Hewlett-Packard: On The Right Track With Whitman

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One remembers the saying from childhood, “For want of a nail”. An extended spiral of consequences teaches the lesson that one small error can result in disaster. It is often supposed that causality can be traced backwards to a single (usually insignificant) event. One of the most well known examples of application of this proverb was made by Chief Justice John G. Roberts in his dissent in Massachusetts v. Environmental Protection Agency. The argument claimed that the loss of Massachusetts coastal land was a direct result of a largely ignored EPA regulation.

For HP (NYSE: HPQ), the horseshoe nail was Leo Apotheker. Credited with the company’s loss of over $30 billion in market capitalization, the decision to make this man the chief executive officer was the beginning of a rapid decline for the technology titan.

Before there was Leo

HP started as a dream for Palo Alto residents William Hewlett and Dave Packard. From their one car garage, the two friends poured blood, sweat, and microchips into their work and raised HP to the world's leading PC manufacturer. Specializing in data storage, networking hardware, as well as software services, its products are found in households, small to medium sized businesses and large corporations.

Through solid leadership and focus, the company saw steady growth throughout the 80’s and 90’s as it stayed neck and neck with other leaders in the industry. In 1999, the company saw fit to spin off part of its business as Agilent Technologies (NYSE: A). Agilent stock is now valued at twice HP’s – about $44 per share.

In 2002, it merged with Compaq. Six years later, it completed an acquisition of Electronic Data Systems, Ross Perot’s startup that was purchased by General Motors. In 2009, with combined revenues topping $119 billion, HP had reached the ranking of number 9 in the Fortune 500.

 

What Happened?

A flurry of leadership changes seemed to halt HP beginning with Mark Hurd’s resignation after a sexual harassment allegation in August 2010. The Chief Financial Officer, Cathie Lesjak, assumed the role of interim CEO. 3 months later, Leo Apotheker was named CEO.

Apotheker’s first order of business was to wildly shift the focus of the company from producing computers and invest in higher margin industries. He also cut the promising investment the company had made into the smartphone and tablet computing world when it purchased Palm earlier that year. Finally, he made the decision to spin off the personal computing division into its own company. This last move was quickly reversed, as it was strongly argued that this division of the company was too integrated and critical to business operations.

Although HP had already been a manufacturer of PDAs and netbooks, the original intent was to be a more powerful force in the context of mobile computing. As its competitor Apple (NASDAQ: AAPL) already had a stranglehold on the market with the iPad, the acquisition of mobile device vendor Palm could have been a legitimate platform for a mobile strategy. In my opinion, the program was axed too quickly before gains could be realized.

Intentions were clear; Apotheker saw the slow decline of PC sales and was attempting to ‘right the ship’. However, his decisions made clear that he didn’t understand the cause. It was not use that was declining – it was restriction. Consumers no longer wanted to be tethered to a large workstation or desktop in order to access anything. They wanted it on the go. Clearly a mobile move would have been beneficial for the company.

Why Leo did it

The model Apotheker attempted to follow was that of competitor IBM (NYSE: IBM). Without argument, it is a successful model – but HP could not capitalize on it in an effective way. IBM emphasizes innovation in order to differentiate its products while HP had used strategic acquisitions to gain market position. IBM has a diversified global reach, with different products servicing different geographic areas. HP had focused on its narrow product line servicing every area.

But what Apotheker saw that caught his attention and prompted the “get out of PC’s now” decision, was IBM’s business server software solutions. As of December 2011, IBM had a services backlog of $141 billion, a strong position in the emerging e-business services.

The problem was, however, it would mean a lot more than redirecting funds to R&D and/or acquiring another software services company such as IBM’s Net Integration Technologies. It would mean cutting off its service contracts already established with businesses. It would be ludicrous to sell a company a million dollars’ worth of servers and computer hardware only to let another vendor step in the following year to offer their brand of products.

HP, like IBM, has sufficient stake in hardware, software and consulting services. But the drastic restructuring and management has kept it from finding its way. The hope of focusing even more on higher margin areas like software and more rapidly growing businesses like storage and servers could not possibly succeed if not done appropriately.

Investors reacted to the appointment and succeeding decisions, and the company’s stock plummeted. In fact, during Apotheker's tenure at HP the stock dropped about 40%, 25% of which happened on the very announcement of Apotheker’s ideas.

 

The Decision to Change

On September 22, 2011, the HP board of directors replaced Apotheker as CEO with fellow board member and ex-CEO of eBay, Meg Whitman. This single decision was the turn of the tide for the company.

Even though first quarter net revenue – around $30 billion – missed the 5% predicted decline, since Whitman took over, HP's stock has steadily risen over the last few months. In the next article, I will discuss how a renewed sense of focus under Whitman’s direction will result in solid gains this year.


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