Is HP Worth The Risk?
Maxwell is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Hewlett-Packard (NYSE: HPQ) recently announced that some former members of Autonomy management used accounting improprieties, misrepresentation, and disclosure failure to inflate the underlying financial metrics of the company prior to Autonomy's acquisition by Hewlett-Packard. Hewlett-Packard said the misrepresentation had been a willful effort to mislead investors and potential buyers and severely impacted Hewlett Packard management's ability to fully value Autonomy at the time of the deal. Since the announcement, Hewlett Packard shares plunged from $13 per share to $11 per share, and the company risks shareholders' backlash over the Autonomy acquisition.
I believe Hewlett-Packard made a grievous mistake, and the company represents a risky investment. But how risky is it? The company is led by Meg Whitman, a member of the board that approved the Autonomy acquisition. Hewlett Packard's stock price has been in a relentless downward trend for a decade, and the company has a history of making poor acquisitions. Apart from the Autonomy acquisition, it has been devastated by tablets in general, and Apple (NASDAQ: AAPL) in particular. Having advisors who were in leadership roles at the time of the acquisition speaks volumes about the seriousness of Hewlett Packard's announcement.
Hewlett Packard's acquisition and its present dilemma came as a result of the decision of the previous board to move deeper into software and services. Personal computers were no longer selling because consumers shifted to smartphones and tablets. The thinking of the previous board made sense given that Hewlett Packard's rivals such as Accenture (ACN), DELL (DELL), and IBM (NYSE: IBM) were cutting into its market share. Lenovo (LNGF.PK) reorganized and was fighting to get a share of the market for personal computers. This speaks volumes about Hewlett Packard's predicament. Samsung (SSNLF), Canon (CAJ), Lexmark (LXK), and Epson also proved competitive in the printing devices market, continuously rolling out products that Hewlett Packard found difficult to outsell. The software and services sector was lucrative. The previous board believed it could be fully explored. Given the track record of members, I believe their assessment was right. With the companies competing with Hewlett Packard for market share, there was good reason to believe Hewlett Packard should acquire a software-making company. Unfortunately, Autonomy had a history of questionable accounts and business practice prior to the acquisition by Hewlett Packard. Now that $8.8 billion has gone down the drain over the acquisition, this makes Hewlett Packard look like a risky stock.
Making the stock even more risky is the fact that Hewlett Packard's announcement has attracted the anger of Autonomy founder, Michael Lynch, who vehemently and publicly disputed Hewlett Packard's claims of wrong doing, leading many observers to wonder whether Hewlett Packard was really the victim of accounting fraud or was just using the alleged accounting issues as an excuse to mask its poor performance. Having this type of observation makes me very much concerned about Hewlett Packard's risk. There is evidence indicating a potential failing of audit firms, Deloitte (UK) and KPMG, Hewlett Packard's board, and its finance team. "This is mainstream part of finance and quite frankly an embarrassing debacle," said Barry Ritholtz of Fusion IQ. "To me, this is just another bad Hewlett Packard acquisition."
I believe that Hewlett Packard is once again left with another black eye in its Autonomy acquisition. Given this belief, it is important to consider whether it is worth investing in the company. Hewlett Packard reported poor performance across the board in its fiscal fourth quarter announcement. Its third quarter report revealed the company suffered the greatest loss in its long and dramatic history and had to write-down $8 billion over the purchase of Electronic Data Systems. Its competitors have enormous financial reserves and outstanding technical abilities. In order to recover from the Autonomy debacle the company may more likely transform itself into an IBM-like services company. This is another reason I think Hewlett Packard may be a risky stock for investors. I don't know whether the company has the ability, the skills, and the management to accomplish this feat. The right atmosphere must be created to transform Hewlett Packard into the force it was once in the hi-tech sector. If Meg Whitman is right, and some members of the Autonomy management team used accounting improprieties to inflate the underlying financial metrics of Autonomy before the Hewlett Packard acquisition, then this is just another bad acquisition and investors should shy away from Hewlett Packard.
Looking at Hewlett Packard's losses after Whitman's announcement will give us some idea as to the level of damage that has taken place. Hewlett Packard shares tumbled 12% to a 10-year low. At around $11 per share, Hewlett-Packard now trades at 6 times its enterprise value, which includes factors such as debt. This compares to 9.7 times for Apple, which is growing much faster and has a rock-solid balance sheet. "HP is the epitome of a value trap," said Ritholtz. Being lenient, let's assume the company wants to make a long, slow turnaround process as Whitman said. Hewlett Packard makes personal computers. But the world is shifting away from personal computers to tablets and smartphones. Assuming it want to make the transition into the new growth areas, competitors will pose stiff opposition, not wanting to lose their market share and compounding Hewlett Packard's situation. This is an incredible situation for a company that once had a wonderful, storied past. But it doesn't mean it can survive its present travail, which some consider hopeless.
If you already own Hewlett-Packard, I advise selling the stock before more damaging and discouraging announcements are made. If you do not own the stock, I advise avoiding it for now.
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