Consumer Flops Force Hewlett-Packard Strategy Shift

The most definitive proof yet that mobile devices are driving personal computers to extinction surfaced last week when Hewlett-Packard Co. (NYSE: HPQ) announced it was throwing in the towel.

Tired of selling low-margin PCs, and with its tablet and smartphone offerings failing to catch on, H-P unveiled a massive change in its strategy - abandoning its consumer efforts to focus on software and services for businesses.

Hewlett-Packard's strategy shift involves three major changes:

  • The company plans to abandon mobile computing altogether. It will stop making its Touch Pad tablet, which debuted just two months ago, and the Pre smartphones it acquired when it purchased Palm Inc. last year for $1.2 billion. H-P said it may try to salvage the WebOS that runs its mobile devices, also acquired in the Palm deal, by licensing it to other vendors.
  • H-P will sell or spin off its PC division, which accounts for about a third of the company's revenue but less than a quarter of its profits.
  • H-P will buy Autonomy Corp. PLC (PINK ADR: AUTNY) for $11.7 billion. The U.K.-based company specializes in business software that can search data such as emails, music, video and social media posts.

Of course, while most analysts agreed with the reasoning behind H-P's decision, they were less than pleased with the suddenness of the move and the apparent confusion in the company's execution.

"What they're trying to do is change the oil in the car at 60 miles per hour," Needham analyst Richard Kugele told USA Today.

Investors expressed their displeasure by dumping H-P stock, and accelerating on Friday. HPQ lost almost a quarter of its value shortly after the announcements Thursday afternoon, falling to $23.60 from its Wednesday closing price of $31.39.

Mobile Meltdown

The decision by H-P to kiss off its mobile products was particularly startling given that the company had bought Palm just a little over a year ago, and that its executives were publicly promoting the company's mobile strategy throughout the spring.

H-P dreamed of taking on Apple Inc. (Nasdaq: AAPL), which has set the pace in mobile computing with its iPhone and iPad products.

"I hope one day people will say "this is as cool as H-P', not "as cool as Apple,'" CEO Leo Apotheker told BBC News in January. That was followed shortly thereafter by the Touch Pad and several new Pre smartphones.

But like other companies that have tried to beat Apple at its own game, H-P found it easier to promise than to deliver.

Sales of the Touch Pad were abysmal. Just before H-P reported earnings last week The Wall Street Journal revealed that of the 270,000 Touch Pads shipped to Best Buy Co., Inc. (NYSE: BBY) stores, less than 25,000 were sold.

"They were too late to the tablet market to make a dent," Forrester Research analyst Charles Golvin told the Associated Press. "They recognized they did not have a high probability of success."

Meanwhile, the Pre smartphones, running the WebOS, got lost in the competition between the iPhone and phones running Google Inc.'s (Nasdaq: GOOG) Android operating system. According to research firm Gartner, Inc. (NYSE: IT) the Pre's global market share was less than 1%.

In last week's earnings conference call, Apotheker said H-P decided it had better places to invest its capital than in its mobile devices, which were losing money. One analyst, Toni Sacconaghi of Sanford Bernstein, estimated the tablet business alone lost $250 million last quarter.

H-P will take a one-time $1 billion charge in its fourth quarter to shut down its mobile businesses.

PC Leader Surrenders

Perhaps even more surprising than H-P's about face on mobile was its decision to exit the PC business.

H-P's 17.6% PC market share is No. 1 in the world, a position it has held for most of the past decade following its $25 billion merger with Compaq Computer Corp. in 2002.

And again, Apotheker sent a different message earlier this year when he told the Wall Street Journal that H-P's consumer Personal Systems Group was "an immense competitive advantage."

Analysts surmise that H-P had grown weary of the slim margins that afflict all PC makers but Apple. H-P's margins on PCs in the most recent quarter were just 5.9%, compared to 11.7% for the company as a whole.

"This is clearly a financial decision on their part to abandon a business that wasn't generating nearly enough margins," Gartner analyst Mark Margevicius told Bloomberg News. "It's the boat anchor that's keeping things at bay."

Although shedding the low-margin PC business should help H-P, analysts worried that the company appears to have no plan to make it happen. Last week Apotheker said that the division would either be sold or spun off, which raised questions over who might buy it and how long any transition would take.

With the matter hanging in midair, nervous PC buyers may turn to competing products from Dell Inc. (Nasdaq: DELL) and Lenovo Group Limited (PINK ADR: LNVGY), effectively devaluing the division, which should fetch between $10 billion and $12 billion.

Another problem H-P would have is finding a buyer who can afford such a price. Only Lenovo and Samsung Electronics LTD (PINK:SSNLF) have pockets that deep.

"The sheer size of the Personal Systems Group means that it is unlikely the entire unit will be purchased by one company," Carter Lusher, an analyst with research firm Ovum, told Reuters.

H-P will probably end up spinning the division off under its current head, Todd Bradley.

"If they don't move the unit intact, they're going to lose value," Roger Kay, an analyst with Endpoint Technologies Associates, told MarketWatch. "If they lose the team, they've got nothing."

The Price is Not Right

The purchase of Autonomy Corp. will complete the Hewlett-Packard strategy shift to a software and services company.

The move mirrors what International Business Machines Corp. (NYSE: IBM) did seven years ago when it sold off its PC business to Lenovo to focus on services to its corporate customers.

H-P wants to graduate to businesses with higher profit margins. IBM's margins this year are expected to be 20%; Oracle Corporation's (Nasdaq: ORCL) 45%.

Autonomy's margins in the June quarter were 87%.

But again, analysts have concerns. Autonomy's revenue is a fraction of H-P's PC division, and the price H-P is paying - $11.7 billion - is on the high side.

"This functionality is coming at a steep price, in our view," Richard Kugele, an analyst for Needham & Co., told The Wall Street Journal. "Not to mention the damage done to the company's balance sheet flexibility to make acquisitions in the future."

Kugele cut his rating on H-P stock from buy to underperform.

Another analyst, Kulbinder Garcha of Credit Suisse Group AG (NYSE: CS), shaved his price target for H-P from $42 to $33, saying that the Autonomy deal is "the correct strategy" but the price is simply too high.

"Effectively, H-P is paying $11 billion for a business that will represent 1% of its revenue and 5% of its operating profit," Garcha told The Wall Street Journal.

Analysts looking beyond the clumsiness of the company's recent moves and the Autonomy deal's price tag, however, think the Hewlett-Packard strategy shift away from PCs and into business services will pay off eventually.

"Their DNA never included being a commodity consumer products manufacturer, which is what the PC has become," Michael Cusumano, a professor at theMassachusetts Institute of Technology'sSloan School of Management, told Bloomberg News. "It's certainly not where the action and innovation is in the business these days. They can reinvent themselves. They may have the capability to do it."

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About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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