H-P Plans Major Restructuring

Zacks

Hewlett-Packard Co. (NYSE: HPQ - News) is planning an extensive restructuring, as announced by its chief executive officer (CEO) Leo Apotheker. In order to focus more on the high-growth and high-margin business, the CEO now wants to spin off or sell H-P’s lower-margin PC business, wash its hands of the webOS business (still looking for a take-off) and buy out business software maker Autonomy Corp. The focus shift would help H-P evolve as a software and services company, without any reliance on the hardware businesses.

Goodbye to PSG Segment

Although HP has maintained its leadership position in worldwide PC shipments for many years, margins in the Personal Systems Group have lagged other areas of its business. The segment generated single-digit margin growth in the last few quarters, less than any of the other segments. Additionally, H-P is also steadily losing share to its Asian competitors, which are flooding the market with variety of lower-cost devices.

PC demand has also been a concern in recent times, with the growing uncertainties telling on H-P’s profitability. As per market research firm IDC, the general slowdown is basically the result of changes in consumer preferences toward smartphones and tablets rather than desktops and laptops.

We believe that the decision will help to bring margins back to historical levels. But on the other hand, we will lose the brand name, on which we used to blindly depend.

HP’s strategy reminds us of a similar decision taken by IBM Inc. (NYSE: IBM - News) not so long ago. The company offloaded its PC unit to China’s Lenovo Group Ltd. in 2005.

A Win-Win for Peers

If H-P’s PC business sell-out plan works out, it will create a huge opportunity for not only another tech giant Dell Inc. (NasdaqGS: DELL - News), but also for Asian manufacturers ASUSTeK Computer Inc. and Acer Inc. Though Dell now holds the second position in worldwide PC shipments, it too is suffering from soft consumer demand.

Picking Up Autonomy Corp.

To strengthen its software offerings, H-P is now acquiring UK-based software maker Autonomy Corp. plc (NYSE: AU - News), for £25.50 (or $42.11) per share in cash or a total value of roughly $10.3 billion. The transaction was unanimously approved by the boards of directors of both H-P and Autonomy. The acquisition is expected to be completed by the end of calendar 2011.

Autonomy has specialized in providing unstructured data analytics and data management software and is a strong contender for a $20 billion enterprise information management space and $55 billion business analytics software and services space. The company serves blue-chip customers such as Coca-Cola Co. (NYSE: KO - News), Nestle SA and the U.S. Securities and Exchange Commission.

Autonomy’s intellectual assets complement existing H-P offerings from enterprise servers, storage, networking, software, services and its Imaging and Printing Group. We think that the acquisition is likely to enrich the portfolio with key assets for information management and data analytics.

H-P expects the new unit to be accretive to non-GAAP earnings per share within the first full year of completion. H-P also believes that Autonomy’s encouraging business model -- which has generated double-digit revenue growth, 87% gross margins and 43% operating margins in calendar year 2010 -- will prove to be a key growth driver in the long term.

The purchase is HP’s largest since the $13.2 billion acquisition of Electronic Data Systems Corp. in 2008. The offer itself indicates the importance of Autonomy to H-P, reflecting a premium of more than 64% to the closing price of £15.58 per Autonomy share on August 17.

Partial Discontinuation of webOS

H-P will also be abandoning operations for webOS devices, specifically the TouchPad and webOS phones. H-P inherited the webOS mobile operating system platform through its acquisition of Palm Inc last year. In June, H-P announced its intention to develop the webOS platform into a leading connectivity platform. In the summit, the tech chief announced plans to launch the TouchPad tablet and new smartphones running on webOS.

But the devices did not meet internal milestones and financial targets and the extremely crowded and competitive market led to their undoing. The webOS platform lagged far behind Apple Inc.'s (NasdaqGS: AAPL - News) Snow Leopard and Google Inc.'s (NasdaqGS: GOOG - News) Android. Similarly, H-P’s handsets were unable to capture the market already dominated by the iPhone and Google’s android-based smart phones.

However, the tech behemoth will continue to explore options to optimize the value of the webOS software going forward.

H-P will record a one-time charge of about $1 billion in the fiscal fourth quarter related to the discontinuing of webOS devices.

Conclusion

Though we think that the three bold steps taken by the H-P chief will strengthen the company’s financial model going forward, we prefer to take a cautious stand given the company’s unimpressive third quarter 2011 results, when revenues increased a mere 1% from the year-ago quarter.

We expect H-P to gain from Autonomy synergies. But here too, we would look out for the company’s strategy to fight the stiff competition in the cloud computing space.

Currently, H-P has a Zacks #3 Rank, which translates into a short-term Hold recommendation.

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