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Sunday, December 05, 2004

HP -To Be Broken Down??

Recently we covered Part 1, and Part II of Carly's defiant defence through her interview in Wall Street Journal about HP's travails.We also recently covered David Kirkpartricks view that Turmoil In Tech Industry besides covering IBM's reported move to sell its PC line of Business. Businessweek writes about call to break HP's business units to unlock the value in its business. Excerpts with some edits and added comments:

It has been more than five years since Carleton S. Fiorina hit town with bold plans to reinvent HP, and she's still struggling to put the company on the right track. She has zealously pursued a bigger-is-better strategy, with hopes of creating a technology world-beater. Thanks largely to its $19 billion acquisition of Compaq Computer in 2002, HP has doubled its sales in the past five years and become a competitor in an unrivaled number of markets, from $100 digital cameras to billion-dollar tech-services deals. Yet in too many of the businesses, HP is losing steam. Sure, its one champion, the $24 billion printing division, gushes profits. But look beyond that crown jewel, and the rest of HP is an underachiever. In personal computers, it's no match for Dell. And HP is too often outgunned by IBM in the global markets for corporate computing. Worse, Fiorina's team faces steep operational challenges as it tries to come to grips with HP's huge stable of businesses. It's not clear HP has gotten the synergies they expected from the other businesses." And many opine that HP should gobble up software and tech-services companies to better compete against IBM. The risk? If the company adds to its portfolio without first tackling the operational issues, the already daunting complexity could multiply. "

Louder Drumbeat : The drumbeat on Wall Street is growing for a far simpler solution: break the company up. The CEO staunchly resists the idea. The breakup options could certainly appeal to beleaguered investors. One of the most vocal proponents of a sell-off, analyst Steven Milunovich of Merrill Lynch & Co. calculates that the total value of HP's businesses could increase by 25% to 45% if it were split into printing and nonprinting operations. The idea is that the printing business, which would probably retain the HP name, could expand its market and partner with HP's computing rivals, including IBM and Dell -- once it was unhitched from the computer company. And managers of the computing company, with its divisions in software, PCs, servers, and tech services, would have to beaver away madly to make profits. No longer subsidized by the printer division, they would have no choice but to perform. Merrill calculates that the spin-off would create $15 billion to $27 billion in incremental value. For now, Fiorina continues to bank on bulk. She contends that HP's breadth pays off in added sales and lower costs. Consumers and corporations, for example, often shop for both printers and computers at the same time. So selling one fuels sales of the other. And HP does reap cost savings from its scale. After the Compaq merger, the company wrung $3.5 billion in annual expenses out of its operations, in part by squeezing components suppliers for lower prices.

Broad Reach: "We think we have a unique opportunity," Fiorina said during a speech in August, "because we have leadership positions and intellectual property at every stage of the value chain."Indeed, rather than break apart HP's existing businesses, Fiorina may look to beef them up. Even as she accelerates the cost-cutting measures, including new layoffs, another substantial acquisition remains a possibility, particularly in software or services. A potential target, say analysts, could be Capgemini's U.S. operations, which the struggling French consultancy is said to be shopping around. Capgemini, however, denies its U.S. operations are for sale. Pulling all of this off could be as critical to Fiorina as it is to HP.

Unwieldy System : Still, HP suffers from poor positioning. In its PC business, HP runs two systems that often operate at odds with each other. One is a direct-sales, build-to-order model to compete with Dell, which carries virtually no inventory. The other is HP's traditional, higher-inventory model for units that it ships through its sales partners. Operating in both worlds leaves HP doubly exposed. It fails to match Dell's scale and efficiency in the direct system. Yet if the company pushes more business into direct sales, it risks angering thousands of HP's traditional retailers and resellers. And HP needs their help to sell its printers and ink. A break-up would help to resolve this dilemma, freeing the computer division to adopt the Dell approach. HP also appears overmatched in its scrum with IBM. Led by CEO Samuel J. Palmisano, Big Blue has put together a more lucrative array of corporate computing products. They span everything from software to servers to chips, and they generate overall 11% operating margins. By comparison, HP's non-printing businesses managed operating margins of 3% in 2004. The disparity is especially clear in the profit-rich software business. In IBM's third quarter, ended in September, its software biz generated $3.6 billion and operating margins of 25%. HP, by contrast, notched $277 million in software sales for its fourth-quarter, ended in October, posting a small operating loss.

Other customers have even more serious complaints. For instance, HP has developed customized Web sites for customers where they can place and manage orders. However, these sites, dubbed B2B (for business-to-business) by the company, have frequently cratered -- erasing accounts, losing orders, and shipping the wrong products, according to former sales managers, customers, and internal sales memorandums .If Fiorina continues to struggle, pressure is sure to mount for her to spin off the printing and imaging division. The unit, spearheaded by Executive Vice-President Vyomesh Joshi, spans everything from printers and ink to digital cameras. It boosted its sales by 7% in 2004, to $24.2 billion. And it's a cash geyser, providing 76% of HP's operating profits, derived from just 30% of total sales. Investors clearly love it. Analysts speculate that freedom from broad corporate management could goose the printer group's performance. And they argue that separating from the printing division could protect HP from its most dangerous long-term threat in the printing business, Dell.

Despite the execution woes, Fiorina is open to acquisitions. Her best bet for boosting enterprise profits is in software. She has $13 billion in cash . HP's services division also needs a lift. With $14 billion in revenues, this group helps corporate customers manage and stitch together new information systems. Yet HP struggles in services against IBM, whose service division is three times bigger. While more than 60% of HP's services business comes from low-end, slow-growing customer support and maintenance, IBM boasts richer contracts. Some 70% of Big Blue's service revenues come from business consulting and strategic outsourcing, the kinds of high-margin deals that put IBM consultants into the corner office. No single acquisition will put HP on an equal footing with Big Blue. A purchase of Capgemini's U.S. operations, valued at about $1 billion, would give Fiorina more of a chance to compete with IBM in this arena. As Fiorina completes a half-decade atop HP, the excitement of the early years has faded. The charismatic and determined CEO who set out to build a titan has now assumed a defensive posture and is working to keep her creation in one piece. For success, she must tackle HP's stubborn operational glitches. This will require every ounce of her guile, passion, and boldness. But at this point, her choices are stark: The only way to defend the sprawling HP she has built is to fix it. Until she does, the calls for the breakup of a Silicon Valley icon will only grow louder.
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