Does The Dell LBO Tell Us Anything About HP?

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.
                                                         HP  Dell
 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.  
                      HPQ  DELL
 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. 


I Continue To Be Positive On Technology for 2013

Following up on my blog post in the beginning of the year, I continue to expect the technology sector to outperform the overall market (S&P 500) in 2013.  This opinion is based on three years of underperformance of the technology sector given a depressed level of telecom and enterprise capital spending which has compressed valuations for technology stocks vs. other sectors like consumer discretionary which as been a strong relative performer over that three year period.  I continue to believe we will have some recovery on capital spending in both telecom and enterprise networks in 2013, which together with lower relative valuations, should allow the technology sector to outperform in 2013.

So far in 2013, the technology sector is up around 4.5% vs. the 2.5% return of the S&P 500.  While it is still very early in the year, this initial outperformance and strong stock performance from IBM and Google (two large components in the technology sector index) today after their reporting their earnings (both are up about 5%-6% so far this morning) are very good signs.   The depressed level of technology stocks has also been supported by recent discussions in the press of Dell being a potential LBO candidate, and HP potentially being broken up to create shareholder value if the company does not show signs of a turnaround in 2013.

The biggest potential risk to technology outperforming in 2013 in my view is the performance of Apple as it makes up to 20% of technology index given its large market cap.  I am not particularly positive on Apple as it is losing momentum (see my prior blog post on Apple for more details) and does not play into the theme of recovering capital spending for technology stocks.  However, the stock has declined close to 30% off its high and is discounting many of the negative fundamentals I discussed in my earlier blog on the stock.

Disclosure:  I am currently not long or short any stock mentioned in this blog post (i.e. Apple, IBM, Google, Dell or HP).  I also do not plan on taking a position on any of these stocks in the next couple of days.  I am long the technology ETF ticker VGT.

Addendum – With the selloff in tech shares today 1/24/13, I am considering purchasing shares in technology stocks mentioned in this post.