Annex Bulletin 2011-07                            February 22, 2011

A partially OPEN edition


HP: Ghost of EDS Haunts HP (Analysis of HP's first quarter 2011 business results)

Case Makes a Case for Innovation (Analysis of new "Startup America" program)



Updated 2/22/11, 7:30PM HST

Analysis of Hewlett Packard's First Quarter Fiscal 2011 Results

Ghost of EDS Haunts HP

Stock Drops Like a Rock on Lower Services, PC Revenues; "Delionizing" Leo

HAIKU, Maui, Feb 22, 2011 - It was the new HP CEO's first full quarter, the start of a new era.  And it started with a bang and a roar.  Not the kind the shareholders like to hear.  The stock dropped like a rock following the company's first quarter fiscal 2011 release.  The roar than ensued was that of the disappointed investors.  As we write this, HP stock is down 12.3% in after-hours trading.  And still in a free-fall, it seems.


HP's actual results weren't bad.  Strike the "not bad."  They were actually quite good.  Revenues were up 4% to $32.3 billion, while net earnings surged 27% since a year ago.  Furthermore, the company added $3.1 billion in cash flow from operations.  Not even $2.3 billion in stock buybacks did prevent a mass exodus of panicked investors after the first quarter results were released.

So what spooked Wall Street into such a hasty retreat?  Was it Wal-mart, which also disappointed its shareholders earlier today? 

Well, that didn't help.  And neither did the Libyan political crisis.  But the HP shareholders suffered a crisis of their own.  It was a crisis of confidence in HP leadership and of their own over-inflated expectations. 

EDS, a company HP bought in 2008, had been suffering for years from a growth deficiency virus.  Considering that EDS was much bigger than HP's own services business prior to the acquisition, it is not surprising that the slow or no growth virus has now also infected HP. 

Here's what we said about that three months ago, when both Leo Apotheker, CEO, and Cathy Lesjak, the HP CFO, sounded bullish both about their services business and the future outlook for the company as a whole:

So the slow growth which has plagued the performance of EDS while it was an independent company has now infected HP Services as well.  No surprise there (see "Drumbeat Continues: Massive HP Layoffs Follow EDS Acquisition," Sep 2008).  At the time, HP's CFO, Cathie Lesjak, said she expected the growth of the merged services unit to be 4% to 6%, down from 8% to 11% growth before EDS. 

We were skeptical.  "We felt what EDS needed back then is SALES growth, not cost cutbacks.  It still does," we wrote in the above Sep 2008 Annex Bulletin.

(An excerpt from "Stealth CEO" Sounds Bullish in His First Public Appearance, Nov 2010)

More importantly, we warned the investors about it at the time HP was boasting about huge growth rates as a result of the EDS purchase.   Here's what we said about it in May 2009, after a heated email and phone debate about it with Mark Hurd, then the CEO and his head of investor relations at the time:

Spinning the Bad News

You'd never know how bad things are at HP if you heard or read what Hurd said at the May 19 analyst teleconference that followed the earnings release.  HP's chief spinmaster made it sound as if everything is hunky-dory, that the universe is unfolding as it should and that things are going the HP way.


Yet, services, services... seemed to have been the main theme of HP's teleconference with analysts.  HP executives chose to highlight their Services business segments results this quarter as the bright light, stressing the 99% revenue jump to $8.5 billion.  It was the first time ever that this perennial hardware company has led its quarterly review with services.  Hurd also boasted about the alleged success of that integration.

(Excerpts from Services, Services... "Financial Engineering" or Misleading Data?,)

Yet we found it to be a thinly veiled effort to pull the wool over the gullible Wall Street investors' eyes (for details, check out Services, Services... "Financial Engineering" or Misleading Data?, May 2009).  And now that the reality has hit home, investors are paying for their sin of gullibility from over two years ago.   Meanwhile, the universe is unfolding as it should.

PC Business Also Disappoints

The second main culprit for Wall Street's disappointment with HP in the first quarter was its PC business, especially the consumer side.  Once again, no surprise there.  And a similar story to that of services.  Overinflated expectations now having to be downsized.

A year ago, HP's PC business was the hero of the quarter.  But we also warned at the time not to read too much into its surge; that the company was benefiting from the pull effect of Microsoft's Windows 7, then newly released. 

Well, now that the dust has settled and the surge has run its course, it's clear that the consumer side of HP business is waning.  In the latest quarter, it was down 12% since a year ago.  Bet the commercial PC revenue grew 11%.  So HP's overall PC business was  down 1%.

It's probably more than just a "coincidence" that at the same time, HP's main competitor, Dell, is thriving.   What goes up must come down.  The law of gravity doesn't always apply to markets.  But eventually Wall Street tends to get it right.  This is one of those times when it comes to HP.

Summary: Delionizing Leo

In light of the above, it would appear that HP's new CEO, Apotheker, got the raw end of the deal.  Leo is being "delionized" by having to explain the sins of overinflating expectations which the Mark Hurd administration committed in the last two to three years.  Such a treatment appears even more unfair in that Wall Street tends to have short memories.  With exception of the Annex clients, few investors would realize that they may have been duped or misled years ago.

So we empathize with Leo.  But wearing the lion's mane carries both responsibilities and benefits.  As the CEO of the world's largest computer company, the HP leaders is more than adequately compensated to take a few knocks here and there.  More importantly he set himself up for this one.  In his first public statements following the release of HP's fourth quarter 2010 results, Leo sounded very bullish (see HP's "Stealth CEO" Sounds Bullish in First Public Appearance , Nov 2010).   That was only three months ago.  And now he is having to eat crow.

At least that part was well deserved.  A more prudent approach might have been to exercise caution before finding out where the skeletons are hidden at HP, and while learning the ropes of a new business.  Wall Street is used to giving a new CEO some rope at the outset, during a "honeymoon" period.  The idea is to use the rope to rappel upward rather than hang himself with it.  It's up to the CEO.

Oh well, live and learn.

Happy bargain hunting

Bob Djurdjevic

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Volume XXVI, Annex Bulletin 2011-07
February 22, 2011

Bob Djurdjevic, Editor

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HP: New Broom Sweeps Clean (Apotheker fills our first prescription in board shake-up)

IBM: Another Phoenix of the IT Industry , Analysis of IBM's 4Q10 result

One Man's Pain, Another Man's Gain? (Analysis of possible impact of Steve Jobs' health on IBM, Intel, other IT companies)

Consumer Rules (Analysis of top 15 global IT leaders' stock and business performances) 

IBM Hardware to Rise and Shine Again (Analysis of IBM STG business results and outlook)

BARRON's: IBM Shareholders Will Like New Year (Analysis of Barron's article on IBM stock)


HP's "Stealth CEO" Sounds Bullish in First Public Appearance (Analysis of HP's fourth quarter business results)


Silicon Valley Rodeo (Editorial on shenanigans and costly trivial pursuits)


IBM Business Up, Stock Down (Analysis of Big Blue's third quarter business results)