HP shares took a big hit on word that it will spin off its PC business, discontinue the TouchPad and buy Autonomy in a bid to beef up its software portfolio, but Auriga analyst Kevin Hunt thinks the company has some value---more like $32 a share.
Now Hunt isn't exactly complimentary to HP. After all, his research note is titled "Even a mess eventually has value." But Hunt does walk through three scenarios for HP---a best case, a middling base case and a worst case. Meanwhile, HP's TouchPad fire sale over the weekend didn't exactly bolster confidence.
Here's a look at Hunt's reasoning as you think about HP's future.
Hunt sets up his note by making the following points:
HP has understandably taken whacks for missing earnings targets and cutting analysts.
Former CEO Mark Hurd set up many of the factors that are now giving Leo Apotheker a headache. Hunt was down on HP in the Hurd years due to increasing use of pro forma metrics, suspect acquisitions and cuts in R&D spending. "We feared the company would have to substantially ramp R&D spending to remain competitive as an enterprise supplier after years of overzealous cuts by Hurd," said Hunt.
Hunt isn't a fan of the Autonomy deal or the timing of the PC spin-off.
Nevertheless, HP shares have taken a beating and may be worth more for the patient shareholder.
Add it up and HP's future goes like this.
A best case scenario where HP gets good value for its PC business, improves software and services and ultimately gets some props for reinventing the company.
A middling case, where HP plods along with its current portfolio and ultimately decides to keep the PC division, which will lose some market share.
A worst case outcome where HP spins off the PC division, but still can't execute. Ultimately HP shares crash to $11 and the company becomes irrelevant.
Working through these scenarios from Hunt is an interesting exercise.
The middle of the road case, assumes that Autonomy is added to HP's portfolio, but the company loses $5 a share in cash (the $10 billion used to buy Autonomy). A weakened PC unit remains with HP. Even assuming a slowdown in tech spending and a plodding printer business, Hunt gets a $38 price target for HP shares based on cash flow.
The extremes, however, are far more interesting to watch.
Hunt's best case scenario is that HP spins out the PC business and gets good value for it. Hunt said:
HP management has done a fairly remarkable job in turning this business around since the Compaq acquisition nearly a decade ago. At that point it was a lagging business with consistent losses. Today it is the market share leader with industry high operating margin. In sum, there really is nowhere to go but down, especially with the threat of tablets looming over the business. If HP is able to maximize value here, they could then put a greater focus on improving results of the recently challenged enterprise focused businesses. It is not unreasonable to assume the PC business could bring decent value, as it is a low capital intensity business, with high free cash flow, so even if “the PC is dead”, or even declining, a decent return on investment can likely be achieved.
How would a spin-out of HP's PC business do? Hunt compares HP's PC unit to Lenovo, which is on a roll today after acquiring IBM's PC business in 2005. Hunt's other comparison is that Arrow, a value added reseller. Why Arrow? PC businesses these days act as resellers---they take PC parts, put them together in a box and market them. Based on Lenovo and Arrow comps, HP could fetch an enterprise value of $9.3 billion.
If HP keeps the printing business, it keeps a lot of cash flow. If the execution is there, HP's assets can garner a market cap of $98 billion, or $47 a share.
The worst case scenario for HP is flat-out ugly. HP continues to overpay for acquisitions---the Autonomy deal is just the latest. For reference, Autonomy cost HP 15 percent of its market value for an outfit that will generate less than 1 percent of sales and 2 percent of expected profits. HP's book value is also hurt by the Palm deal, said Hunt. These pricey acquisitions mean that much of HP's book value goes to goodwill that was acquired---and will probably be written off later.
According to Hunt, the bearish case assumes that HP's PC business unravels. The post-PC era really arrives and HP's PC unit is only worth $3 billion as a standalone entity. While HP reels from not getting full value for the PC business, its printer business also stumbles and is worth only $12 billion or so. As these unpleasant HP events unfold, the company has to pony up to fix its services business, but the payoff never comes. "In that case, we believe the Street will begin to view HP as a dinosaur on its way to extinction, like many of the tech names of the past. So rather than choosing a world class executor like IBM as a comp, we decided to use 'old school' tech companies like Cray and Unisys, companies that most investors probably think went away years ago, but are still out there plugging away," said Hunt.
If PCs, printers and services stumble, HP could be seen as a dead company walking. If HP also fails to execute, shares could hit $11 if everything goes wrong.
The wild card for the worst case scenario is that private equity investors could swoop in before HP got that bad. In addition, management would be replaced. The other wild card is that Oracle and Larry Ellison could take out HP before everything unraveled.
Bottom line: The truth here probably lies in the middle somewhere, but the prospects are worth noting.