Earlier this week, I posted a blog on the math surrounding the HP merger and on the increased financial stress that will be placed on this new company as customers, costs and valuations adjust to their new form. The two firms will have distinctly different weaknesses. The HP Enterprise firm will have razor slim profits, which will likely drop into losses once the separation bucket is no longer able to segment out costs that otherwise would be in the income statement. The PC unit will have debt at about 50 percent of revenue, which should more than consume its initially higher margins. Their biggest margins are from printing consumables, which should be in accelerating decline. Rather than one company in distress, they end up with two companies with less complexity (which could make them potentially easier to turn around) in greater financial distress. So what happens next?
The reason many believe as to why HP hasn’t been acquired is because no one wants its PC and printer businesses. By spinning those businesses out, HP becomes an acquisition target. EMC has been speculated, but I think there is too much overlap with that firm. And EMC doesn’t buy troubled properties, based on Joe Tucci’s comments at the last analyst event.
Oracle would typically be the most likely HP buyer. While there is a lot of bad blood between HP and Oracle, the same thing was true of PeopleSoft, and Oracle successfully bought it and then shut down operations, seemingly relishing in finding the executives in that company some alternative career paths.
Unlike IBM or Dell, Oracle doesn’t seem to have a problem acquiring troubled properties and the animosity between the firms may actually increase its incentive to buy HP. Mark Hurd, in particular, is likely very attracted to the idea of having a lot of the folks that bad mouthed him when he left once again under his authority. I expect, if folks thought him harsh when he last ran HP, they will see the new meaning of “harsh.” (In reality, he was arguably more successful than either of his successors, which likely really peeves him.)
China has a lot of free cash at the moment, but the hostility between the U.S. and China makes regulatory approval unlikely for any company. Lenovo would be the most likely to consider a merger with HP, but it’ll still be in the midst of doing two massive mergers at once, and picking up HP on top of the IBM x86 server group would likely be a bridge too far for the U.S. government and Lenovo. Samsung in Korea is also a possibility, but only if its financial performance improves, because the extra drag of HP under Samsung would seem to create too much financial risk for that firm.
An acquisition would allow Whitman and the HP board to accelerate their options and provide a substantial financial incentive for this path, making this by far the more likely outcome.
Another alternative is taking the firm private, but the financial cost to the CEO for a move like that makes it unlikely for anyone but a founder.
HP as a firm will have to continue as a separate entity, and while going private would be particularly attractive to it, given the desperate need to dramatically restructure the printing unit while out of the public markets, I still doubt a non-founder will take this path unless they can mitigate the personal financial costs related to it. Given that these two units were the least desirable of the HP family, finding a buyer would be very difficult, and while the PC unit might be attractive to Acer or a Chinese tech company wanting to enter the segment, they’d have to spin out the printer unit first to create what would be a very complex, though not impossible, outcome. This makes it relatively unlikely that HP Inc. will be purchased as a complete unit, but regulatory agencies would be less concerned with China buying part of this firm. Given that much of the retail placement of products is done by the printing side of this company, there is a high risk that the PC unit would collapse should the firms be separated quickly. In short, I think due diligence will prevent an acquisition unless the printer unit can be revitalized or the PC unit can demonstrate that it can stand alone.
Standing alone isn’t pretty either, though, and having debt that is half of revenue or over 10 times its likely annual income after the separation will be a huge drag on any turnaround effort, which will likely force more draconian cost cuts so that the firm can maintain some investment in its future. Dion Weisler, the HP Inc. CEO, is well regarded in the PC industry as a subject matter expert and has been executing better than Whitman at HP—it is as if she agreed to race him but only if she could shoot him in both legs first. But Apple was in worse shape than HP Inc. will be and it still managed to eventually become a more powerful company than HP, suggesting that with sharp execution, Weisler could do the same. It will likely depend on a variety of things, including Weisler’s ability to get out from under Whitman’s failed policies (even though she will be chairman of HP Inc.), market recovery, and his ability to spin out or turn the printing unit from a cash cow to a more strategic growing asset. (There are several opportunities here, including all types of 3D printing, which is a market HP has yet to enter.)
If HP Inc. continues, it will likely have to expand into servers, storage and networking unless it pulls back to the consumer market like Apple did. If it takes this latter path, it could partner with Oracle/HP, IBM, or EMC like Lenovo and Apple (IBM) have. That could make things even more interesting.
I expect both units will go through massive staffing changes (i.e., staffing up on the resources they now share and staffing down everything else to contain/reduce costs). I think the enterprise version of HP is most likely to be acquired, with Oracle as the most probable buyer. While the transition would be painful, particularly for firms that don’t like Oracle, Hurd has proven to be the better manager, which suggests that once the merger was complete, the unit would be in better shape. HP Inc. should remain independent, but any sign that it is spinning out the printing business would likely be a preamble to its own sale—likely to a Chinese buyer. However, if it can show success in a new market, like 3D printing, it’ll more likely stay the course.
If, as I expect, Whitman will step down from both firms once the HP enterprise company is sold, that would be a strong indicator that HP Inc. will be aggressively stepping out and attempting to emulate Apple’s incredibly successful turnaround. Any incredibly unlikely move, like taking the unit private to emulate Dell’s successful path, would also be indicative of a management team more focused on turning the firm around than in milking it for quarterly results—which is a common problem in the public segment.
Investor risk remains highest with HP Inc., because of the debt and the lesser likelihood of a relatively quick acquisition. Technology buyer risk is higher with the enterprise side of HP, given that its leadership and ownership are most likely to change. PC buyers don’t have the strategic requirements that other enterprise buyers have and while declining, the printing business is far too lucrative to shut down, so there is little additional risk of buying PCs or printers from PC Inc.
It is highly unusual to see a split up during a time of market consolidation and it is likely this will be named “Whitman’s Folly.” We’ll see.
Rob Enderle is President and Principal Analyst of the Enderle Group, a forward-looking emerging technology advisory firm. With over 30 years’ experience in emerging technologies, he has provided regional and global companies with guidance in how to better target customer needs; create new business opportunities; anticipate technology changes; select vendors and products; and present their products in the best possible light. Rob covers the technology industry broadly. Before founding the Enderle Group, Rob was the Senior Research Fellow for Forrester Research and the Giga Information Group, and held senior positions at IBM and ROLM. Follow Rob on Twitter @enderle, on Facebook and on Google+