This PC Giant is a Steal

Alvin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I first recommended Hewlett-Packard (NYSE: HPQ) back on July 17 when the stock was near $19 per share. As of this writing, HP is at $11.71 per share. At this level, the company is a steal. Currently, HP has been posting massive losses due to its bad acquisitions. In Q4 and Q3 fiscal year (FY) 2012, HP posted impairment charges of $8.847 billion and $9.188 billion, respectively. The charges are due to its purchases of Autonomy ($8.8 billion impairment), Electronic Data Systems ($8 billion impairment), and Compaq ($1.2 billion impairment). Basically, HP finally admitted that it drastically overpaid for its acquisitions, a fact that many investors already knew. It should be noted that these are non-cash charges, which mean that the money was already gone and was lost back when HP made the purchases.

In Q4 FY 2012 and in the full year, HP generated negative EPS of $3.49 and $6.41, respectively. However, these numbers are obscured by impairment and restructuring charges. Take a look at the following table.

<table> <tbody> <tr> <td> </td> <td>Q4 FY 2012</td> <td>FY 2012</td> <td>FY 2011</td> </tr> <tr> <td>Net Revenue (millions $)</td> <td>29, 959</td> <td>120,357</td> <td>127,245</td> </tr> <tr> <td>Impairment of goodwill and purchased intangible assets (millions $)</td> <td>8,847</td> <td>18,035</td> <td>885</td> </tr> <tr> <td>Restructuring Charges (millions $)</td> <td>378</td> <td>2,266</td> <td>645</td> </tr> <tr> <td>Net Earnings (millions $)</td> <td>-6,854</td> <td>-12,650</td> <td>7,074</td> </tr> <tr> <td>EPS ($)</td> <td>-3.49</td> <td>-6.41</td> <td>3.38</td> </tr> </tbody> </table>

Adding back the impairment charges (which is basically just HP admitting it overpaid for its acquisitions) and restructuring charges, in FY 2012, HP earned a much more respectable profit of about $6.2 billion or $3.15 per share. At HP’s current price of $11.71 per share, this comes out to a PE of just 3.72. However, HP has a negative tangible book value per share of $6.69. Taking this into account, HP has a PE of 5.84.

Meg Whitman has often been ridiculed for HP’s declining business segments and for approving the purchase of Autonomy while part of the board of directors. However, in the one year that Whitman has been in charge, there have actually been improvements in the company’s balance sheet and R&D budget.

<table> <tbody> <tr> <td>millions of dollars except %</td> <td>FY 2012</td> <td>FY 2011</td> <td>Change (%)</td> </tr> <tr> <td>R&D</td> <td>3,399</td> <td>3,254</td> <td>4.46</td> </tr> <tr> <td>Notes payable and short-term borrowings</td> <td>6,647</td> <td>8,083</td> <td>-17.77</td> </tr> <tr> <td>Long-term debt</td> <td>21,789</td> <td>22,551</td> <td>-3.38</td> </tr> <tr> <td>Total debt</td> <td>28,436</td> <td>30,634</td> <td>-7.18</td> </tr> </tbody> </table>

As shown, Whitman reduced the company’s total debt by about $2.2 billion or 7% and increased R&D spending by $145 million or 4.5%. Keeping a strong balance sheet and investing in products were two things that Whitman did consistently at eBay. At eBay, Whitman kept the balance sheet clean (zero long term debt from 2005 to 2007) and invested in product development consistently (above 7% of revenue after 1998). Also, while Whitman is not a great CEO, she is better than Apotheker, Hurd, or Fiorina. The previous CEOs focused on empire building. Apotheker orchestrated the purchase of Autonomy for $11.1 billion, Hurd bought EDS for $13.9 billion, and Fiorina bought Compaq for $25 billion. Whitman’s biggest acquisition, while she was at eBay, was Skype, which eBay bought for about $3.1 billion and eventually turned a profit on.

Going forward, HP might continue to post impairment charges. However, these charges are non cash. They are just moves by HP to come clean and admit that it paid too much. The money spent on the acquisitions is already gone. As long as investors use tangible book value per share, which ignores goodwill and other intangible assets, impairment charges have no effect on valuation. Similarly, the Autonomy debacle is another distraction. The main things investors should focus on are HP's positions in PCs, mobile devices, and servers. Printers are important, but HP really cannot do anything about the overall decline happening in the industry.

Currently, PC sales are stagnant. However, Microsoft (NASDAQ: MSFT) recently launched Windows 8, which could drive upgrades to touch screen PCs. Regardless, the PC is not going to go away and HP is tied for first with Lenovo as the largest PC vendor and Dell (NASDAQ: DELL) is number three. Also, PCs are still shipping at high numbers, almost 88 million units shipped in Q3. Once the global economy recovers, the PC industry should resume its growth. Similar to the PC market, HP is tied for first with IBM in the server market (in terms of revenue) and Dell is number three. Over the long term, the demand for servers should continue to rise because of cloud storage, the rise of digital distribution of media, and the rise of mobile devices. 

However, the mobile device craze is real and Microsoft, HP, Dell, and other PC giants are being crushed by Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOG). In Q3 2012, Android and iOS accounted for 75% and 14.9% of smartphone shipments, respectively. In tablets, Android and iOS have 41% and 57% market share, respectively. The mobile device market is important to HP because mobile devices are taking sales away from the PC industry. In Q3 2012, HP and Dell experienced declines of 16.4% and 14%, respectively, in PC shipments. Meanwhile, smartphone and tablet shipments increased by 46.4% and 43% year over year, respectively. However, PC vendors could reach a strong presence in tablets due to Windows 8. The touch friendly OS allows PC OEMs to build Windows 8 tablets that are also fully functional PCs. Also, due to its superior hardware, the PC is essential for getting work done quickly.

In summary, HP is not dead. The massive decline in stock price presents a great buying opportunity. First, the majority of the company’s losses are due to impairment charges stemming from companies acquired before the current CEO. Adding back impairment and restructuring charges, HP earned $3.15 per share in FY 2012. At the current price of $11.71 and taking into account the negative tangible book value per share, HP has a PE ratio of just 5.84. In addition, the company has a dividend yield of 4%. Second, HP remains a global leader in PCs and servers. Although mobile devices have been huge, looking forward, as the world continues to advance, PCs and servers will likely continue to play a central role. Also, Windows 8 could prove to be a good catalyst in PC tablet sales. Finally, the stagnant PC market, which HP depends on heavily, should restart its growth when the global economy recovers. At this price level, HP is a steal.

iamgreatness owns shares of Microsoft. The Motley Fool owns shares of Apple, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Dell, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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