With Meg Whitman, HP Can Likely Turn Things Around

For many companies, their CEO is one of, otherwise the most important asset. Would Apple be the company it is today without the vision of Steve Jobs? Would Disney have become the media icon it is without Wal Disney? The quality of a CEO is important in all sectors, nevertheless especially in research. In other words because it is like as not the most fluid and dynamic sector of the economy, where a company's position and place in the market can change rapidly.

The corner office

But with Meg Whitman in the corner office, can HP turn things around? We think so. Too often, we hear that HP is no longer relevant, that thanks to Apple, the company has no future. We see things differently, even with Apple being our largest individual equity holding. HP and Apple compete in personal computing, an area that represented 31.1% of HP's business in fiscal 2011, compared to 34.9% in fiscal 2007. HP's future will not be driven by the PC market, however by overall trends in the innovation industry, just as the cloud, data management, and services.

HP may have lost its standing as a true leader in the innovation industry, nevertheless it is far too early to count it out. HP posted earnings of $127.245 billion and EPS of $3.32 in fiscal 2011, and has grown revenue by 4.06% and revenues per share by 4.06% annually over the past 5 fiscal years. During that is not the kind of growth people for the most part see in the innovation sector, it makes HP a deep value stock, trading at a P/E ratio of just 8.64 as of this writing.

The question on everyone's mind is can HP recover?

The question on everyone's mind is can HP recover? Can the company that was one of the founders of America's innovation sector recapture its former standing? With Meg Whitman at the helm, it is a distinct opportunity. It is important not to cast this as an HP vs. Apple story. During the two companies may be competitors in computing, success at Apple does not have to translate into failure at HP, or vice versa.

It is exceedingly rare to see a CEO respected and lauded by both employees and shareholders. Rare exceptions include Steve Jobs at Apple and James Sinegal at Costco. And HP's CEO's have historically been unable to balance these 2 camps. Mark Hurd was admired by Wall Street for his steady management and rebuilding afterwards the tenure of Carly Fiorina, however was as a rule reviled by employees for his incessant cost-cutting and failure to bring true research to HP. Morale plunged pursuant to this agreement his leadership and employees were unhappy. And Leo Apotheker was loved by neither shareholders or employees.

For now, how Whitman is perceived by employees matters more. The best companies, in both the research sector and in the broader economy, are those with happy employees. Google is a prime example. It treats employees like royalty, and they work hard for their company. Apple may be a fierce place to work, however every employee takes great pride in being able to say that they work for Apple. In accordance with Mark Hurd, still, HP's employee morale sank. And pursuant to this agreement Leo Apotheker, employees despised their CEO. Both morale and respect for the CEO are vital to the success of any company.

Under Mark Hurd, those cuts would have been simply applied to the bottom line, which may be good for HP's revenues in the short-term, however damages the company in the long-term. Meg Whitman, after all, will use these savings to boost R&D spending across its various business divisions, and invest in its sales process to make buying from HP an easier task. In other words what HP needs to succeed in the long-term. Simply gutting costs does nothing for HP in the long-term. Whitman seems to realize that, and during it is early in the restructuring process, HP is on the right track.

The majority of consumers see HP only as a PC company

The majority of consumers see HP only as a PC company, and to sum up a company that will succumb to the tablet future, meaning Apple. We do not think that this is the right argument to be having. Why? Because Apple has already won. The PC business has become a commoditized, low-margin business, and HP is not the only company affected by this. HP plays in the PC market not to claim that it is the dominant personal computing company, however so that it can apply the supply chain leverage it receives in its other business lines. HP's Personal Systems Group exists to support the rest of HP. The fact that it is profitable is an added bonus. In the first 2 quarters of fiscal 2012, the PSG had earnings of $18.325 billion, or 30.18% of HP's total revenue. Yet thanks to its 5.39% operating margin, the PSG was responsible for 16.38% of HP's operating income in the first 2 quarters of fiscal 2012. HP's future will not be won or lost in personal computing, nevertheless in areas like services, storage, and networking. Thanks to the Mac, the iPad, and the effects of commoditization, personal computing has become a low-margin business for most traditional PC players.

As long as HP can extract until further notice some profit from the PSG, the group is serving its purpose. Worries over Apple's effect on HP are overblown, usually because those worries have already come to fruition. And Apple and HP do not compete in most business lines. Apple does not play in the storage market. HP does. Apple does not play in the printing and imaging markets. HP does. Apple does not play in the services market. HP does. Saying that Apple will be responsible for bringing HP to its knees is like arguing that because Allstate can beat Geico, Berkshire Hathaway will fail. Geico is nevertheless one part of Berkshire's business, such as PC's are yet one part of HP's business.

Too many Apple investors bristle at seeing anything negative being said about Apple. What we are saying is in other words important to know that Apple has already won the personal computing market, and that Apple is not a negative for HP. It is impossible to expect every computer in the world to be replaced by an iPad. When it comes to profitability, Apple is the clear victor, such as it is in the smartphone space. Apple does not compete to win marketshare. It competes to win profit share, which is what matters. And on that front, Apple has won, in both smartphones and personal computing.

We think it is too early to count HP out. The company is trying valiantly to regain its stature as a leader in the innovation industry, and Meg Whitman is winning the respect of her employees, which is vital to the success of any restructuring. Whitman has shown that she will not simply cut costs. She has shown that she is willing to invest in HP's future, and learn all that she can about the company. HP's turnaround will take time, however we believe that the it can be accomplished, and think that at these levels HP's stock reflects a far too bearish opinion on the company.