When the Titanic was sinking, would breaking it into smaller pieces have helped it stay afloat?
This is the logic employed by The New York Times’ Rob Cox and Robert Cyran in their recent attempt to justify breaking up Hewlett-Packard (HPQ) and selling off or re-packaging the component businesses (e.g., printers, PCs) as standalone entities.
Here’s a quick synopsis. Note that HP considers itself to be comprised of five operating segments:
1. Personal Systems Group (e.g. PCs, etc., plus the calculator division)
3. Imaging and Printing
4. Enterprise Servers, Storage and Networking (including their cloud offerings)
5. Software; plus the financing arm and HP Labs and other pure R&D investments
Cox and Cyran in the NYT’s Dealbook imagine the company splitting into five public companies, corresponding to the five segments on the aforementioned list. Cox and Cyran’s valuation methodology is to simply take the total revenue of each division, apply an enterprise value-to-sales multiple of the most logical public competitor (e.g. Dell, for HP’s Personal Systems Group), and, voila, you have five public companies worth an aggregate of $50 billion (net of the $16 billion in debt on HP’s balance sheet). HP’s current market cap is $27 billion.
Would HP ever consider this? I seriously doubt it. Even if breaking up HP is the “right thing to do,” their board of directors isn’t known for that type of risk-taking.
I think the board believes that HP is special and that selling off bits and pieces a la Dealbook’s plan would be like selling the family silver.
How does that special feeling manifest itself? Consider that the offices of founders David Packard and Bill Hewlett are preserved at HP’s headquarters, looking like nothing so much as any random office on the Mad Men set. It’s one thing for a corporation to have values; it’s another to be trapped in amber, wishing the good old days will return.
But in this era of cloud computing, bring-your-own-device, software-as-a-service and cell phones on which the entire functional set of an HP-12c calculator can be purchased as a $15 app on iTunes, HP is an anachronism, hoping the world will stop spinning.
So what if the Hewlett board seriously considered breaking up the company? Is it a good idea? In my opinion, no. The logic behind Dealbook’s valuations are deeply suspect, beginning with the fact that the company’s actual tangible book value is -$13 billion as of the end of the 2nd quarter 2012 .
Dealbook’s analysis uses comparable valuations of similar businesses, but the rest of it is lacking:
- The analysis includes a lot of bundled revenue attributable to package deals, rather than business won strictly by the segment itself.
- It ignores the need to add salespeople who are specialists in the products and service sold by each segment, and part with those who have been account managers straddling multi-product customers.
- It sidesteps the problem that much of the current company’s operating cash flow comes from the imaging segment; the other segments are being subsidized in a way that would end were the company broken up.
- It assumes you can find capable executives to run businesses that are already flailing. Sure, there are turnaround artists out there, but what are the chances you’ll find the Picasso of printing? The Cezanne of storage?
- It compares HP’s PC business to Dell, which is bizarre since Dell itself is a multi-line company and shares many of HP’s problems.
- It doesn’t take into account the substantial expense of running a public company.
- It doesn’t take into account the amount of business won thanks to the Hewlett Packard brand name, which would likely only adorn one of the five survivors.
So the right way to play it is to continue avoiding HP. Yes, that means you’ll miss the inevitable “stock pop” when some eventual activist hedge fund manager (e.g. Einhorn, Loeb, Icahn) casually mentions HP as looking “interesting” in an interview, but chasing that would be foolish.
I’m hardly biased against HP. I’m writing this on an HP laptop, which is connected to an HP printer. But the laptop is six years old; the printer, 11 years. I’m a single data point, but how many of you are using an HP smartphone? An HP tablet? HP has cloud services, but like so many of their products and services, it seems generic.
Which leads to my advice for the board: Present a single unified face to your customers. Return to your innovative roots. Acquire some smaller leading-edge players in software-as-a-service and bulk up your in-house R&D staff. Plan on growing 5%-6% year after year, by some combination of organic and acquired growth. And learn to live with that.
Bill and Dave would be proud of you.
Disclosures: This commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.
Certain information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. The manager believes that such statements, information and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.