<%@ LANGUAGE=VBScript %> <% Set asplObj=Server.CreateObject("ASPL.Login") asplObj.Protect Set asplObj=Nothing %> Analysis of HP's 3Q08 business results (Aug 19, 2008)

Annex Bulletin 2008-17                            August 19, 2008

A partially OPEN CLIENT edition


"Beat the Street" Drumbeat Continues (Analysis of HP's 3Q08 business results)

Big Blue Stock Sags on "No News" Days (Analysis of IBM institutional shareholdings)



Updated 9/15/08, 6:00PM PDT, adds Massive HP Layoffs...

Analysis of HP's Third Quarter Business Results

"Beat the Street" Drumbeat Continues

Stock Up After-Hours as Company Again Blows Wall Street's Revenue, Profit Estimates Out of Water

SCOTTSDALE, Aug 19 – At HP, “beat the Street” continues to be the drumbeat to which the company dances every quarter.   Once again, HP has exceeded Wall Street estimates for both profits and revenues.   It has done so consistently ever since Mark Hurd took over as CEO over three years ago.  Third quarter revenues were up 10% to $28 billion (vs. $27.4 billion analyst average estimate), while net earnings were $0.86 per share (vs. $0.83 Wall Street expectations).

This time, however, HP got a little help from the weak dollar.  With 68% of its business coming from outside the U.S., the company had strong financial tailwinds in both Europe (11% boost) and Asia/Pacific (6% boost).  But even in constant currency, HP managed to grow its business in all three major geographies (up 3% in the Americas, up 5% in Europe and up 8% in A/P). 

Furthermore, revenues from emerging markets, such as the so-called “BRIC countries” (Brazil, Russia, India and China) grew 24% over the prior-year period and accounted for 10% of total revenue.  Cathie Lesjak, HP's CFO, said the company had a triple digit growth in Russia.  HP is an important supplier to the country's burgeoning energy sector, among others.

If there were a blemish in HP’s latest results, that would be a growth weakness in the Imaging and Printing Group (IPG), whose revenue grew only 3% to $7.0 billion.  Within this total, supplies revenue grew 11%, while commercial hardware revenue declined 5% and consumer hardware dropped 14%. Printer unit shipments declined 2% year over year.  Yet, despite the disappointing revenue figures, HP still managed to generate operating profit of $1.0 billion, or 15.0% of revenue, versus $981 million, or 14.5% of revenue last year.

The HP Services’ revenue growth was impressive and well balanced across its horizontal lines of business.  Technology Services grew 13%, while Consulting and Integration and Outsourcing Services were up 13% and 18% respectively.  Services’ operating profit was $574 million, or 12.1% of revenue, up from $417 million, or 10.0% of revenue, in the prior-year period.  All this bodes well for the completion of the EDS merger. 

The EDS acquisition is "going well," according to Mark Hurd, HP's CEO.  There are 500 people working on the deal that is expected to close later this month.  "We are confident in the benefits this (merger) will bring to customers and shareholders" of both companies, he added.

"Services many times is counter-cyclical in an economic environment where as economies go through some tougher times," Hurd said, answering an analyst question about the reasons for such a strong performance.  "There is more opportunity for services companies, particularly in  outsourcing."

"But make no mistake about it: We are going to execute on the EDS acquisition," he added, pointing out the strengths that HP will bring to the newly constituted services unit after the merger is complete. "We're going to bring the strength of HP's operating discipline, the strength of HP's innovation, the strength of HP's position in the marketplace - to make a combined business quite competitive."

But it was the HP Software, the company’s smallest operating unit, that turned in the best quarterly performance.   HP Software revenue grew 29% to $781 million, led by 32% growth in the Business Technology Optimization portfolio. Operating profit was $122 million, or 15.6% of revenue, up from $51 million, or 8.4% of revenue, in the prior-year period.

Summary & Outlook

So it looks like HP, like IBM, seems impervious to the economic tumult that the financial crisis in the U.S. has whipped up since a year ago.  The disappointing third quarter growth  performance of the HP printing and imaging unit, which depends heavily on consumer demand, is the only indication so far of its possible vulnerability, should the financial problems spread to consumers around the world.  But overall, we expect HP to continue to meet or exceed investor and shareholder expectations.

HP also issued an optimistic outlook for the current quarter, its fourth fiscal period of 2008, trying to quell recent investor worries that its overseas business will be hurt by the strengthening U.S. dollar and a possible sales slowdown in China.  The company said it expects revenue for the current quarter of between $30.2 billion and $30.3 billion and earnings per share of 95 cents to 97 cents.

Happy bargain hunting! 

Bob Djurdjevic

EDS Acquisition to Lead to Massive HP Layoffs

HP to lay off 24,600 people over three years, take $1.7B charge

SCOTTSDALE, Sep 15 - Since most acquisitions have cost cuts as a part of their justification, it was hardly a surprise that HP announced today after the markets closed it would lay off some people whose functions overlapped in the two companies.  What was surprising, however, in fact - it was downright stunning - was the staggering amount of layoffs.  HP plans to eliminate 24,600 jobs over a three-year period and take a charge of $1.7 billion in its fourth fiscal quarter related to the EDS acquisition.

Are there really that many redundant positions or is HP using the EDS acquisition as an opportunity to streamline its global operations across the board?  We don't know the answer to that question, but we do know that even after the massive layoffs the HP productivity will drop as its ranks swell up by the addition of some 142,000 EDS employees who generate revenues of "only" $21 billion or so (see above charts).

Still, the EDS acquisition makes good sense from an HP viewpoint.  We even suggested the idea to Carly Fiorina in June 2004.  But she was too gun-shy at the time after a lot of heartburn caused by HP's trying to digest the Compaq megadeal from Sep 2001.  “No major acquisitions,” she declared without even pausing to consider the merits (see "Delivering Value Horizontally," June 2004).

The reason the EDS deal made sense to us then and it does now is that the two companies don’t really have that much overlap in terms of customer sets.  EDS is strong in government and transportation sectors where HP has minimal presence.  And HP is strong in technology that can help EDS be more competitive than having to buy it at retail prices from companies like IBM or HP. 

Mark Hurd even highlighted that point in today's meeting with analysts (see "limited account overlap" in the above chart).  So we have a sense that that’s what made the acquisition  attractive to the current HP CEO, too, besides the price, of course.  He saw the mutual benefits from a deal Fiorina was too scared to even look at.

Ann Livermore, the head of the company's Technology Solutions Groups that includes services, wrote to this writer after the analyst conference saying, "we are very excited about HP's capabilities with EDS now part of the portfolio.  Our clients are very positive."

Furthermore, the EDS deal gave Hurd a chance to carry out massive layoffs.  Michael Jordan, the former EDS CO, has also been slashing jobs at EDS for years.  But we were critical of him at the time because EDS was already the LEANEST of all top global IT services competitors (see "EDS to Cut Up to 20,000 More Jobs," Sep 2004, and "Pain without Gain", Oct 2003). We felt what EDS needed back then is SALES growth, not cost cutbacks.  It still does.

Cathie Lesjak, HP's CFO, pointed out today that the combined revenue growth of the new HP IT services unit will be only 4% to 6%, versus 8% to 11% for the non-maintenance portion of HP Services before the EDS acquisition.  And EDS will also dilute HP Services' operating margins, at least in the short term - from 13%-14% to 9%-10%.  In the long-term, the HP CFO is hoping to get them back into the 13%-15% range (see above chart).

Also, the distribution of the job cuts seems a bit peculiar.  Considering that both HP and EDS have been hailing the strength of their Indian operations, and given that “most of the job cuts are to come from areas replicated in both H-P and EDS such as legal, human resources, real estate and information technology operations,”  as HP said according to a Dow Jones MarketWatch story, we find it a little strange that about half of the layoffs will be in the U.S. (meaning, most of the jobs mentioned are supposed to be in India and elsewhere around the world in the lower labor cost fulfillment centers of the two companies).  Again, the question looms... are there really that many overlapping jobs?

Notwithstanding such questions, the big picture of the EDS acquisition is a net positive for HP.  In terms of financial metrics, EDS will contribute about $3.5 billion to HP's top line in the current (fourth) quarter, and about $21 billion in the next fiscal year. 

At the bottom line, the EDS merger and the related charges will have a negative impact in the first year, before turning to black in fiscal year 2010, according to Lesjak (see above chart).  That's because the company expects to save about $1.8 billion per year as result of the cost cuts.

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Volume XXIII, Annex Bulletin 2008-17
August 19, 2008

Bob Djurdjevic, Editor
e-mail: annex@djurdjevic.com

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