A "BUST" for Hewlett-Packard

Sep 19, 2011 | 2:30 PM EDT
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Hewlett-Packard's (HPQ) management has just capped off an awful, four-year run of miserable capital allocation decisions with the terribly expensive acquisition of a decent software company, Autonomy. At 10x revenues and for 25% of the market value of this $130 billion dollar enterprise, HP is acquiring less than $1 billion on revenues and $200 million in operating profit. Ouch!

Another way of looking at the deal is to understand that Hewlett-Packard paid 10x sales for revenues that will be valued at 40% of sales, HP's own EV/sales revenue valuation level. In other words, the $1 billion in sales that Hewlett acquired will be valued by the markets inside HP at $400 million, when, in fact, the company paid $11 billion. The loss to shareholders is around 95% of the deal the moment the acquisition closes. I consider this HP's "BUST" -- big, ugly, stupid transaction. It reflects HP management's blatant disregard for shareholder value, and, as mentioned, finalizes a four-year run of atrocious capital allocation decisions.

I won't detail or debate all of HP's ill-fated ventures, management scandals, board room shenanigans, market share losses and poor investment decisions. Instead, I will cite just three numbers to make my point. Over the past four fiscal years, including the expected closing of the Autonomy deal in the fourth quarter of fiscal 2011, ending this month, HP will have spent around $26 billion on share repurchases and $28 billion on acquisitions for a total of $54 billion of shareholder cold hard cash. And, what do shareholders have to show for it?

Nothing. Nada. Nichts. Zip. Actually, worse than ZIP. Shareholders would be quite fortunate to get back to ZIP!

Since the beginning of fiscal 2008 and this disastrous capital allocation program, HPQ shareholders have lost 50% of their value. Despite spending $54 billion on deals and repurchases in four short years, management has destroyed almost $100 billion of shareholder value. Today, HP's market cap is below $46 billion, less than the last four years' worth of spending on stock and deals alone, and a fraction of the $135 billion market value it had 48 months ago.

It's not as if the base businesses imploded into obsolescence and HPQ was forced to reinvent itself. Its core businesses remain pretty much intact, despite the inability of HP to out-innovate or execute their competitors. Despite the billions of dollars spent on R&D over the four year period, the company seems to have "invented" very little. Too often, technology conglomerates, such as HP, turn into civil service-like bureaucracies. HP's track record of innovation, or lack thereof, suggests that has happened. So, the company is a $130 billion technology revenue behemoth that invents little, spends a ton and generates far too little shareholder return on its investment.

What should HP do now? In my opinion, the company should abandon its BUST, the Autonomy acquisition. The company cannot change its stripes and become a nimble, high-growth software company. It would destroy the company's stock price even further to sell/divest businesses at 50% of revenue for acquisitions, such as 3Par and Autonomy at 5x-10x revenues. If HP's business are junk, it should become the technology king of junk, and buy businesses such as Lexmark (LXK)or Computer Sciences (CSC) at similar valuations to HP, and on a highly accretive basis.

With the cash machine that HP would become if it were to do this, it should then mount a massive dividend payout strategy. During the past four years, despite $54 billion burning a hole in the directors' pockets, the company has paid a miserly dividend of about $3 billion dollars. The corporate leaders have been quick to write checks, just not direct ones to the owners of the business. This needs to change.

Even if HP cannot grow much organically and cannot afford dilutive software deals at price-to sales ratios 20x that of its own stock, it can return a massive amount of cash to shareholders in the form of obscenely generous dividends. Just imagine how much better HP shareholders would have been had management paid $54 billion in cash to shareholders.

Once the company admits its growth is limited by its behemoth size, the futility of dilutive deals in hot tech areas and the ineffectiveness of large share repurchase programs, the big dividend becomes the only rational option for free cash flow usage. Hewlett-Packard could easily pay out $2 per share in dividends and manage modest, bolt-on, accretive transactions in PCs, services and printing areas to supplement modest growth.

HP's BUST has crystallized investor contempt for its management and directors, and that sentiment is reflected in HPQ's pitiful 5 P/E ratio and 3 EBITDA multiple. Yet, HP management and directors don't get it. It seems they believe more overpriced acquisitions, making directors' private equity investments profitable and other public shareholders rich, is the solution. They believe that buying billions of stock to inflate options value or goose earnings per share (EPS) is the solution. It's not.

HP's attempt to serve two masters, the consumer and the enterprise, has failed. It's attempt to morph from one into the other has destroyed almost $100 billion in shareholder wealth. HP should be split into two companies, each aimed at different target markets. Splitting HP into a consumer gadget company with PCs, tablets and printers and a CEO who understands consumers will give that business a chance. Let the existing CEO keep the enterprise hardware, software and services companies.

Most important, drop the waste of shareholder capital on overpriced acquisitions and futile share buybacks. Turn the cash that HP generates into dividends. One BUST is all HP shareholders can take.

In the process, it wouldn't hurt if the company started inventing stuff again. It's been a long time since HP delivered something new and exciting in gadget land.


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