Hewlett Packard Enterprise (HPE) surged over 13% on Wednesday. Strong underlying results were one-upped by the announcement that the company will spin off and merge its business-services division with Computer Sciences Corp (CSC) in an $8.5 billion deal.
But understanding the evolution of Hewlett Packard goes back to Meg Whitman’s efforts to unbundle the conglomerate she inherited when she became CEO in 2011.
Remember when Hewlett Packard was a company of dysfunction? From infighting over its 2002 Compaq merger with then-CEO Carly Fiorina to the ouster of the scandal-infused leadership of Mark Hurd to mismanagement by Leo Apotheker, many investors were left questioning what the future would entail for the fallen tech giant.
In the fall of 2014, Whitman announced the company would separate its computer and printer business — now HP Inc (HPQ) — and its software and services business Hewlett Packard Enterprise. The split, which occurred in November 2015, was positively received by investors. HPQ, which reports on Wednesday after market close, was seen as a cash-cow yield play for PCs and printing, with a call option on 3D printing. Meanwhile, HPE, the more focused and nimble enterprise company, was regarded as better primed for growth.
The latest announcement allows HPE to separate its services business — where CSC can accelerate cost reductions — from its storage component (including servers), again unlocking value.
Importantly, this tax-free spin-off fits right into the playbook of successful spin-offs that the market has embraced over the last decade.
Just since the start of this year, we have seen notable spin-offs including from Biogen (BIIB), Hilton Worldwide (HLT) and Xerox (XRX).
The value creation of spin-offs
Analysts in a study led by Citigroup’s Chris Montagu, highlighted the value of spins, especially in a low-GDP growth environment.
“A challenging macroeconomic backdrop in a low-growth environment has left many companies questioning how to deliver value to shareholders. Spin-offs represent an economically efficient method of realising value through improving corporate focus and in turn profitability,” said Montagu.
When a parent and a subsidiary business have different operating focus or growth profiles, a separation has been shown to enhance value, according to the analysis. In addition, Montagu noted that improved operating efficiency, tax efficiency, investor transparency, and capital raising opportunities all further enhance the value for spins.
According to the analysis, globally, the average market-excess return upon announcement to the parent company is +1.4%, rising to +9.3% over the subsequent year. Spun-off companies also experience similar positive excess returns.
While historically, the original conglomerates like Tyco, ITT and GE, were seen as gold standards, investors have now placed lower valuation multiples on these companies. As Citi shows below, there is a Conglomerate discount relative to more pure-play peers.
Indeed, a spin enhances the valuation multiple for the component parts of the company.
“A win for parent companies as they deliver value in a low growth environment and a win for the spun-off company as they can operate with transparency unencumbered by their larger parent,” Montagu said.
And Hewlett Packard seems to be doing just that.
