A Value Trap Which is Turning Around

By Anh HOANG - October 9, 2012 | Tickers: DELL, HPQ | 0 Comments

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Earnings can be manipulated, but cash flow is not. In fact, cash flow is not as easy to be manipulated as earnings, but it still can be misleading. That is the case for Hewlett-Packard (NYSE: HPQ). Jim Chanos, one of the most famous short-sellers in the world, pointed out that it was a value trap. So is HPQ a value play or value trap?

Let’s look at HPQ’s operating cash flow and free cash flow for the last 5 years. Free cash flow = operating cash flow – capital expenditure (CAPEX)

It looks good! For value investors, HPQ seems to be the cash cow with the increasing trend of operating cash flow and free cash flow. How about its stock price for its last 5 years of generating a lot of cash?

During 5 years of generating a lot of cash as we’ve seen above, HPQ lost nearly 70% of its value. A lot of investors might think it must be a value play with a cheap valuation of only 0.9x book and 3.3x cash flow.

Now if we include acquisitions in the calculation of free cash flow, HPQ doesn’t look as good anymore.

In 2011, instead of having $8.1 billion, it actually had negative $2.3 billion in free cash flow.

And by spending a lot of money on acquisitions, a valuation of 0.9x book is not cheap anymore. Out of $31.6 billion shareholders’ equity, HPQ contains a whopping $36.8 billion goodwill and nearly $8 billion intangible assets. So in fact, HPQ currently has a negative tangible book. Its tangible book value is -$13.2 billion, or -$6.7 per share.

Is the growth strategy via acquisitions successful? A track record of HPQ shows it all, with a series of impairments and write-offs with Compaq, Palm, EDS and Autonomy.

HPQ’s peer, Dell (NASDAQ: DELL), is in the similar but somewhat better position.

For DELL, out of its $9.7 billion in shareholders’ equity, it has $7.5 billion in goodwill and $2.6 billion in intangible assets. So its tangible book is around -$400 million, or -$0.24 per share.

A declining trend in the PC business strongly affects most of tech big boys such as Intel (INTC), Microsoft (MSFT), DELL and HPQ. HPQ is the most vulnerable as the two main segments of its business are PC and printers. Meg Whitman, its CEO is leading the company on its turnaround plan. She said that the real recovery cannot be seen until 2014 and we should expect the significant fall in earnings in 2013. It is no certainty that its plan will be successful. If investors believe in Meg Whitman and prospects of its plan, HPQ could be a good choice for their portfolios to hold in the long run.  

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