the smaller, less relevant parts.
That said, the likelihood of HP being broken up is higher
after Fiorina's departure, although the Board of Directors has indicated that no
such move
is currently planned. (Not) "currently planned"…
hhhmmm, whatever that means.
The company is spread
too thin – trying to be all things to all people – and competing in too many
diverse segments without effectively leveraging potential synergies. A more
cohesive, selectively focused strategy could better leverage HPs resources and
deliver more robust results. I always questioned
Hewlett-Packard’s big move into services
when IBM is so strong in that area. I could understand HPs motivation, but
believed that making baby steps could have been more effective tactically for
the company: either acquire tiny companies that have proven themselves in niche
areas, or do like Royal Dutch Shell does – partner, infiltrate, and then
acquire. I’ve also
wondered why HP went for head-to-head competition with Dell, when Dell’s low
overhead from efficient use of direct marketing makes competition in the low-end
extremely difficult.
HP always did well in
printers, and hopefully the company’s focus on this business will return.
However, the merger
transformed this formerly largest and most profitable unit of HPs business into
a much smaller contributor to the total numbers.
Strategically, what
I’d like to see an enterprise hardware company be successful at is marketing to
the small business owner. They could give small businesses the capability to log
onto a website, select a network solution based on their projected business
needs, and obtain market pricing as well as pricing on different service level
agreements.
HP needs
to get back to being a quality leader
Here are some steps
Hewlett-Packard could take to get past the price war, and get back to being a
quality leader and being true value again.
First, kill Compaq or just
use its products for one level of computers – end the confusion.
Second, elevate the high-end
further and revamp the R&D structure to divide all R&D into an R&D core group in
one facility (or maybe one R&D group per continent — it depends on distribution
of R&D staff and physical properties).
Third, create a non-profit holding company or foundation for R&D. This would
take economic pressure off R&D and allow it to pursue new technologies that
require several years of development. Bell Labs and others such as HP are
shuttering these kinds of programs, despite that they are better in terms of
maintaining an edge and generating future growth and profit. In the current HP
model, technological advances are limited by economics. This appears to be one
reason the 64-bit chip it had been building was abandoned; however, had it been
pre-contracted to others it could have lived in this holding company model.
Companies generally don’t sign more than an LOI (letter of intent) contract
unless the device is assembled and operational at an alpha or beta. So with a
pure R&D model, other manufacturers can invest in the non-profit / match
foundation funds, etc. for R&D and use tax breaks, investment tax credits, and
write-offs to distribute risk and cost more easily. In addition, this is a model
that can use Angel money, especially if R&D is U.S.-based. It’s an easier
vehicle for university partnering as well, considering tax advantages / breaks
are a sacred ground for foundations and colleges. So the dividing out of R&D
would be a logical route to take in order to continue to innovate.
Fourth, put printers into the same model. Maintain Hewlett-Packard as “the
brand†since it’s a strong suite. Just give HP the R&D advantage it needs to
beat Lexmark, which already has a digital paper machine in alpha (no trees used
for this).
Fifth, put cameras, scanners
and optical drives into a new division, into which all other consumer products
would also be placed. This way, it’s set to spin off at any time. In addition,
Hewlett-Packard drives could be sold to other manufacturers, which is part of
the IBM long-term success and survival strategy. Remember who owns the base
patents for the original AMD chips and HDDs? IBM. Just like the reason Intel has
a tough time besting Texas Instruments; Intel has to keep paying TI until it can
build a transistor-less IC. It’s the same for every other IC manufacturer.
Owning core technologies is a nice path for a long life in this world, just that
you may have to keep updating when other parts change.
HPs cameras, scanners and
optical drives all use the same basic core components — touch screens / LCDs,
optics and glass, micro circuit boards and flexible boards, ribbon connects,
batteries and memory cards. By keeping these businesses in one division, HP
could simplify the supplier list and logistics and consolidate orders and buying
power effectively in one master order. With different divisions in different
places and with different bosses, how much harder is it? There’s another
advantage for HP with this approach: launch a Chinese or Korean manufactured
line of cameras, etc with a new name that are the low-end low-cost units. In
this way, it could compete with Dell, Kodak, Canon and all comers in these
areas.
So the computer divisions could keep making computers, the consumer unit could
make parts and OEM them to other business units, and the printer business should
be stand-alone. In this way, software / hardware development would be given a
renewed core focus and room to breathe and innovate. It’s close to what IBM has
done but with a better structure. That’s missing in the HP model and IBM cannot
match it with the structure they have. It’s a magnet for R&D and invention.
Hewlett-Packard could adapt in some form outlined above, or else adapt by cost
cutting and other “cut your nose off†methods used in IT. Being a low price
leader is no shelter from rapid innovation when the initial cost is amortized
out on a longer shelf-life. Redistributing R&D repayment over time instead of
the current “per unit sold†system creates a slippery slope for any other
manufacturer unless they use the same pricing model, which tries the reserves in
a traditional P&L company. But not at a company where a loss is an advantage.
HewCom-Paqard merger left HP lagging its competition
Strategically, I was never a
fan of the “HewCom-Paqard†merger. HP became so obsessed with Compaq and Dell
they it took its eye totally off the ball in trying to be the biggest Wintel
reseller. I’ve also wondered why HP went for head-to-head competition with Dell,
when Dell’s low overhead from efficient use of direct marketing makes
competition in the low-end extremely difficult.
Despite all the promise of
the merger, HP has failed to capitalize. Carly “my company has pre-announced
every quarter since I’ve been here” Fiorina blamed a couple of quarters last
year on “unacceptable execution†in its enterprise businesses – servers and
storage products sold to large businesses and organizations. When it reported
last August, for the quarter ended July 31 2004, management warned that profits
for the quarter ended October 31, 2004 would fall short of Street expectations
and that it would make “immediate management changes†at its servers and
storage business. Three senior sales executives were duly axed. Fiorina stated
the storage business specifically was “significantly below planâ€. She
said the division had been affected by a migration to a new order processing
system that was “more disruptive than planned,” that HP had
supply-channel problems in Europe, and that an expected ramp in business during
the latter part of the quarter didn’t happen. (“Yeah, we know the quarter sucked
and the mid-quarter update isn’t looking great; but we’re cautiously optimistic
that the mythical quarter-end ramp will get us out of the holeâ€â€¦. whatever.)
Dell’s conference call a few
weeks later was an interesting contrast. Dell management tends to be straight
shooters. Unlike much of corporate America with the way overrated Carly
uppermost on the list of technology offenders (right up there with John “Cisco
Kid” Chambers, Oracle’s flim-flam man Larry Ellison, and Sun Microsystems’ Scott
McNealy and a couple of others). For the last few years, Dell has been growing
market share across the board, and it’s definitely coming at the expense of HP,
more rapidly since the Compaq merger, Fiorina’s tough-guy act notwithstanding.
She should have resigned instead of blaming those three stooges … I mean,
executives.
The acquisition of Compaq was
supposed to enhance services revenue, improve HPs revenue mix with more
Department of Defense contracts, and capture more mid-level server market share.
However, the merger was messy internally, it created too much duplicate expense,
the layoffs were much larger than originally expected, and for too long there
were too many people at HP with unclear work plans or not enough to do. There
were many cultural and operational impediments to the merger integration; this
curtailed the efficiency of HPs operations and also limited HPs sales growth
prospects during the past couple of years across a variety of business units.
The merger
integration didn’t go nearly as smoothly as management indicated. (They rarely
do; heck, management had to sell the idea to shareholders, right?) In some
instances in the press, Hewlett-Packard blamed a downturn on the sales force
when only a couple of years earlier, in 2000 or thereabouts, Sales and Marketing
Magazine had rated HPs sales force as the best in the world. There were folks at
HP who had no clear direction on what they were supposed to do… for a year or
more. There was overlap; confusing commission plans. And all this was music to
Dell’s ears. To top it all off, there was a horrendous SAP implementation that
in large part failed to provide timely data. In short, the merger was a mess
internally and the layoffs were much larger than originally anticipated. Perhaps
in the 30,000 range, as opposed to the 15,000 estimated. There were too many
people at HP with not enough to do for too long.
It was less a matter
of turf wars than a matter of people that didn’t get their fingers deep enough
into how the two businesses really ran before they decided what processes should
be used going forward. The merger synergies and efficiencies touted by Fiorina
and her team were more likely to be hard-won over years, not months during the
“integration” progess.
Product strategies were similarly vague, particularly in the consumer PC group.
HP inherited a single group managing two distinct product families that had huge
overlap, but with the vague idea that they should appeal to different markets
and be sold differently. It took over two years before there was any real
direction on the matter. Meanwhile, Dell was grabbing market share and continued
to consolidate market share over the last three years.
There was little clarity on how the combined entity would support older Compaq
PCs. HPs support infrastructure was selected over Compaq’s. Unfortunately,
however, those systems were not designed to handle the knowledge base,
registered customer information, or even the product descriptions for older
Compaq consumer PCs.
HP was looking for ways to “retire†employees on the HP side age 60+. So many of
the smartest and most experienced employees left or were looking for ways out,
and even in the weak economy there was always a way out for the smartest people.
HP has blamed a downturn on the sales force, sometimes in the press, when only
about 3 years ago, Sales and Marketing Magazine had rated the HP sales force as
the best in the world. I understand that many at HP feel they have no clear
direction on what they’re supposed to do. There is overlap and confusing
commission plans, all of which is music to Dell’s ears. And top this off with a
horrendous SAP implementation that, in large part, has failed to provide timely
data.
Company culture was, and still is, unclear
Vanity Fair did a real
hatchet job on Carly back in 2002. However, I always thought that she was the
right person at the time for the job at Hewlett-Packard, since the company was
struggling at the time with an Internet play/presence. Shortly after she arrived
at HP, she (appropriately) put an end to a lot of vendor finance deals for
dotcoms, saying “HP isn’t a bank” and more tightly focused the company’s
strategy. I’ll bet companies like Sun Microsystems wish they had done the same.
Sun bled red (and is likely continuing to bleed on the amortized debt, etc.)
from the dotcoms bust. My big criticism is that Carly brought an AT&T / Lucent
hierarchical management style to a culture that had traditionally thrived and
innovated under egalitarian rule. Although considering the size and breadth of
the post-merger Hewlett-Packard entity, this more hierarchical, structured style
was ironically an asset in pulling it all together. But it’s not a management
style that’s likely to support innovation as it was in the old days of HP.
Hewlett-Packard used to have
first rate manufacturing facilities. It’s the only American company ever
to have won the Deming award in Japan for quality. Now, the company has
de-emphasized R&D, outsourced almost all of its manufacturing, and has become an
assembler of someone else’s parts with margins that are fixed. No innovation.
The “HP Way” appears to have long gone thanks to a focus on outsourcing,
paranoia about the diversity programs and other nonsense. For the last decade,
it’s been more about spin. I can’t help but think that the real spinning is
going on in Dave Packard’s grave.
These points about corporate
culture and innovation are exactly why I believe HP needs restructuring — to
regain focus. R&D in an open environment is a return to the old ways that
worked. There’s also a chance to concede to Carly’s architecture at the top and
thus fit the freethinkers into a freer space, which, with just a little
structure and discipline, could be a successful system.
UNIX a
sunset business, Linux on the rise
Very long-term, I expect HPs
UNIX business could well decline to “close to nothing” as Linux becomes the
standard. The downturn in UNIX sales at Hewlett-Packard was in large part due to
Sun Micro taking advantage of the legacy that Belluzzo left when he retired. In
addition, it has been compounded by HPs lack of a coherent strategy. In
addition, Carly put Compaq management in charge of the UNIX business: a team
that’s experienced with Windows rather than UNIX, and which does not appear to
have the necessary depth of understanding or experience with solutions selling.
Overall, HP is starting to remind me of Unisys.
Linux is a survival strategy
for HP, because Linux is growing at a steady pace and has a devoted little cult
backing it that generally all hate Microsoft, thus a united cause. That’s tough
to beat, it like the Apple fanatics who keep it alive, but this is an
Open-source OS, so it’s a different animal in the numbers. Linux requires no
factories or mass infrastructure. However, security of Linux issues will keep
BSD and other UNIX variants alive. This is because a BSD base with Linux kernels
and a middle proprietary layer is just about the most secure OS that can be
assembled today from what’s there today in hardware and software.
HP needs to be available to
the Linux camp, because a growing camp means sales growth is possible, and the
better the HPs can run any Linux variant the better for sales. UNIX variants and
parts of the code can continue to be reintroduced to Linux (except, of course,
no one will touch SCO code anymore) in order to shortcut development time and
create patches and such post haste. Linux is very similar to UNIX (hence, the
SCO legal trysts), which means that the UNIX code will possibly live forever in
Linux, until Linux itself is history (very, very far in the future). Linux has a
better kernel structure, which means it can outperform UNIX. Although a current
limitation is that not all the applications or software are written for Linux
yet, so the gaps get filled with UNIX and UNIX-based pieces. And since much of
Linux is written without a royalty (except for RedHat, Novell, SuSe, etc.), on
balance how many will want to slave for 200 hours to do what can be done in ten
with a UNIX driver or code segment? So I expect the connection with UNIX will
exist in some form for a very long time, if not for as long as Linux.
Valuation and risks
HPQ could trade up into the $25 to $27 range over the next 12 months with the
removal of the “Carly overhang”, some positive catalysts and turnaround
potential. However, HP needs to capitalize on these opportunities; if it fails
to do so, then HPQ is likely to continue to languish.
For the last three years, the stock has reflected investors’ evaluation of HP as
an “also-ranâ€. To some extent, the cost savings alone justified the
“HewCom-Paqard†merger. However, I’ve always believed the deal revealed just how
weak both management teams perceived their respective positions to be. And it
was always difficult to claim that either of these two firms really dominated
anything, aside from HPs market position in printers. The real internal
issue is that neither company had a cohesive strategy prior to the merger. So,
in the end, we got nothing more than two struggling giants bootstrapped
together, each with declining margins (due to increased commoditization), and
limited growth platforms; and all this in the context of an ongoing weak
economy.Â
Long-term, I’m less confident
of HPs ability to regain lost ground and market share in its primary enterprise
businesses. Success in the enterprise categories (in particular, servers) is key
to driving incremental revenue and profit in other segments like storage,
software and services. These revenue streams should become increasingly
important in offsetting any further deterioration in consumer demand.
Consequently, HP runs the risk of continuing to lose share to more focused,
higher quality enterprise OEMs (Dell in the PCs; IBM in servers) during the next
one to two years (or for so long as it continues to be weighed down by what it’s
become following its merger with Compaq). It’s unlikely that this loss will be
offset HPs printing and imaging business: although HP continues to be the
premier franchise in this segment, the merger transformed it from being HPs
largest and most profitable business unit into a much smaller contributor to the
total numbers.Â
Melanie Hollands