HP has been a horrendous stock in the past two years. In my view this was due to weak fundamentals in the PC market, poor management decisions on acquisitions and a weak board of directors. However, HP is still a company with annual revenues off about $120 billion making it one of the largest companies in the market. HP is not going to disappear, and with some better management decisions and perhaps a better IT spending environment, it could be an interesting turnaround story. It could, however, also be a value trap that continues to have its stock price decline. I think HP is more likely to be a good stock performer than a value trap in the next year. I base this on very negative sentiment and compelling valuation that is only supported by the recently announced LBO of Dell.
Below is a table showing the relative makeup of both Dell and HP. Since each company segments it’s revenues differently than the other, I made some assumptions in formulating this competitive table. A more precise comparative analysis could be performed dissecting SEC filings.
Printing or Peripherals 20% 16%
PCs/Devices 29% 52%
Services 28% 14%
Servers Storage and Networking 17% 17%
Other 6% 0%
As the table shows, Dell and HP have similar revenue compositions. In addition, both companies have similar gross margins in the 20s and recent revenue trends of flat to declining revenues year over year. In a sense, Dell is a smaller version of HP, without the management and board issues. The smaller size and market capitalization of Dell made an LBO possible, while an HP LBO is very unlikely. Even though HP is not a LBO candidate like Dell, I think looking at the Dell valuation metrics at the LBO takeover price can provide insight into whether HP offers any value to investors.
The table below shows recent valuation metrics for HP and Dell. As the the table shows, HP is a cheaper stock on EV/EBITDA and Price/Book while Dell is a bit cheaper on EV/Sales. Since value investors tend to be more focused on cash flow metrics like EV/EVITDA and book value of the company, HP trades at a cheaper valuation than Dell. While HP shareholders will not benefit from a potential LBO, any additional missteps from the current management team could lead to increased activism among shareholders forcing a change of strategy, management team, company break up or some other favorable catalyst for the stock. If the current management team executes better, the low valuation should provide a base from which the stock can appreciate.
Price/Book 1.47 2.34
EV/EBITDA 3.40 4.86
EV/Sales 0.47 0.37
Another important point I would like to make is the trend in free cash flow at HP. HP has tended to deliver consistent free cash flow (defined as cash flow from operations less capital spending) on the order of $2 billion a quarter or about $8 billion a year. I believe recent negative reports from tech companies exposed to HP as either an OEM, EMS or reseller (e.g. Mellanox) is reflective of HP trying to manage its cash flow to continue to show solid performance on this important financial metric.
Finally, the sentiment on HP is extremely negative on the street. Currently, there are only the equivalent of 2 buy ratings vs. 23 neutral ratings and 9 sell ratings. The sell side clearly continues to view HP as a value trap given this composition of stock ratings. Also, most IT executives I speak to view HP as a weak company with little prospects for any turnaround. This may end up being correct, but I think in this current age of increased shareholder activism, the recent Dell LBO and continued focus by HP on cash flow generation, HP is more of a Buy than a Sell. Longer term, I am not yet convinced that HP will be a great stock or company, but in the short to intermediate term, I think the stock looks somewhat attractive.
Disclosure: I currently own shares of HP. I may currently or in the future solicit any company mentioned in this report for consulting services for NT Advisors LLC.