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Struggle for HP Continues Post-Split

Posted on Tuesday, Mar 8th 2016

This was the first quarter that HP reported its financials as two separate entities – Hewlett Packard Enterprise Co. (NYSE: HPE) and HP Inc. (NYSE: HPQ). Despite the split and the company managing to surpass market expectations, HP doesn’t appear to be doing anything radical to beat the declining trends in the industry.

HP Enterprise’s Financials
For the first quarter of the year HPE’s revenues fell 3% over the year to $12.72 billion, marginally ahead of the Street’s forecast of $12.7 billion. The company was hurt by currency fluctuations as the revenues actually increased 4% over the year on a constant currency basis. EPS of $0.41 was also ahead of the market’s forecast of $0.39 for the quarter.

By segment, Enterprise Group revenues grew 1% over the year to $7.1 billion with servers revenues increasing 1% and networking revenues growing 54% over the year. Enterprise Services revenue of $4.7 billion fell 6% over the year driven by an 8% decline in Technology Outsourcing revenues. Software revenues fell 10% over the year to $780 million with License revenues falling 6% and professional services falling 7%. Financial Services revenue fell 3% to $776 million. The performance looked marginally better on a constant currency basis as Enterprise Group revenues grew 7% over the year and enterprise services revenues were flat over the year. Software revenues fell 6% over the year while Financial Services revenues improved 3% on a constant currency basis.

For the second quarter, HPE estimates diluted net EPS to be in the range of $0.39-$0.43. It expects to end the year with earnings of $1.85-$1.95 per share. The market was looking for earnings of $0.42 per share for the second quarter and an EPS of $1.87 for the year.

HP Enterprise’s Product Growth
During the quarter, HPE has continued to deliver several product enhancements. Earlier this month, it announced the release of advanced security offerings through a new cyber reference architecture, mobile security offerings and an expanded ecosystem of partners to cater to the growing trends of Internet of Things (IoT) and the mobile ecosystem. The HPE Cyber Reference Architecture is a comprehensive information security framework that includes 12 domains, 63 sub-domains and over 350 distinct security capabilities to cater to the cyber security challenges provided by cloud, mobility, Machine-to-Machine (M2M), and Internet-of-Things (IoT).

HPE also announced its plans to launch a ProLiant-based virtualization server targeting Nutanix and the hyperconvergence space. According to IDC, sales of hyperconverged systems grew 155.3% in 3Q 2015 versus about just 6% growth in converged systems sales. Even though it is a fast growing segment of the converged systems market, it is quite overcrowded with players like Cisco, Dell, VMware also vying to get a piece of the action.

Within the mobile space, it released a new module in its Application Performance Monitoring software suite that will allow developers to leverage application analytics to identify and rectity issues at their source. The HPE AppPulse Suite is integrated with HP’s advanced analytics engine and analyzes real-user interactions to identify errors and measure resource usage. Its AppPulse Active allows developers to emulate real-user behavior, using scripts and transaction robots to identify problems and fix them. The AppPulse Mobile will allow customers to track the digital user experience of mobile apps in production and the AppPulse Trace will give developers the ability to find errors before they reach end-users.

Surprisingly, in times when cloud computing is driving growth within the technology sector, HPE’s strategy on the cloud appears to be rather tame. After announcing plans to shut down its public cloud Helion Public Cloud Platform, last year, HPE had shifted its focus on to a hybrid cloud offering. The only movement worth noting within the segment was the recent deal that HPE struck with Canada’s communication provider Rogers to convert Rogers’s existing traditional IT to a hybrid cloud system.

HP Enterprise and Dell-EMC Merger

To make matters worse, instead of highlighting growth strategies that HPE wants to follow, it is relying on the recent $67 billion acquisition of EMC by Dell to help it out. HPE believes that the confusion that surrounds a deal of this size will ultimately benefit it. According to HPE’s management, an acquisition of this magnitude involves questions on sales coverage, growth, and product lines, which take time to resolve. The acquisition will take an year to close, during which both Dell and EMC may be unstable – a feature that does not bode well with enterprise customers. Additionally, the deal will require Dell to manage a $60 billion debt and it will need to support $2.7 billion that EMC spends on R&D. Clearly, Dell will be in a lot of financial stress. HPE is hoping that its smaller size, focus on new technologies and lower leverage will prove beneficial in face of this merger. HPE claims to be experienced in “taking advantage of the disruption in the marketplace” as it has benefited in the past under similar circumstances when IBM sold its server business to Lenovo.

The market was pleased with HPE’s results. Its stock is trading at $15.97 with a market capitalization of $27.78 billion. It touched a high of $18.50 in October last year. The stock has recovered from a low of $11.63 it touched in January this year. I think the stock is only reacting to HPE’s plans to increase its commitment to return at least 100% of its free cash flow outlook to shareholders in the current fiscal year. During the past quarter, HPE already returned $1.3 billion to shareholders in the form of stock repurchases and dividends.

HPQ’s Financials

The story doesn’t appear too rosy for HPQ either. According to IDC’s recent reports, during the fourth quarter last year, total volume of PC shipments fell 11% to 71.9 million units. The market was dominated by Lenovo which has a 21% market share and saw a 4.5% decline in PC shipments over the year. HPQ maintained its second biggest vendor position with 19.9% market share compared with 19.8% a year ago. But HPQ also reported the steepest decline of 10%.

HPQ recently announced its first quarter results and, as expected, revenues continued to fall. Revenues declined 12% over the year to $12.246 billion, but were still ahead of the Street’s forecast of $12.167 billion. EPS of $0.36 was in line with the Street’s forecast.

By segment, revenues from Personal Systems fell 13% to $7.467 billion driven by 11% decline in commercial revenues and a 16% decline in the Consumer segment. In terms of volume, HP saw a 13% decrease in total unit shipments. Revenues from notebooks fell 11% over the year and desktop revenues fell 14%. Printing revenues fell 17% year over year to $4.642 billion.

Given the current industry trend, HPQ is not hopeful that the company’s performance will improve tremendously in the next few quarters. For the second quarter, HPQ expects an EPS of $0.35-$0.40 compared with the market’s forecast of $0.39. HPQ forecast an EPS of $1.59-$1.69 for the year compared with the Street’s projections of $1.60.

HPQ’s Product Upgrades

HPQ is counting on improving its mobile device offerings to capture a bigger pie of the already decreasing market. As part of this focus, it continues to upgrade its EliteBook portfolio as it is among the world’s thinnest and lightest business class notebooks. Last month at the Mobile World Congress in Barcelona, HPQ announced the release of HP Elite x3, a mobile device that is able to integrate phablet, laptop, and desktop experiences into a single device. The device operates on the Windows 10 Mobile platform and allows users to perform functions ranging from texting to working on spreadsheets and PowerPoint presentations.

Within the printing segment, HPQ released the PageWide XL, a new product in its graphics portfolio focused on the technical production market. The new product line delivers a fast, large-format mono and color printing capability that is targeted at the $1 billion market opportunity. It is also working on other printing capabilities including the release of a continuous ink-supplying deskjet printer for SMBs in emerging markets and through the development of 3D printing offerings.

HPQ’s stock is trading at $11.31 with a market capitalization of $19.53 billion. It touched a 52-week high of $16.17 in May last year. The stock has recovered from a 52-week low of $8.91 it touched earlier last month.

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