Will 2013 Be Any Better?

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

For Hewlett-Packard (NYSE: HPQ), the end of 2012 could not come soon enough. The company’s revenues and earnings were down. Its main business, personal computers (PC’s) and printers, is in decline. The stock price is reflective of the company's poor performance and is down by almost 50% for the year. 

What Went Wrong?

The biggest problem that HP has is that it is at the wrong end of the computing business. Desktop computers and even laptop computers are now considered old school, while tablets and smartphones are all the rage. There is still money to be made in the computer business, but the money is being made by companies that provide cloud based computing solutions. Companies like Apple (NASDAQ: AAPL) and Samsung have seen both their earnings and their stock prices flourish. Old school computer companies like HP, Dell, Intel and Microsoft (NASDAQ: MSFT) have fallen behind, and their stock prices are near 52-week lows.

Microsoft's RT Surface has had a tough time gaining traction against competitors like Apple. In an interview with French newspaper LeParisien, Microsoft CEO Steve Ballmer said sales so far have been “modest.”  According to Barron's roundup up of analyst estimates, Microsoft sold 1 million Surface tablets at best last quarter. Citigroup analyst Walter Pritchard thinks Microsoft sold between 700,000 and 800,000 Surfaces last quarter, while Goldman Sachs analyst Heather Bellini predicts Surface sales will only reach meager 230,000 units.

Apple, on the other hand, sold 22.9 million iPads in its most recent quarter, up from 14 million in the previous quarter. This marks a 33% increase year-on-year, compared to 15.4 million during the same period in 2011. On top of this, the iPad mini is performing so well that some analysts think it is eating away at sales of its larger iPad counterpart. I believe a change in consumer mindset for lower cost products and greater device mobility is fueling iPad mini sales growth.

On top of all this competition in the hot tablet space, a recent report by the World Economic Forum highlights the core problem for HP. It predicted that in 2012 PC sales will decline for the first time in 11 years. There are a myriad of reasons for the decline in PC sales. Weak macro-economic conditions, cannibalization from tablets and smartphones as mentioned above, elongation of replacement cycles (I have had my PC for 4 years) and the final straw is full penetration in emerging markets. Analysts at IDC and Gartner said PC shipments in this year’s third quarter were down by 87.5 million, or 8% lower than a year ago. What is particularly troubling for HP is that the decline in PC sales will be an ongoing trend.  Todd Bradley, the head of Hewlett-Packard’s PC business, said he thinks the core PC market will stay flat “potentially through 2015.”

The second reason that I would not invest in HP is that the company has had too many changes in management and too many horrible acquisitions. After so much confusion and so many missteps it will take quite a while to turn the company around. The purchase of EDS and Compaq were terrible mistakes, but the 2011 purchase of Autonomy for $11.1 billion was devastating. The purchase did not help the value of HP’s portfolio and HP has written off $5 billion of Autonomy’s value. In addition on November 21 HP confirmed that the U.S. Department of Justice was investigating Autonomy’s books. Over the last 10 years HP has spent $67 billion acquiring companies and its current market cap is less than $27 billion.  These mistakes have hurt HP badly.  They have caused the company to take on excess debt ($28.4 billion) and will hamper its ability to restructure itself as it moves forward.

The third reason that I would not recommend investing in HP is because as its CEO Meg Whitman has said “Make no mistake about it; we're still in the early stages of a turnaround.”  HP plans to transform its business from being a PC maker to providing software services, cloud computing services and possibly even providing mobile devices.  Unfortunately for HP, it has formidable competitors that are way ahead of it in these businesses.  In the software services business it must compete against giants like Microsoft, IBM and Oracle. In the cloud computing service business it will compete against Amazon “Web Services,” Rackspace and Salesforce.com.  Finally, in the mobile device business it would be forced to compete against Apple and Samsung.  I do not doubt HP’s CEO’s Meg Whitman’s good intent, but HP will have a hard time catching up with any of these companies.

More Bad News

Another bit of bad news for HP came when the company accused two former employees in Austin, Texas, of conspiring to resign simultaneously and recruit 16 colleagues in their information technology department to take jobs with General Motors.  It now seems that HP’s announcement of 29,000 job cuts by 2014 has caused tension between management and rank and file employees. Adding to the problem is that in October GM announced that it would hire 3,000 of HP’s IT employees. Losing valued employees during a period of transition could be a big problem for HP. HP has filed a lawsuit with a Texas court saying that “former IT directors Gregg Hansen and Todd MacKenzie had led a "seemingly orchestrated departure" to GM in an abrupt move November 30.” When employees revolt against their employer that has got to be a bad sign.

HP does have a couple of factors working in its favor. The company’s balance sheet will be helped by the big third and fourth quarter write-offs. Also in the fourth quarter, the company had $2.8 billion in positive cash flow, and ended the quarter with $11.3 billion in cash and equivalents. Another positive for the business is that its IT and cloud computing businesses are showing good margins, and its software business grew 18% year-over-year.

Summary

It is now official that HP stock will be the worst performer of any stock in the DOW Jones 30.  The stock is down by 48% on the year. The stock has rallied by nearly 22% since it hit its low on November 20, but I doubt that it will move much higher. HP will have to go through a long restructuring process and Meg Whitman has warned that for HP Fiscal year 2013 will be a "fix and rebuild" year.  She also went on to tell the investors “real recovery and expansion at HP” would not happen until 2014. Some investors will be tempted to buy into HP because the stock is cheap (Forward PE ratio 3.95/price to book ratio 1.2) but I would advise against that. I think that HP will eventually reinvent itself and become profitable. However, I predict that matters will get worse for HP before they get better.


jordobivona has no position in any stocks mentioned. The Motley Fool recommends Apple and General Motors. The Motley Fool owns shares of Apple 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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