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HP Must Provide A Clear Long-term Business Model: Barclays

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Hewlett-Packard Company (NYSE:HPQ), will be holding its next Analyst Day, an occasion traditionally used to issue guidance for the following financial year. However, Barclays Equity research analysts believe that this time around, the CEO, Meg Whitman, should go beyond this point, and explain to the audience what HP really is. Most importantly, the analysts expect Whitman to explain why HP is involved in so many businesses, some of which, face significant secular and structural challenges.

HP Must Provide A Clear Long-term Business Model: Barclays

Former CEO, Mark Hurd, used to tell the analysts attending the forum that Hewlett-Packard Company (NYSE:HPQ), was well positioned in converged infrastructure. However, analysts feel that this strategy needs to be streamlined. Additionally, the analysts would like to see Whitman address the question of accountability, as well as her relationship with the board.

The other issue that Meg Whitman needs to address in detail, is cash flow; this is because HP has been experiencing a big challenge in free cash flows for several years. Currently, the PC maker is in dire need of improving its balance sheet; it needs to look into its debt, and try to reduce it significantly.

The company has seen a material decline in its PC and printing business, and this has been eating on its free cash flows, as restructuring costs continue to sore. The company’s cash flows have been pressed below non-GAAP EPS, which Barclays analysts believe, is not a good measure for HP’s free cash flows per share, at the moment.

HP has been deluded to believe that earnings will resolve its free cash flow issues; on the contrary, the PC industry is likely to drag on further, as featured in some of our articles. Additionally, the PC industry also faces a stiff challenge from smartphone makers who seem to have developed a winning alternative to PCs, in the form of tablets. Technological advancements and the evolving human behaviour have slashed a huge chunk of business from the PC market, as mobility conveniently continues to define the future.

HP’s FQ2 is a good exhibit on how the PC maker has been scoring in the charts of free cash flows. The company reported $2.8 in operating cash flows, or $1.00 per share, as compared to non-GAAP EPS $1.00. Nonetheless, this was just one of those topsy-turvy levels of cash generated in recent quarters. The company’s trailing twelve months has free cash flows of $2.36 per share, as compared to a non-GAAP EPS of about $4.07.

Barclays Equity Research analysts share the opinion that restructuring will definitely boost non-GAAP EPS, but not free cash flows. The company has laid down a restructuring plan that would save it approximately $3.7 billion by the end of 2014. This suggests more near short term savings for the company, but analysts believe that a majority of it will be wiped out by the cash needed to finance the plan in its initial stages. The plan includes about 29,000 layoffs, and a majority of them will be as a result of early retirement, which calls for some significant expenditure, in the form of take-home packages, among other benefits.

The Equity Research analysts have outlined four segments of HPs’ business that need to be addressed in the next Analyst day forum.

The trajectory of free cash flow and plans for debt reduction

HP is currently sitting on a massive $20 billion net debt, half of which, is net debt from financing activities. The company needs to explain clearly to investors how it intends to face out this debt to good leverage levels, and how soon. Additionally, HP will need to clearly, illustrate the impact of reducing the debt on the company’s capital structure.

Furthermore, the investors will be expecting Whitman to explain to them how the reduction is going to impact on dividends and capital allocation in terms of repurchases and acquisitions. Finally, HP will need to guarantee the security of cash flows being generated, as its printing and PCs units continue to face challenges.

How HP can stabilize the PC and printing businesses

The investors will be looking to know the long-term outlook of the unit, as well as whether channel inventory supplies are in for another cut. The unit accounts for 20% of HP’s revenues, and has experienced several quarters of very volatile performance and bloated channel supplies, against depleted demand this year. Analysts believe that a major cause for this decline in demand has been competition from smartphones, which have rendered Inkjet printers old-school.

The PCs are suffering the wrath of the new age of tablets. The infamous “dotcom” slogan is becoming an outdated stone-age-like era, as mobile replaces stationary, in the computing world.

Plans to reposition Enterprise Servers, Storage and Networking (ESSN) to achieve faster growth

This bit accounts for 17% of its revenues, and the company is facing a one billion question, of convincing investors that its x86 servers carry a bright future in terms of growth. The investors will be very keen to know what HP is planning to do to improve an area where it commands the largest market share, following recent declines. It faces a stiff challenge from the cloud based servers that seem to be becoming popular in the market, and once again, technological evolution is taking a toll on its major business unit.

Cloud players are using ODM partners, like Quanta, to make their own servers, thereby ditching products from HP, IBM, and Dell. This year, HP’s market share, has declined to 34.5%, from 35.9% last year, following the influx of the new types of servers in the industry.

Initiatives to revitalize and stabilize Services margins.

The PC maker has been facing strong headwinds in improving its service business. The company’s IT services contribute 29% of its revenue, which is nearly a third. Considering the challenges it has been facing, the high investment in this business unit has been dragging HP’s margins, and analysts feel that the unit has no future in its business model. Actually, the PC is already planning to exit this business unit, and focus on more profitable investments, noted Barclays Equity research analysts.

Finally, the company has also been involved in the software industry, and this segment accounts for about 3% of its revenue. The investors will need to know what its strategy is, as this industry is already dominated by industry giants Microsoft Corpoartion (NASDAQ:MSFT), Apple Inc. (NASDAQ:AAPL), Intel Corporation (NASDAQ:INTC), and Oracle Corporation (NASDAQ:ORCL). Google Inc. (NASDAQ:GOOG) has also joined the furor, as well as other up and coming, small, innovative companies.

At the time of this writing, Hewlett-Packard Company (NYSE:HPQ) was trading at $17.09 per share, down $0.13, or 0.77%, from yesterday’s close.

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