Hewlett Packard's (HPQ) breakup news certainly made for an exciting start to the week -- and there are so many different angles to attack this type of mouth-watering news. For one thing, who will buy one of the HP divisions? Which other old-tech name could split amid their shift to a more service-oriented model? Ugh, selling hardware and software is so 1999.
Beyond tech, if behemoth Hewlett-Packard could financially engineer a divorce -- and get rewarded by the stock market for it -- could Wal-Mart (WMT) finally chop off its low-margin Sam's Club division? I have long been a proponent of such a spinoff, and I think Wal-Mart will have to do this at some point in order to reallocate resources to more productive areas, such as smaller-format stores and e-commerce. (However, any such mega announcement won't be coming at the company's investor day on Oct. 15.)
The minor issue with the grabby HP news is that average investors -- those with limited access to information -- probably lack a firm understanding as to what a corporate breakup means. If the basic mechanics aren't understood, it becomes impossible to scour the market for similar situations that are likely to be viewed favorably. In light of this, here is a helpful everyman's explanation of corporate divorces.
- First, the company pushes aside low-to-no-growth areas and, as a result, investors can now partake in higher-growth areas of the corporation. One really has to dig into earnings calls for executives hinting at major future business-model shifts. As I noted on Columnist Conversations Sunday evening, Cisco (CSCO) is undergoing a transformation to a service-oriented business in the spirit of HP.
- After the split, and as execs slash costs and expenses (yes, costs and expenses are different), that low-to-no-growth business transforms into growth that beats Wall Street consensus estimates -- for a short while.
- Larger companies pay up to buy the smaller, faster-growth spun-off entities. This supports comparable companies, as well as the broader market. See recent news on CareFusion (CFN), which was spun off from drug wholesaler Cardinal Health (CAH) a few years back: Becton, Dickinson (BDX) just agreed to buy CareFusion for $12.2 billion. (Also see Jim Cramer's take.)
- These faster-growth, spun-off companies grow even more quickly, as their execs don't have to worry about older, boring brother looking over their shoulders.
- A new generation of transformational execs emerge, with goals of releasing innovative products and services. Society benefits.
J.C. Penney (JCP) shares plunged on Monday ahead of the company's Oct. 8 analyst day, which my firm previewed in a note yesterday -- we discussed the likelihood that the company will likely announce store closures this week. We have reiterated our Hold rating and $10 price target. Although the market locked in to those fears, our note emphasized the benefits of J.C. Penney closing underperforming stores in a measured form, even if it means a charge to the income statement.
First, a measured pace of store closures over the next five years signals the company's balance sheet, as it looks today, could support the maneuver.
Second, capital will be conserved, as every store closure means less inventory, lower transportation costs and so on. J.C. Penney, and all retailers, need smaller store bases given the rate at which goods and services are being consumed on mobile devices. It's a structural shift that was in no way predicted when zillions of stores were built 20 years ago -- the typical time frame of a department-store lease.
Third, capital could be reinvented in stores that sport stronger economics.
The problem is that the market has gotten accustomed to the negative connotations of store-closure announcements by specialty retailers, as they have generally been of the large, round-number variety. Think hundreds shared in one disclosure, as seen from such companies as Abercrombie & Fitch (ANF), Aeropostale (ARO) and American Eagle (AEO).
On the other hand, measured store closures -- as leases expire -- are OK. They are natural in retailing.