By Charles King, Pund-IT, Inc. October 22, 2014
For well over a decade, bigger has been better in the IT industry. Large vendors have become ever larger by gobbling up companies of every size. Go-to-market strategies are revamped to account for broadening portfolios and new assets. Start-ups arrive with “Buy Me” tags affixed to their founders’ foreheads. People in every IT sector and sub-sector listened rapt to the Gospel of Consolidation and shouted, “Hallelujah!” But recent announcements and rumors suggest that once-overflowing revival tents may be stored away for future use.
First and foremost, Silicon Valley stalwart Hewlett-Packard (HP) surprised the market by announcing that it will separate into two discrete publicly traded companies. One, HP Enterprise, will be comprised of its server, storage, networking, converged systems, services, software and cloud platforms (led by current CEO Meg Whitman). The other, HP, Inc., will include its Printing and Personal Systems Group and will be led by its current president and GM, Dion Weisler. Current HP shareholders will own shares of both businesses.
Less than two weeks earlier, another Valley heavyweight – eBay – announced that it would spin off its PayPal division to better address challenges and pursue opportunities in the growing electronic payment market. Then last week, Symantec confirmed rumors that would divide its operations into two standalone companies. As the company’s recently appointed CEO Michael Brown explained, “It has become clear that winning in both security and information management requires distinct strategies.”
Is consolidation dead?
The size, longevity and reputations of these three companies make their organizational and strategic shifts noteworthy, but do they portend some larger trend about the viability of mergers and acquisitions (M&A)? Yes and no. Taking the latter point first, the fact is that M&A seems very much alive in IT for many or most of the same reasons it has been popular since the original dot.com boom.
In short, it tends to be cheaper to acquire viable or mature technologies than it is to develop them in-house. Plus, if a company is commercially successful with an established customer base, paying off the required investment proceeds quickly and often creates new “sell-in” opportunities (where the new parent leverages the acquisition’s client base for new marketing efforts). Finally, don’t forget potential “economies of scale” benefits related to reduced component and/or supply chain expenses.
As proof of these points, consider how just two IT vendors – Dell and Lenovo – have used M&A to evolve and enhance their individual businesses. Since Michael Dell’s return to the CEO position in 2007, the company (which had never been known as an active acquirer) made a score of purchases, including Perot Systems, EqualLogic, Compellent, Wyse and Quest Software, which provided the foundation to become an end-to-end system vendor. Lenovo pursued a similar course via two blockbuster deals with IBM; first for its PC division and, more recently, for the System x server group as well as strategic partnerships.
But at the same time, Dell and Lenovo are clearly different in both a business and organizational sense than HP, eBay or Symantec. Michael Dell, in fact, successfully completed one of the industry’s largest private buyouts just last year, returning the company he founded to private ownership. Though Lenovo is a major player in U.S. IT markets, the company is a multinational business with headquarters in China and North Carolina, and operations in 60 countries, selling into 160 different countries. As such, Lenovo is likely sensitive to a broader set of investor imperatives than U.S.- or Eurozone-based businesses.
Investor sentiment trumps innovation
The reason we raise this point is due to what appear to be the prime motivation behind the announcements from HP, eBay and Symantec – a need to appease institutional investors focused on short-term benefits instead of long-term performance. The apparent model of successfully dealing with this issue (particularly for HP) is IBM, which for over a decade has systematically exited lower margin, commodity-driven markets in favor of promoting higher value homegrown innovations, including its Power Systems and System z mainframe servers and Watson analytics solutions.
The desirability of this approach is especially stark when comparing the two companies’ financial performance during the most recent fiscal year (FY2013). While HP’s revenues were significantly higher than IBM’s ($112.25B to $99.75B), its net income during ($5.11B) was less than a third of IBM’s $16.48B. Similarly, HP’s $2.62 earnings per share (EPS) was overshadowed by IBM’s robust $15.06. Still more painful, IBM delivered far superior financial results than HP despite the fact that it spent nearly twice as much in R&D ($5.96B to $3.14B) on projects designed to fuel future innovations and profits).
It’s hardly surprising that shareholders of every stripe would prefer to see similar performance from HP but at what price? IBM’s strategy has been in the works for over a decade, and was determinedly pursued despite the heat and controversy the company faced along the way. Anyone doubting this should look up the headlines and analysts’ comments concerning the sale of the PC division to Lenovo. Ceding to the whims of shareholders, particularly those focused on short term gains, is usually a dangerous game.
Final analysis
The situations at Symantec and eBay are considerably different than at HP. While the former’s 2004 purchase of Veritas for $13.4B in stock may have made strategic sense at the time, the company never effectively integrated its security and storage/information management assets (as, say, EMC did with RSA in its federated model). So at this point, it’s wiser to separate the businesses entirely.
Keeping PayPal close was initially and entirely sensible for eBay and helped the company become the dominant player in online auctions. But with that market looking as if it has reached its peak, and a slew of competing electronic/online payment players and solutions (including the new Apple Pay system) ready to rumble, the smart money says PayPal will be more competitive as a standalone business with experienced management attuned to its markets.
Whether or not HP can and will successfully negotiate the separation should be closely watched. If customers and partners, especially those focused on personal systems and printers, are not properly served, numerous competitors, including Dell and Lenovo will be ready and waiting to pick up the slack. Consider also HP shareholders who will soon discover whether holding stock in two companies – one more strongly profitable than the other – is better than ownership in one.
So do HP’s plans and those at Symantec and eBay signal that over a decade of IT industry consolidation is on the wane? We don’t believe so, though they will likely be cited as a litmus for other breakups being proposed or considered by activist shareholders and management. But the fact is that in some companies, poorly executed acquisitions have certainly resulted in organizations that are increasingly unmanageable. But others, like Dell, IBM and Lenovo, have used and continue to use M&A activities to grow effective, successful businesses more quickly than they otherwise might have.
Just as growth for the sake of growth is no sure path to success, dividing poorly structured or hard to manage businesses does not guarantee surer manageability. Rather than representing a bellwether, the restructurings under way at HP, Symantec and eBay simply represent shifts in organizational form that the companies’ leadership believe are most appropriate for their assets, ambitions, employees and customers.
The eventual outcomes are obviously important to the companies involved, but their success should not be mistaken as proof that similar efforts are workable, let alone desirable for other businesses.
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