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HPE Closes Spin-Off & Merger Deal, Lowers Earnings Guidance

Zacks Equity Research

Hewlett Packard Enterprise Company HPE announced the completion of a spin-off and merger of its Enterprise Services (ES) business with Computer Sciences Corporation, following the approval granted by its majority shareholders last week.

The new company, DXC Technology Company Common S DXC, will begin trading on the New York Stock Exchange (NYSE) from Apr 4, 2017.

DXC Technology will provide digital transformations – creating greater value for clients, partners and shareholders, and presenting new growth opportunities for customers.

In May 2016, CSC announced its decision to merge its business with HPE’s Enterprise Services business and spin off from the parent company.

Post Spin-Off Structure

Following the spin-off, HPE will receive approximately $13.5 billion after tax, which will include an equity stake in DXC, a cash dividend payment to HPE shareholders and DXC’s assumption of debt and other liabilities.

Post-merger, the combined entity will become the world’s second-largest IT services company after Accenture plc ACN and generate revenues of approximately $26 billion. Per the deal, shareholders of each of the companies will own about 50% of the combined company.

HPE will continue to invest in Pointnext, its newly defined technology services organization in order to address customers need by providing them expertise and financial services support. Moreover, HPE will also maintain a strong relationship with DXC, with HPE CEO and president Meg Whitman holding a seat on DXC board.

Financial Impact

Following the anticipated spin-off of its ES business, HPE is adjusting its guidance for the second quarter and fiscal 2017. A long-range financial outlook provided by the company is as follows:

The company revealed that three major headwinds, heightened pressure from unfavorable currency exchange movements, increased commodities pricing and some near-term execution issues, have developed since it initially issued the outlook for 2017 at its Securities Analyst Meeting in Oct 2016. Citing these near-term challenges, HPE has lowered its earnings outlook for second quarter and fiscal 2017.

The company now expects non-GAAP earnings per share for fiscal 2017 in the range of $1.46 to $1.56, down from $1.88 to $1.98 projected earlier. The Zacks Consensus Estimate is pegged way higher at $1.94. GAAP earnings projection was also lowered to 27–37 cents  from the previous projected range of 60–70 cents.

The company also provided disappointing earnings guidance for fiscal second-quarter 2017. HPE now expects non-GAAP earnings per share in the range of 33–37 cents, down from 41–45 cents projected earlier. The Zacks Consensus Estimate is pegged at 44 cents. On a GAAP basis, the company has guided the bottom line in the range of a loss of 3 cents to 7 cents against the previous guidance of a loss of 3 cents to earnings of a penny.

Why the Spin-Off?

In the last one year, HPE has also undergone massive restructuring. We believe, by trimming its size, the company intends to focus more on fast-growing and high-margin businesses such as high-performance computing, private cloud, all-flash arrays and hyper-converged computing.

According to Meg Whitman, “The close of this transaction leaves HPE with a crystal clear mission, tied directly to the solutions our customers and partners tell us they want most.”

Enterprise Services revenues were down 11% to $4 billion in the last reported quarter. Adjusted for divestures and currency, the segment’s revenues declined 6%. Revenues were hurt by a 17% decline in Application and Business Services and an 8% drop in IT Outsourcing. Hence, we believe  that the spin-off of its ES business exposes a tougher and more fixated HPE that is well positioned to compete with its peers and succeed in today’s rapidly changing market.

This deal will also bring CSC’s strengths in insurance, healthcare and financial services together with HPE’s Enterprise Services expertise in industries like transportation, pharma, technology, media and telecom.

For the past few years, Computer Sciences has been focusing on cloud computing and the Big Data business to cash in on growing demand. Companies are increasingly relying on cloud-based services to make IT systems more agile and productive, and save costs considerably.

We believe that the merger with HPE’s business will strengthen Computer Sciences’ capabilities, allowing it to become a leading player in the IT services domain.

To Conclude

Notably, shares of Hewlett Packard Enterprise underperformed the Zacks categorized Computer-Integrated Systems industry over the past one year. The industry gained 20.4% in the said time frame while the stock yielded a negative return of 0.2%.

However, given that the challenges are short lived, we are optimistic about its ongoing restructuring initiatives that will drive growth over the long run.

Notably, since its split from HP Inc. HPQ in Nov 2015, Meg Whitman has been looking at reducing the company’s large portfolio of non-core businesses that are now struggling to stay on their growth trajectory.

Although the company is still struggling to determine its true business focus, its turnaround strategies, which include trimming down businesses, lowering costs through job cuts and making some strategic acquisitions, are in the right direction.

We believe that HPE’s ongoing business overhaul will yield long-term benefits by supporting innovation and leading to cost savings.

We also believe that successful deployment of the company’s products will boost its top line in the long run.

However, macroeconomic challenges and tepid IT spending remain near-term concerns. Competition from International Business Machines (IBM) and Oracle adds to its woes.

Currently, Hewlett Packard Enterprise carries a Zacks Rank #5 (Strong Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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