HP Restructuring: Top 5 Challenges

Technology giant Hewlett-Packard (NYSE:HPQ) announced a series of developments Thursday, including the potential spin-off of its personal computer business that would kill the Touchpad tablet computers based on Palm's webOS software. The deal comes only days after Google agreed to buy Motorola Mobility for $12.5 billion.

HP said its board has authorized the exploration of strategic alternatives for its Personal Systems Group and plans to close down its webOS device business. California-based HP also agreed to buy British-based software company Autonomy for about $10 billion.

Following are the six key issues that lie ahead of HP, according to BMO Capital Markets analyst Keith Bachman:

Autonomy Acquisition Expensive:

HP is paying a very high purchase price for Autonomy. Bachman said that HP is paying about $11.7 billion in cash or about 11x-12x price/sales, given Autonomy's trailing twelve-month revenues of about $931 million and given its content management business is not a high-growth business.

Further, Bachman said that this acquisition will not add meaningfully to HP's revenues and profitability over the next few years, given the analyst's revenue forecast for fiscal 2012 is about $129 billion.

More important, such a large transaction will substantially reduce the amount of share buyback that HP can undertake, in our view.

Net, we do not think that this transaction will create much value in the next few quarters, Bachman wrote in a note to clients.

Services Challenges Continue:

HP's company specific problems in services will continue for the next several quarters, and that this business will grow at below market growth rates until the issues relating to front-end sales and execution are fixed.

During the July quarter, the services revenues were $9.09 billion, compared to consensus estimate of $8.94 billion. However, the services op margins are expected to decline to about 12.5 percent over the next four to six quarters, compared to HP's earlier guidance of 13.5 percent to 14 percent and historical op margins of about 15.7 percent in the past six quarters.

Further, we think that slower revenue growth and lower profitability will make it difficult for HP to retain top talent during this transformation process, said Bachman, who now models the services revenue to remain roughly flat year-over-year in the October quarter and increase only one percent in fiscal 2012.

Printer Issues:

Printer revenues were $6.09 billion versus the Street estimate of $6.28 billion, hurt by lack of availability of laser jet hardware and toners due to the supply chain impact from Japan earthquake.

Further, given the higher-than-channel inventory at the end of the quarter, we forecast printer revenues to increase 6.7 percent q/q in the October quarter and decline 1.2 percent q/q in 1QFY12, the analyst said.

The analyst also projects operating margins in printers to decline sequentially in the October quarter, due to lower supplies mix and forex.

PC Business - Uncertainty Remains:

HP's indication about evaluating strategic options to separate its PC business will create more uncertainties.

Bachman said that given HP derives significant synergies in the supply chain and with the VARs and resellers owing to its large PC business, this evaluation exercise may not result in a spin-off, while the long evaluation process will continue to have a negative impact on both end market demand and the potential valuation for the PC business.

Net, we think that this announcement will probably create more questions than answers in the mind of the investors and employees, until any option is finalized by HP, the analyst wrote.

Enterprise Business - Oracle Effect

Revenue in the Enterprise business was $5.4 billion, as compared to consensus estimate of $5.49 billion. While the performance was strong in the industry standard segment, the higher margin business critical server revenues declined in the July quarter owing to the ongoing dispute with Oracle.

In addition, the operating margins declined during the quarter by 80 basis points owing to lower mix and incremental opex.

We forecast revenues to increase by 2.8 percent y/y in FY12, mainly owing to a 10 percent y/y decline in business critical servers, as compared to revenue growth of about 10.4 percent in FY11 and 22.9 percent in FY09, the analyst noted.