Latepost Hp's Suspension Upward : Value Enhancement, Pricing Game Or Administration Hype?

In my post on corporate breakups, I looked at the value too cost consequences of breakups. Since that post service was triggered past times the tidings stories virtually HP too eBay splitting themselves, I though it would brand feel to set those companies nether the microscope, to encounter if they are good, neutral or bad candidates for the breakup story. In this post, I volition focus on Hewlett Packard, a society amongst a long too rich history every bit a applied scientific discipline company, that has been a instance study on bad corporate governance, the dangers of overpaying for acquisitions too the perils of bad accounting for the finally few years.

HP: From a bad past times to a better future?

The finally decade has non been a expert 1 for Hewlett Packard. During the period, the society has non only seen its marrow businesses (computers, printers, occupation organization services) come upwards nether develop on but it has also had self-inflicted wounds from read the post service here.

Meg Whitman, who made her reputation past times edifice upwards EBay, joined the board of directors at HP inwards 2011 too became CEO inwards September 2011, amongst the hope that she would plough the society around. Ironically, she was instrumental inwards rejecting an before project design to intermission upwards the company, contestation that the society was “better together”. In the finally iii years, Whitman has toiled amongst mixed results on both the profitability too the stock cost front. HP’s revenues receive got declined inwards the finally iii years too its margins are nether pressure:

The cyberspace loss inwards 2012 reflected the write off of their ill-fated Autonomy acquisition. HP’s stock cost has reflected this turmoil, dropping inwards 2011 too 2012, before making a recovery inwards the finally twelvemonth too a half:

You tin dismiss teach HP’s latest annual report, 10K too 10Q, every bit good every bit a summary of the company’s financials over time.

In early on October, HP announced that it was planning to intermission itself upwards into ii companies, 1 containing the estimator too printer businesses too the other incorporating occupation organization services too its fiscal arm. The official statement (or at to the lowest degree presentation) that HP made virtually the intermission upwards is here. In the presentation, HP provides the wide details of the ii businesses:

From HP Investor Presentation Deck

Note that the combined operating income for the ii businesses inwards the finally twelve months ($11.4 billion) exceeds the operating income for HP every bit a consolidated society ($8.6 billion) past times virtually $2.8 billion. The footnote suggests that this does non include corporate investments (I assume that this refers to unallocated corporate costs) too seems to exit the impression, intended or not, that these costs volition disappear afterwards the intermission up.

Valuing the Break up

In my post service on valuing the effect of a intermission up, I argued that at that spot were ii questions that needed to live answered. The outset is an assessment of the effects of the intermission upwards on cash flows, growth too run a risk too the resulting effect on value. The second, too merely every bit important, pace is deciding on why the society needed to intermission upwards to attain these changes:

a. The Value Effect

In the tabular array below, I practise fairly uncomplicated (and simplistic) valuations of HP every bit a consolidated society too the broken upwards pieces:

Note that the broken upwards businesses reverberate the characteristics of the consolidated society amongst depression growth too reinvestment, but the broken upwards units receive got a value that is $31.85 billion higher than the consolidated company. Magical, right? Before y'all teach likewise excited virtually the value creation, almost all of the value add-on hither comes from the upfront supposition that the operating income of the pieces volition live $2.8 billion higher than the consolidated company’s income. If y'all believe that HP has $2.8 billion inwards annual operating costs that are genuinely wasteful, the intermission upwards volition add together value, but only if the intermission upwards is a prerequisite for the cost cutting to happen.In this finally part, that is the query that I explore past times looking at what the value increment volition live every bit a business office of how much of the $2.8 billion volition actually live cutting too how much is mirage that volition manifest at the novel HP pieces. To guess the effect, I considered dissimilar estimates of the cost savings too the touching on on value. Thus, if at that spot are no cost savings, the value alter goes to null too every bit the cost savings increment every bit a pct of $2.8 billion, the value effect of the breakup also increases:

Annual Cost Savings	Value Change
$0.00	$0.00
$500.00	$601.00
$1,000.00	$7,386.00
$1,500.00	$14,170.00
$2,000.00	$20,936.00
$2,500.00	$27,738.00
$3,000.00	$34,522.00

You tin dismiss cheque for yourself, past times downloading the spreadsheet that I used too tweaking or changing the numbers that y'all retrieve I got wrong.

b. The remove for a intermission up

Even if nosotros select HP at its words too select their statement that the intermission upwards volition atomic number 82 to pregnant cost cuts too lay offs, the query is why these cost cuts too layoffs cannot live carried out past times the consolidated firm. Looking at the possible explanations, I don't encounter whatever of them asset upwards to scrutiny:

Bad management: It is solely possible that the existing management at HP was aware of its bloated cost construction too chose to practise zilch (or real little) virtually it. The work amongst this rationale is that the broken upwards units volition live run past times the same management (Meg Whitman too Dion Weisler) that run the consolidated company.
Culture: It is possible that Meg too Dion wanted to cutting costs but that they were unable to practise too hence because of the HP civilization (which has historically focused on growth too innovation). While it is possible that the ghosts of Bill Hewlett too David Packard inhabit HP headquarters but the storey would receive got to a greater extent than resonance if the novel units had made a build clean intermission amongst the HP culture. (At the minimum, would it non receive got made feel to hand them names other than HP?)
Regulatory considerations or other restrictions: As far every bit I tin dismiss tell, at that spot are no obvious restrictions on HP laying off employees or cutting costs. The only peripheral concern may live that HP has its corporate base of operations inwards California, a terra firma amongst to a greater extent than stringent restrictions on corporate actions than most others inwards the US. For this storey to receive got whatever play, though, 1 or both of HP's units would receive got had to motion its corporate base of operations elsewhere.
Financial leverage too taxes: While debt ever seems similar a gimme when it comes to value enhancement, the debt ratio of 19% that is borne past times the consolidated HP is greater than the debt ratios of the ii sectors that its units volition inhabit. Hence, if at that spot is pregnant borrowing capacity that volition live unleashed past times this intermission up, I don' encounter it. It is also possible that this intermission upwards is a comprehend for a taxation inversion, where 1 or both of HP's units volition motion overseas, but I seriously incertitude it.

In summary, fifty-fifty if HP is right virtually the potential for cost cuts inwards the company, the intermission upwards seems to live an elaborate too unnecessary machinery to teach inwards happen.

Pricing the Break up

As I noted inwards my before post, the motivation for a intermission upwards may receive got zilch to practise amongst value too everything to practise amongst price. By breaking up, a society may uncovering itself priced to a greater extent than highly because investors reprice the parts to yield a higher aggregate value than the consolidated company. Revisiting the reasons for this repricing, I am hard pressed to uncovering a expert one:

Market mistakes: It is possible that the marketplace is nether valuing HP but it is hard to debate that this is because the marketplace is significantly misplacing inwards 1 of the pieces. The reality is that neither part of HP (business services or computers/printers) has been doing good too that the marketplace is edifice inwards the expectation of continuing revenue decline too margin compression.
Contaminated parts: Neither part of HP carries toxic attachments that may drag the society down. In fact, the most toxic parts of HP are the acquisitions that it has done inwards the finally 5 years too breaking upwards into ii businesses is non going to halt that predilection.
Simplicity story: Is HP much simpler to value every bit ii businesses than every bit one? I don’t retrieve so. The businesses are non vastly dissimilar inwards their risks too cost structures too on the confront of it, at that spot is piddling to live gained from having ii independent units that y'all could non receive got gleaned from the consolidated enterprise.

There is a cynical rationale for the intermission up, which is that it powerfulness live exploiting the laziness of equity inquiry analysts, who similar to role wide metrics (EBITDA) too the tunnel vision that they convey to their comparisons. Just to render an instance of the potential payoff, I looked at repricing HP's units, using the median revenue too EBIT multiples of the sectors that I idea they best gibe in:

Do I believe that HP's cost volition triple if they intermission up? Not for a moment, but I would non blame HP's management for trying to play this game, where they concur forth the most desirable operating metric for each unit of measurement (revenues, EBITDA, EBIT) too force analysts towards the sector that delivers the highest multiple of that operating metric. I don't retrieve it volition locomote because HP is beingness priced every bit a no-growth, declining-margin society at in 1 trial too breaking it upwards into ii no-growth, declining-margin companies does non alter the calculus.

Bottom line

Your assessment of this intermission upwards boils downwards almost solely to whether y'all retrieve that at that spot volition live cost savings from the intermission upwards too how big too lasting those savings volition be. I am skeptical. I retrieve that the society is over estimating its capacity to cutting costs, finesse upper-case alphabetic lineament construction too grow inwards the time to come too I am afraid that it is carrying bad (value destructive) habits amongst it into the novel ventures. I am also unclear virtually why at that spot has to live a breakup of the society for their cost savings to manifest themselves. I don't encounter a pregnant potential for a pricing correction from the intermission up, either, since at that spot are no radical differences betwixt the ii units too real piddling clarity added past times the intermission up.

Attachments: