This article originally appeared in Business Insider
Turnarounds are only sexy when seen in the rear view mirror. In the moment they are chaotic spectacles of decline. Market share, profitability, value and morale all plummeting, often with the organization having lost hope that there is a way to pull out of the tailspin. In the growth-obsessed world of technology, turnarounds are even more difficult, and management teams and employees look with envy at fast-growing upstarts and mature companies seek to boost their growth prospects through disciplined acquisitions.
There is nothing sexy about the mess that Hewlett-Packard (HPQ, $17) finds itself in now, and I am confident that CEO Meg Whitman would agree. The company could rightly be attacked for a Byzantine structure that is sapping profitability, but that would seem unfair to the Byzantines, who after all retained relevance for 1,000 years after the fall of Rome. At present there is little indication that the company founded by Bill Hewlett and David Packard in 1939 might enjoy the corporate equivalent of such longevity.
Hewlett-Packard’s current valuation screams distrust. With a Price/Book of 1.5 and an Enterprise Value / EBITDA multiple of less than 4.0x, the market is clearly showing no signs of optimism for this beleaguered company. How did this technology giant (LTM revenue of $120.4 billion, operating cash flow of $10.6 billion) find itself tagged as such an uncertain prospect by the market?
In the war for enterprise IT spending, Hewlett-Packard is facing strong competitors with a more coherent value proposition. A representative list includes:
· IBM (IBM, $205): This is almost certainly the white whale Meg Whitman and her lieutenants are chasing, and for the good of shareholders they need to stop. IBM is a diversified powerhouse, strong in enterprise hardware, software and services. The turnaround that former IBM chief Lou Gerstner engineered was a masterpiece, but that was in a different market, and with a different company. It is worth noting that Gerstner got out of businesses he did not see a future in, and found a way to leverage the strong but slow-growing mainframe business to strengthen a push into consulting.
· Oracle (ORCL, $35): A company with not quite a third of Hewlett-Packard’s revenue, but stronger operating cash flow, Oracle is a company with roots in enterprise software (founder Larry Ellison started the company after reading an IBM white paper on relational databases and deciding to build one himself) and a demonstrated ability to make savvy acquisitions. The 2009 acquisition of Sun Microsystems not only made Oracle a player in the enterprise hardware space, but secured Oracle’s flank by giving it control of the open-source MySQL database product, which was beginning to gain traction over Oracle’s far more costly database offerings. Sadly, Oracle too represents a path not open to Hewlett-Packard, given the focus the company has displayed.
· Accenture (ACN, $72): At not quite a fourth the size but nearly a nearly 40% higher market cap, Accenture perhaps represents what Hewlett-Packard might have had in-house if the EDS acquisition had not been botched. This is a company that has built a reputation as being a go-to source for large, complicated IT integration projects. It remains to be seen if the market is under-valuing Hewlett-Packard’s offerings in this area, or if Accenture truly deserves to be seen as a cut above. What is not in dispute is that Hewlett-Packard has a far more muddled story that Accenture.
· Dell (DELL, $13): If Meg Whitman is thankful for anything, it may be that at least she is not running Dell. Both companies are generating sub-par profit margins, but only Dell is small enough to be a viable takeover target.
A company the size of Hewlett-Packard competes globally, and a full listing of its competitors would certainly include more than four companies, but there are some lessons to be learned from the abbreviated list above.
1. Tech diversification does not work. It was has worked for one company, IBM. This is the exception that proves the rule, and should not be taken as an invitation to try to be all things to all people.
2. The market values a coherent story. IBM can do it all. Oracle does mission-critical enterprise hardware and software. Accenture does the heavy lifting on massive IT implementation projects. Three simple stories, three companies valued at considerably higher multiples than Hewlett-Packard.
3. The PC business is a tough place to be. Hewlett-Packard’s acquisition of Compaq may go down as one of the more ill-conceived tech purchases of the past ten years, if only because thin margins have only gotten more so over time.
Slow Down the M&A Machine
The company has made numerous (and some sizeable) acquisitions in hardware, software and consulting, with little to show for it. It is likely past time for a thorough rationalization of all that has been purchased, and a streamlining of costs. Transformation via acquisition has failed; management will have to roll up their sleeves and turnaround the company the old-fashioned way.
Rich Rewards for Patience
On a sum-of-the-parts basis alone Hewlett-Packard should be worth considerably more than it is currently trading at. If over the coming years Meg Whitman and her leadership team are able to stabilize the company’s multiple lines of business, identify a coherent core to build around, then spin-off or sell non-core businesses, shareholders could be well compensated for their patience.
There is little to feel bullish about in the Hewlett-Packard story. If scale offers profit maximizing benefits, those benefits have not been apparent. The approach of using financial strength to buy into profitable niches has failed (the massive Autonomy write-down serving as only the most recent example). Competition is ferocious and generally more focused. The company’s share price is down 40% over the last 52 weeks, and there is no turnaround at hand. Shareholders may have no options other than to sell or hold on for a multi-year turnaround.