Goodhaven fund Q2 shareholder letter. Below is an excerpt on Jim Chanos and Hewlett-Packard Company (NYSE:HPQ) followed by the full letter embedded in scribd.
Late last year, a well-known short-seller (for whom we have much respect) called Hewlett-Packard Company (NYSE:HPQ) “the ultimate value trap” based on an assessment that personal computers, servers, and printers were in rapid and permanent decline. We disagreed and to date have been rewarded for our contrary view. Although Hewlett Packard is a large business facing significant challenges, it also has employee talent, long-standing business relationships, and financial levers that it has used to maintain its large free cash flows despite declining sales. HP’s stock price has appreciated meaningfully from the lows of late last year.
When reviewing securities for purchase, we always try to carefully examine the negative cases of other investors when owning a security. In the case of HP, some felt that R&D was disastrously low. Others felt that the PC business was permanently impaired and headed to zero and that inkjet printing was in the midst of a huge decline.
Upon careful research, the business changes that have occurred are real, but not as extreme as many feared. In particular, HP spends more on research than most think, given that much of personal computer R&D is performed by chip-makers and device manufacturers while HP is mostly responsible for design and marketing. The widespread adoption of mobile devices has undoubtedly extended the replacement cycle for desktop computers and reduced but not eliminated demand for that segment while consumer printing demand has been reduced by Internet based photo sharing, although commercial demand remains reasonably strong. Furthermore, in some large segments, overall revenue has continued to shrink – always a tough hurdle to overcome. However, despite these transitions, HP has core critical businesss trengths on which many large companies(and governments) depend.