By James B. Stewardt | October 10, 2014
When Hewlett-Packard’s chief executive, Meg Whitman, announced this week that the company would split, she said the two new companies would be “a lot more nimble, a lot more focused.”
Would that it were so easy.
“Nimble” and “focused” are hardly the first words that come to mind at the mention of HP. “Chaotic” and “hapless” are more like it. HP has lurched from one strategic plan and ill-fated acquisition to the next under a rapid succession of chief executives and board members.
To her credit, Ms. Whitman has brought some desperately needed stability since taking over in 2011 after the brief but disastrous tenure of Léo Apotheker. HP’s stock has nearly tripled since bottoming in November 2012. But at nearly $35 a share this week, it’s still far from the peak of over $53 that it reached during the tenure of Mark Hurd, who is now co-chief executive of a rival, Oracle.
In spinning off its computer and printer operations into one unit, to be called HP Inc., which will use the HP logo, and putting everything else into another, called Hewlett-Packard Enterprise, the company is joining what’s shaping up to be a corporate stampede toward spinoffs. In the last week and a half, eBay, where Ms. Whitman spent a decade as chief executive, said it would spin off its PayPal unit, and the software and information management company Symantec said it would split into two companies. This year is now on track for 66 or more corporate spinoffs, according to Joe Cornell, who follows spinoffs as president of Spin-Off Advisors in Chicago and publisher of a newsletter, “Spin-Off Research.” This year is likely to top the record of 66 spinoffs reached in 1999 and 2000, the peak of the technology bubble, according to Mr. Cornell’s calculations.
The surge in popularity has been fueled by activist investors and hedge funds pushing for breakups as well as academic research supporting the notion that the parts are often more valuable than the whole. A study by two Pennsylvania State University professors, James Miles and J. Randall Woolridge, of 174 spinoffs from 1965 to 1994 found that the stock prices of those companies rose an average of 76 percent in the five years after they were spun off, compared with a 31 percent gain in the Standard & Poor’s 500-stock index. And they found that spun-off companies were three times more likely to be acquired.
“Different businesses may need different capital structures and more entrepreneurial management,” Professor Woolridge said this week. “The spun-off company will often be totally different from a culture standpoint. It can get a better board that understands the business and can get the capital structure right. We found that the spun-off companies tend to grow revenues and profits faster.” HP also noted that the two new companies would have distinct customer bases, which they can now focus on, and will rank as the 48th and 49th largest corporations in America.
Still, the averages mask the wide variation in performance among companies that have been spun off. For every Motorola Mobility, the cellphone maker spun off by Motorola in 2011 and promptly acquired by Google (and then Lenovo), there’s a Delphi, spun off by General Motors in 1999 only to end up in bankruptcy six years later.
So where is HP likely to fall on the spectrum? The prospects have some analysts worried. “It’s debatable that HP is doing this from a position of strength,” Toni Sacconaghi, a senior technology research analyst at Sanford C. Bernstein, told me this week. “That doesn’t inspire much confidence.”
Investors initially cheered the news, but on further reflection, they seemed to share Mr. Sacconaghi’s reservations. HP shares rose nearly 5 percent after the announcement on Monday, but by Thursday, they were lower than before the news was disclosed.
Mr. Sacconaghi noted that many of the most successful spinoffs have involved separating slow- (or no-) growth commodity businesses from higher-growth, more entrepreneurial operations. Time Warner and News Corporation are among the media companies that have spun off print operations, hoping to achieve higher multiples and stock prices for faster-growing cable, film and digital media properties. Those recent examples have yielded mixed results so far, with shares in both News Corporation (the print operation) and Fox lagging the S.&P. 500. Time Inc. shares have dropped over 4.6 percent since they were spun off in June, trailing the S.&P. 500’s slight gain. But Time Warner shares have outperformed, gaining over 8 percent.
HP’s strategy doesn’t fit the slow growth-fast growth paradigm since both of the new companies have been slow- to no-growth operations. Personal computers and printers, the core of the new HP, are perceived as mature businesses. HP Enterprises, in theory, should be the faster-growing, more entrepreneurial of the siblings. But in the most recent year, HP’s revenue from personal computers has been growing faster than its enterprise businesses.
Especially worrisome to several investors I spoke to is the decline of HP’s Itanium server business, where service contracts and maintenance operations generate significant revenue and profit. The installed base of Itanium servers is dwindling as customers replace them with cheaper alternatives. In August, HP reported an 18 percent decline in revenue for its business critical systems unit and a 6 percent drop in enterprise services. By contrast, a bright spot in HP’s results was personal systems, which includes personal computers, where revenue was up 12 percent. HP said that viewed broadly, personal technology could again be a growth business, with HP at the forefront.
“This doesn’t fit the playbook of your typical spin out,” Mr. Sacconaghi said. “Here the growth profiles really aren’t that different.”
And there are risks. HP will lose economies of scale, which was one of the main reasons the company gave when it reversed its decision to spin off its personal computer business just three years ago.
“There really are synergies in distribution and sourcing,” Mr. Sacconaghi said. He noted that when HP reversed its decision, it cited a potential loss of synergies amounting to as much as $1 billion. Adding printers may enable HP Inc. to maintain greater scale, and “maybe they can mitigate the damage,” Mr. Sacconaghi said. “But even if it’s half that, that’s still 5 to 6 percent of their operating profits.”
Moreover, it’s unclear how HP Enterprises will finance growth once it loses the cash flow from personal computer and printer sales.
There’s also a whiff of desperation surrounding the plan. HP was rumored to be interested in acquiring Rackspace to gain a foothold in trendy cloud-based computing services, a field now dominated by Amazon and Google. But nothing came of that. There was talk HP might acquire another aging technology giant, the data storage provider EMC (which is under pressure from activist investors to spin off one of its own units, the software maker VMware.) Nothing concrete has materialized. (An HP spokesman declined to comment on any potential deals.)
Something could still happen. HP said it possessed material nonpublic information, so a large deal could be in the works. That has made investors nervous given HP’s dismal track record, most recently its disastrous $11.7 billion acquisition of Autonomy. (Still unresolved are HP’s claims that it was defrauded when it bought the British software maker in 2011.)
But what alternative to a spinoff did HP have? Now in the third year of her original five-year recovery plan, with promised growth in 2016 looking increasingly elusive, Ms. Whitman needs an exit strategy. “The market didn’t indicate any confidence in the status quo,” Mr. Sacconaghi said. “HP was already the cheapest technology stock in the S.&P. 500 based on a price-to-forward earnings basis. How can it get any worse? With two separate teams crafting a vision, maybe Wall Street will gain confidence and valuations will go up.”
View article on nytimes.com: Doubts Linger as HP Poises for a Split
Spin-Off Research is published by Spin-Off Advisors, LLC. Spin-Off Research is a subscription-based service for Professional and Institutional Investors. Blog entries are delayed. Spin-Off Research subscriber-base receive the spinoff report at time of press via Email Bulletins. To learn more about becoming a subscriber, please contact us. Spin-Off Advisors, LLC provides coverage on all US and major Global spinoffs, carve-outs and split-offs; Spin-Off Research published since March 1997.