On Monday, Hewlett-Packard (HPQ) announced it was splitting in two. The split will create two giant Fortune 50 companies. Each will have revenue of about $57 billion and an operating profit between $5.4 billion and $6 billion.
Hewlett-Packard Enterprise will contain HP's server, storage, networking and cloud businesses. The unit will have revenue of about $58 billion and an operating margin of 10.2%. Meg Whitman will be CEO. Dion Weisler will be the CEO of HP, Inc., which will include the personal computer and printing business. HP Inc. will have an operating profit of 9.4%. The spinoff is expected to be tax free and will be completed sometime late next year.
As of the end of the third quarter of fiscal 2014, about 36,000 employees have been laid off with an additional 19,000 left to go by the time the split is finalized.
Wall Street likes the deal for two reasons. First, a sum-of-the-parts "analysis" shows that each piece is worth more than the whole. And second, the split will make it easier to sell off the slow-growth PC business.
The sum-of-the-parts analysis goes like this. The PC business generates around $34 billion in revenue and almost $4 billion in profit. If the business sold for 0.2x sales, which is what Gateway and IBM's (IBM) PC division sold for, it would be worth around $3.50-$3.70 per share.
Printing generates $23 billion in revenue. If you compare it to peers like Xerox (XRX) and Lexmark (LXK), the printing business is probably worth around $16 a share. Finally, the Enterprise Group is probably worth around $23 a share, based on the value of competitors. Add it all up and HPQ should be worth $45 a share, or 25% more than yesterday's closing price. At least that's the theory.
The second reason Wall Street likes the deal is because it makes it easier to sell the PC business to another buyer, like Dell. By the time the split is complete, all the dirty work will be done. The layoffs will be finished. The excess facilities will be closed. The operations and logistics will be streamlined. A buyer like Dell or Lenovo gets a nice, clean, profitable PC business without the hassle of firing half the workforce and closing factories. Who knows? Maybe they can get more than $3.70/share for it.
I always hate these deals. Why? First, the sum-of-the-parts math is always bogus. It's not like they are unlocking some phenomenal business from its low-growth cage. All these businesses stink. HPQ revenue has fallen 11% in the last three years. In the same time, Apple's (AAPL) revenue has climbed almost 58% (and Apple did it with 1/10 the number of employees). All those assumptions behind the sum-of-the-parts valuation are likely to be worth a lot less next year. You really think the commodity server business is going to be worth $23 a share next year by the time the deal is done? Those values are based on comparison valuations done today. Why won't the business be worth $15 a share next year? These are shrinking businesses, not growing.
And what about the debt? HPQ has more than $32 billion in long-term debt and other liabilities. What happens to that? Nobody ever mentions that. And what happens to the $31 billion of goodwill? Do they just write that off? That $30 billion represents the amount management overpaid for its acquisitions. Another $30 billion down the toilet? All that goodwill and debt is like an albatross around the necks of investors.
Does anyone remember when HP spun off Agilent (A)? About 14 years ago HP spun off Agilent to unlock the hidden value of its bioanalytical equipment. Agilent has underperformed the S&P 500 and HPQ for 14 years. That didn't work. That genie never got out of the bottle. That sum-of-the-parts math didn't work.
I'm skeptical about this split. To me, this plan is just Wall Street financial engineering that will result in a temporary pop that hedge funds will sell into. The split is being used as a replacement for revenue growth. If management were able to grow the business, none of this would be needed. I'm staying as far away from this deal as possible.