Why S&P Is Standing Pat on HP


Carly Fiorina's high-profile tenure at computer-hardware giant Hewlett-Packard (HPQ) came to an end on Wednesday, Feb. 9, after the board of directors asked for her resignation. Her departure comes after more than five years at the helm, during which she shepherded the merger of Hewlett-Packard with computer manufacturer Compaq.

But in recent years, HP has struggled to compete with peers, and the merger has disappointed those who were hoping HP would profit from synergies between the joined forces.

Megan Graham-Hackett, a computer-hardware analyst who covers the company for Standard & Poor's Equity Research, spoke with BusinessWeek Online's June Kim about Fiorina's departure as CEO and chairman and what it might mean for HP's future. Edited excerpts of their conversation follow:

Q: Why did you keep HP stock rated at hold (3 STARS)?

A: I left it at a hold because there could be new strategy that could unlock some value. The stock is trading at discount to peers -- Dell (DELL) and IBM (IBM) -- and there's the potential that if they were to introduce a strategy that would improve operating margins or revenue growth, then you could see the multiple widen for the stock to match the peer average.

Of course, we'll have to reevaluate when a new CEO is named. [CFO Robert Wayman was appointed interim CEO.] There is no timeline to when a new CEO would come in.

Q: What does Fiorina's resignation mean for HP's strategy and execution?

A: I would hope that they would reexamine the company's strategic direction. But [board member and newly appointed nonexecutive Chairman] Patricia Dunn said they felt comfortable with the strategy they currently had in place and would not be changing direction.

We were surprised by that. We were hoping the move was meant to accelerate the execution of the strategy. That's our biggest concern for the stock. HP has no compelling competitive advantage to really differentiate itself from IBM or Dell.

From our perspective, we would expect a new strategic direction to be outlined, to lead the company in a path that would be unfolding competitive advantage to regain market share and differentiate itself from competitors.

The greatest execution issue...is in capturing market share, specifically within the enterprise division. This includes HP's server division, storage division, as well as its software assets. Within servers, it's in the No. 2 position behind IBM, and recently IBM has done better in mid-range and high-end segments.

The issue goes a little deeper than just market share. HP has changed its server strategy a couple of times in the past couple of years, leading to customer confusion. That's a deeper problem.

In storage, it was late to market in certain technologies, and it lost market share. When companies are competing in this marketplace, the enterprise division is very highly competitive. Right now, execution comes down to having a competitive cost structure and a strategic road map when it comes to introducing innovative new product lines. It's a process of continuous execution, and that has been lacking at HP for both the storage and servers divisions.

Q: What do you think are the reasons why the board asked Fiorina to leave?

A: Carly was public about saying that she has had differences with the board, and there was growing frustration within the board. Their PC and server divisions would have been more profitable, their stock price hasn't fared better...and the company had a big execution miss in the third quarter of fiscal 2004, when the enterprise division had a large operating loss. It reflected salesforce-execution issues, and it wasn't discovered until very late after the quarter had closed.

You'd expect that from a company that has a new salesforce strategy, new management, but not a company the size of HP, with the tenure that Carly had.

It was surprising that you would have that kind of large miss as far as operations go, when you would imagine a company would have a good handle on its business on a day-to-day basis.

One of the things we thought they needed for awhile and wanted for the company was a COO. But Carly didn't agree with that, and the board wasn't signed up to that strategy either. They're still not undergoing a search for a COO. However, one of the things that Dunn outlines is that [the board] wanted someone who was closer to day-to-day operations.

Q: How did the merger of HP and Compaq reflect on Fiorina's tenure?

A: It's very hard to say what would have happened to the two companies individually if the merger hadn't gone through. But not a lot of synergies were garnered from it, and there has been a lot of criticism.

HP hasn't come out as the competitive force it was hoping to become when the deal was first announced. The synergies that were imagined didn't really occur. The company had to give up vying for No. 1 [in PCs] and simply wasn't able to act fast enough or effectively enough to reduce its cost structure to match Dell's.

For Fiorina, it was a very high-profile bet and caused a lot of tension. Basically, the strategic rationale is really in question. But to their benefit, it was a very difficult environment to undertake the merger.

Q: Does Fiorina's departure make sense for HP?

A: She was a high-profile executive, and she got the same criticism that Lou Platt, the previous HP CEO, got. This makes us think there are problems structurally within HP that still need to be addressed -- rather than just a single person.

She got to a point where she was becoming inflexible in some of her decisions. She was adamant on a couple of issues in HP, and maybe now those issues can be reexamined. Maybe there's someone who has better ideas for synergies between their PC and printer divisions as well as a better strategic road map for their enterprise division, specifically their server strategy.


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