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HP: A monolith cut down to a value-size stock price

HP has given investors plenty to worry about in recent weeks, from a couple of expensive acquisitions to a left-field pick to replace fired chief executive officer Mark Hurd.

The resulting angst has served to drive down the shares into value territory. And that sets up investors for a nifty short-term gain even if HP never again trades like a darling of the tech industry.

The turmoil at HP began in August when the board dismissed Mr. Hurd for violations of the company's code of conduct without naming an in-house candidate as successor. Shortly afterward, the company conducted an expensive bidding war with Dell Inc. for 3Par Inc., winning the data storage firm for a hefty price equivalent to 180 times 3Par's earnings.

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HP followed with another expensive acquisition, this time of ArcSight, a company that produces computer security software, before surprising the markets late last month by appointing Léo Apotheker, former CEO of the German software company SAP AG, as its new chief.

The hiring of the multilingual software veteran, who served as CEO of SAP for barely two years before being excused a few months ago, failed an apparent all-star test. CNBC personality Jim Cramer, who influences markets despite his periodic buffoonery, likened Mr. Apotheker to a double-A-level minor-league baseball player - someone, not one, but two steps away from the majors.

The result of the negativity is a stock that has "the dubious distinction of possessing one of the lowest valuations of any major technology company," says Gleacher & Co. analyst Brian Marshall. At around $43 (U.S.) a share, HP trades for just eight times estimated 2011 earnings, Mr. Marshall estimates. He has a "buy" rating and a $50 target price on the stock.

While the CEO shuffle and expensive acquisitions have dimmed investor enthusiasm, HP's biggest challenge may be its sheer size. Most acquisitions barely register on a company of its scale. Significant growth is hard to come by.

With $123-billion in revenue in the past 12 months, HP posts more sales to its top line than Microsoft and Dell combined. Several pieces of HP would each make a fair-sized public company on their own. Its personal computer business, for instance, racked up $40-billion in sales in the past 12 months, while its printer business posted $25-billion. Its enterprise services business, which consults on large-scale corporate computer systems, added another $35-billion.

Given the company's size, HP's acquisition binge looks far more modest than initial impressions might suggest. While the deals to buy 3Par and ArcSight were unquestionably pricey, their combined $3.8-billion purchase price represents just three months of cash flow for HP, notes analyst Ben A. Reitzes of Barclays Capital.

And each of the acquired companies helps HP in areas it needs to grow in. Like other tech giants with a significant business clientele, HP is focused on being a one-stop destination for large companies in need of integrated hardware and software systems, plus all the services to make them work. IBM, Oracle and EMC are each vying for a piece of the same pie.

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While HP is among the top three firms in services, it lags in storage and servers (14 per cent of revenue) and software (under 3 per cent of revenue). Margins and profits in those areas easily exceed those in HP's consumer-oriented businesses of printers and personal computers.

Success in high-margin corporate markets would boost HP's bottom line, but it will take a lot to move the needle given the company's size. Some analysts fear a spate of pricey acquisitions similar to the last two will drag down HP's profits. Others simply think HP can't keep pace.

The analyst team at UBS, which has a neutral rating and a $44 target price on HP, notes that the S&P 500 trades at 12 times earnings, but expects the aggregate earnings of the index to grow at 15 per cent. Since the UBS team pegs HP's growth rate at a lacklustre 7.4 per cent, they think investors should pay no more than nine times earnings.

Even Gleacher's Mr. Marshall acknowledges the concern. "Due to absolute size, limited growth potential and a dependence on commoditized hardware offerings, we believe HP deserves to trade at a discount to the S&P 500 and its peers." However, he believes an appropriate price-to-earnings multiple is 10, which would suggest that HP is a $50 stock. For investors looking for a short-term gain, HP is more attractive than the recent negativity would suggest.

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More

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