The Urgent Need for a Reboot at HP


By Megan Graham-Hackett From the comments of Carly Fiorina, who stepped down as chairman and chief executive of Hewlett-Packard (HPQ

; S&P investment rank 3 STARS, hold; recent price, $21) effective Feb. 7, and those made to analysts by new Chairman Patricia Dunn, HP's board had grown frustrated with the lack of progress toward profitability in its flagging computer-hardware business. A new set of skills was needed to guide one of the world's largest information-technology companies, with some $80 billion in annual revenues.

Many questions remain, in our opinion at Standard & Poor's. According to Dunn, the current HP strategy is the right one. Yet we believe Fiorina's departure speaks to potential structural issues within HP -- issues that may require more than a new CEO. Indeed, many of the same criticisms directed at Fiorina were made of predecessor CEO Lew Platt -- lackluster revenue growth, inconsistent results, and lack of synergies between businesses in HP's portfolio.

EVERYTHING ON THE TABLE. While HP's board stated that it doesn't foresee a change in the company's portfolio, we believe all options should be on the table. The board, however, may be leaving such a recommendation up to a new CEO.

Some of the strategy issues we think should be considered include:

Should the printing and imaging division be spun off from the enterprise and PC divisions? What value does the PC business hold for HP, and can it ever achieve a cost structure to match Dell's (DELL

; 5 STARS, strong buy; $41)? Can synergies be created between the PC operation and the printing and imaging businesses, and what is the best way to achieve that goal? Finally, should HP follow the lead of IBM (IBM

; 5 STARS; $95) and make a bigger bet in software and services to better compete in the high end of the IT industry?

TOUGH DECISIONS. In our opinion, these tough decisions require an individual with experience of the technology industry. A computer-hardware background would be helpful, as well as a strong grounding in operations and an ability to discern the cost structure and systems that will help HP execute its strategy and compete.

At the same time the board considers candidates, HP's competitors are expected to aggressively pursue the outfit's large corporate accounts. Dell made no secret of this in its quarterly earnings conference call with analysts and investors on Feb. 10. Even after HP selects a candidate, it will likely take some time before the new CEO can learn the company, the issues, and the markets, and affect a new game plan.

We expect revenue growth of 8% for HP in fiscal 2005. Admittedly, much of this would come off a somewhat depressed base in 2004. Specifically, if the company had not executed poorly in the third quarter of 2004, our revenue-growth estimate would be closer to 6%. In addition, we believe our revenue-growth forecast is vulnerable if HP witnesses attrition in its customer base following Fiorina's departure.

INVESTOR SENTIMENT. However, we believe the stock price reflects these challenges. Trading at roughly 0.8 times sales, the shares are already at a discount to peers, and we believe they're fairly valued. Using our discounted cash-flow analysis, we also arrive at a value approximating the current share price.

The shares appreciated after Fiorina's departure. We believe this reflects investor sentiment, which could be the catalyst HP needs to finally rethink its positioning in the marketplace, its product road map, and, potentially, portfolio changes. HP has a very large installed base of customers and is ranked the No. 1 or No. 2 vendor in all major categories in which it competes. There is value to unlock, in our estimation, but we believe it will take more than just a new CEO. The entire organization needs to reexamine its culture, markets, structure, and strategy, before its potential can be fulfilled.

Note: Megan Graham-Hackett has no stock ownership or financial interest in any of the companies in her coverage area. All of the views expressed accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed. Price charts and required disclosures for all STARS-ranked companies can be found at www.spsecurities.com

Required Disclosures

5-STARS (Strong Buy): Total return is expected to outperform the total return of the S&P 500 Index by a wide margin, with shares rising in price on an absolute basis.

4-STARS (Buy): Total return is expected to outperform the total return of the S&P 500 Index, with shares rising in price on an absolute basis.

3-STARS (Hold): Total return is expected to closely approximate the total return of the S&P 500 Index, with shares generally rising in price on an absolute basis.

2-STARS (Sell): Total return is expected to underperform the total return of the S&P 500 Index and share price is not anticipated to show a gain.

1-STARS (Strong Sell): Total return is expected to underperform the total return of the S&P 500 Index by a wide margin, with shares falling in price on an absolute basis.

As of December 31, 2004, SPIAS and their U.S. research analysts have recommended 26.5% of issuers with buy recommendations, 61.3% with hold recommendations and 12.2% with sell recommendations.

All of the views expressed in this research report accurately reflect the research analysts' personal views regarding any and all of the subject securities or issuers. No part of the analysts' compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.

Additional information is available upon request to Standard & Poor's, 55 Water Street, New York, NY 10041.

Other Disclosures

This research report was prepared by Standard & Poor's Investment Advisory Services LLC ("SPIAS"), and may have been provided to you either by: (i) Standard & Poor's under a license agreement with The McGraw-Hill Companies, Inc., which holds the copyright to this report; or (ii) a Standard & Poor's client who is granted a sub-license by Standard & Poor's. This equity research report and recommendations are performed separately from any other analytic activity of Standard & Poor's. Standard & Poor's equity research analysts have no access to non-public information received by other units of Standard & Poor's. Standard & Poor's does not trade in its own account. SPIAS is affiliated with various entities, which may perform services for companies covered by the recommendations in this report. Each such affiliate is operationally independent from SPIAS.

Disclaimers

This material is based upon information that we consider to be reliable, but neither SPIAS nor its affiliates warrant its completeness or accuracy, and it should not be relied upon as such. Assumptions, opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale so any security or other financial instrument. Securities, financial instruments or strategies mentioned herein may not be suitable for all investors. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation of particular securities, financial instruments or strategies to you. Before acting on any recommendation in this material, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Analyst Graham-Hackett covers computer hardware stocks for Standard & Poor's Equity Research Services


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