By Charles King, Pund-IT, Inc. May 25, 2016
Hewlett-Packard Enterprise (HPE) president and CEO Meg Whitman shook up financial markets by announcing the company will execute a tax-free “spin-merger” to combine its Enterprise Services business with Computer Sciences Corporation (CSC). HPE shareholders will own about 50% of the new combined company that HPE said is expected to have annual revenues of approximately $26B and serve 5,000+ customers in 70 countries and every global region.
HPE said the transaction is expected to deliver about $8.5B to shareholders on an after-tax basis, including over $4.5B of shares in the new company, a cash dividend of $1.5B and the assumption of $2.5B of HPE debt and other liabilities. The deal is also expected to produce cost synergies of approximately $1B post-close, with a run rate of $1.5B at the end of the first year. HPE said shareholders will gain from those synergies, as well as future earnings growth.
One-time costs for the deal will be offset by lower costs associated with HPE’s FY 2015 restructuring plan. The deal is expected to close in March of 2017.
For analysts of a certain age, Hewlett Packard embodies Silicon Valley soap opera at its finest. This latest twist in the company’s tale actually began in 1999 when HP’s board voted to replace CEO Louis Platt with an outsider who had no experience as a CEO, Carly Fiorina, rather than the internally-favored candidate, Ann Livermore. Fiorina couldn’t have been more different than Platt who exemplified “The HP Way” – a management philosophy based on mutual respect between managers and employees, and collegial problem solving.
Instead, Fiorina favored a conventional top-down management approach and business strategies emphasizing large-scale deals. That included controversial acquisitions, like the failed proposal to buy the technology services arm of PricewaterhouseCoopers (PwC) for $14B. But Fiorina succeeded with the even larger purchase of Compaq for $25B in stock, an agreement that still tops many lists of worst-ever tech industry deals.
Many consider the primary aim of that deal to be HP’s desire to maintain its position as the market’s largest PC vendor, fending off Dell’s surging success. But Compaq also included considerable data center solution assets, including market leading midrange storage systems, UNIX-based AlphaServers (which many believed were superior to HP’s homegrown PA-RISC-based servers) and enterprise-class Tandem Non-Stop solutions, which were often compared to IBM’s mainframe systems.
In other words, Compaq offered HP the assets it needed to position itself as an enterprise class vendor and to stake claims that it was the equal of or superior to IBM in every way. In the years following the Compaq deal, HP and the CEOs who followed Fiorina after her unceremonious 2005 ousting continued to pursue often massive deals in that same vein. Those included the $13.9B acquisition of technology services giant (with 139,000 employees) EDS led by then-CEO Mark Hurd in 2008.
That made strategic sense given the success IBM had enjoyed from its own business and technology services units which together contributed over half of the company’s annual revenues. But EDS was a poor fit for HP culturally, and its workers faced brutal rounds of layoffs after the deal closed. In the end, the acquisition never delivered the hoped for goods. By the time Hurd was fired in 2010, it seemed clear that HP would likely remain a relatively minor player in the enterprise services IT market.
The deal to “spin-merge” the group into CSC underscores that point but also highlights current HPE CEO Meg Whitman’s attempts to capture for her company’s shareholders the dynamic benefits that Ginny Rometty and her predecessor Sam Palmisano have for IBM. Both of them executed controversial divestitures of business units where the company held market or technical leadership positions, including PCs, hard disk drives, enterprise printers and Intel-based servers.
The shorthand justification for these deals is that IBM simply does not wish to participate in “commodity” markets. But a closer examination would note the substantial “drag” that commodity products and services place on the company’s aggressive margins/earnings goals.
The results of this overarching strategy have been impressive, with IBM reporting $13.60 in annual diluted EPS (earnings per share, excluding extraordinary items) for 2015. Though that figure is almost $2.00 lower than the diluted EPS IBM reported for 2013 and 2014, it’s more than 10X more than the $1.34 in 2015 diluted EPS that HPE reported.
HPE’s own earnings have strengthened considerably since it spun out its PC and printer business (into HPQ), and the CSC announcement also noted a $0.10 bump up in its 2016 GAAP diluted net EPS outlook. That still leaves the company far behind IBM’s earnings performance but investors liked the move and gave HPE shares a substantial upward push following the CSC news.
The larger question, of course, is where the CSC deal will leave HPE after it closes. The $33B in annual revenues that a “’standalone” HPE is expected to earn is considerably less than a third of the $120B+ in revenues the fully united Hewlett Packard delivered in 2012. HPE will argue that its obviously close ties to HPQ and ownership stake in CSC will allow it to collaborate with those companies according to the needs of customers.
If this succeeds, shareholders who have stakes in all three entities will also profit. But whether the companies together can deliver value and economies of scale similar to competitors remains to be seen. At this point, Dell and Lenovo are delivering Intel-based systems comparable to anything offered by HPE. Plus, both are pursuing desktop-to-data center strategies where integration is baked into the entire solution development/delivery process.
HPE’s pursuit of higher earnings has obvious parallels to IBM but this new deal sees it moving in a direction few of its peers would likely consider. If nothing else, the company’s continuing self-reinvention will serve as a very public experiment in the value and validity of go-to-market strategies that the IT industry has long held dear. But whether HPE has found a path forward that adequately or fully replaces The HP Way it lost long ago remains to be seen.
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