HP Faces Uphill Battle With Newly Minted PC Unit

Hewlett-Packard Co's Chief Executive Officer Meg Whitman appeared to be banking on growth markets like 3D printing and a trickle back in PC sales when she announced on Monday a spin-off for the company's computer and printing business. But some on Wall Street are skeptical.

Investors and analysts generally gave a thumbs up on the move to separate HP's computer and printing business from its corporate hardware and services operations, sending its shares up almost 5 percent. Yet some questioned the move, expressing doubt over whether the newly christened "HP Inc" can break out of what appears to be a terminal slump in desktop computing.

"HP Inc will be a fairly good cash-generating machine but growth will certainly be a struggle," said Brian Fox, a portfolio manager at Standard Life Investments. "There's not a whole lot they can do to improve that growth profile."

The split does creates a company with strong cash flows, a high dividend yield and a major market position. At the same time, though, it may raise operating costs over the longer term, and together with abortive talks to merge with EMC Corp, it could reflect HP's inability to grow profits organically, according to Bernstein's Toni Sacconaghi.

Global shipments of PCs are in for "slow but consistent" growth over the next few years, forecasts tech research firm Gartner, as they recover from three years of declines caused by a surge of tablets and smartphones. But they are still not expected to equal their 2011 peak until 2018 at the earliest.

Moreover, that growth is not expected to come from HP's mainstay of desktops and laptops, but from a new breed of mobile computers such as Apple's MacBook Air, Google-powered Chromebooks and Microsoft's Surface Pro.

HP is a massive force in PCs and printing, which will account for about half the company's $112 billion revenue this fiscal year. But HP Inc "will likely be pitched as the slow/no growth, high cash generating business," Sacconaghi said in a research report. He estimated that HP Inc's revenue would decline at about 1 percent annually over the next few years.

"It is not clear if the separation would necessarily attract new classes of investors or 'unlock' value in the same way that other spin-offs do," Sacconaghi said.

HP shares are now up 78 percent over the last 12 months, compared to a 17 percent increase in the S&P 500. But the company is still one of the cheapest tech stocks, trading at around nine times earnings expected over the next 12 months, compared to an average close to 12 for large tech firms.

Post-PC blues
HP has struggled to adjust to the post-PC computing era, making a few false starts with early tablets, and surrendered its crown as the world's No. 1 PC maker to Lenovo.

The new company may need to do some mergers and acquisitions to change that, some analysts suggested, although it is not clear which rivals HP Inc might team up with.

Some say HP is moving in the right direction.

"They've had good numbers for the past several quarters both in the consumer and the enterprise side of the PC business, including the Windows tablet form factor," said Neil MacDonald, an analyst at Gartner. "HP has actually gained some market share back because of innovation and design."

Whitman emphasized on Monday that HP Inc will not focus on the consumer devices market dominated by Apple and Android devices, and instead will look to play to its strengths, such as with 3D printing.

"There's lots of innovation (going on) but often not in the area that people expect," Whitman said in an interview. "It may show itself in unexpected ways."

"There's still lots of opportunities in other adjacencies, where we don't chase the market leaders," she added.

Having said that, PC growth will not be Whitman's most pressing concern. She is slated to be CEO of the other company, to be called Hewlett-Packard Enterprise, focusing on tech infrastructure, software and services.

Additional costs
There is also the question of the additional costs the PC unit will have to bear. Analysts noted on Monday that when HP rejected the idea of splitting into two companies in 2011, it estimated such a move would cancel out $1 billion in annual savings, chiefly from bulk-buying components, and also mean $1.5 billion in one-time startup costs.

The split also means HP's sales force can no longer cross-sell products to large customers, and could create some confusion.

"If the decision by HP is not well communicated or is not well executed, the negative share shifts could be material," said Barclays analyst Ben Reitzes.

HP does have experience in splitting off old businesses. In 1999 it spun off its non-computing operations under the name Agilent, with an initial public offering that raised $2.1 billion.

MacDonald at Gartner said the PC and printing unit can be successful if HP follows the template for a declining printing market.

"HP has gained share and improved margins in a market where the overall number of pages printed has declined," he said. "HP has shown it can handle a market in decline. That's the model that would need to be applied to the traditional Windows PC market."

© Thomson Reuters 2014