After Hewlett-Packard Co. announced in 2001 its $25 billion bid to buy fellow computer maker Compaq Computer Corp., Sun Microsystems Inc. founder and then-CEO Scott McNealy likened the deal to "two garbage trucks colliding."
To hear some critics of HP's latest transformational move, Léo Apotheker, who has been at the wheel of the Palo Alto, Calif.-based technology giant for 10 months, is now driving the storied company off a cliff.
Apotheker surprised many last month when he announced the company was considering bidding adieu to its top market share, $40.7 billion PC business, unveiled a high-priced deal to acquire U.K. enterprise software maker Autonomy Corp. plc and moved to shutter several other consumer hardware businesses. HP quickly shut down sales of devices based on the webOS mobile-operating system, which was billed as the main reason for acquiring smartphone maker Palm Inc. last year for $1.2 billion. That move included canceling its TouchPad, HP's first tablet offering and a product billed as an attempt to make a run at Apple Inc.'s iPad, just two months after it hit store shelves. Retail outlets such as Best Buy slashed prices from $500 to $100 on the devices, which quickly sold out despite a lack of technical support and a very limited universe of software applications. HP also was crying uncle in the mobile phone market, leading one equity analyst to call HP's Palm purchase "a total loss."
The market's reaction to the bold new strategy? The day after the announcement, HP shares lost 20%.
"All these moves are signs of desperation at HP, and show a lack of insight," says Ashok Kumar, an analyst with Rodman & Renshaw LLC. "They are paying a peak multiple for Autonomy; they are exiting a major, important business in a haphazard way. The way you build credibility on the street is through measured moves, not surprise U-turns -- I think this reflects very badly on the board and management."
HP is now at a crossroads. In the past decade, the 72-year-old Silicon Valley company has gradually starved its once-vaunted research and development operations, with the percentage of revenue spent on that area declining from about 6% in 2001 to 2.3% last year. Instead, like many other tech companies, it has been looking outwardly for growth. In 2010, a tumultuous year that saw HP oust its cost-cutting CEO Mark Hurd, it struck about $7.8 billion worth of big-ticket acquisitions in the data storage, security, networking and mobile devices markets.
The big question: How will HP come out on the other end of this process? HP's answer is to exit the low-margin PC business and continue its push into higher-margin software and enterprise technology businesses. Apotheker, the former chief of German business software giant SAP AG who took HP's CEO role Nov. 1, argues that more revenue must be derived from higher-margin software. HP generates about 3% of its sales from this area, a mere sliver compared with the quarter of total revenue that rival IBM Corp. gets from software.
Some on Wall Street are tentatively agreeing with Apotheker, arguing that the disposal of the computer unit is a critical way to focus on higher-margin target markets.
"For too long, HP's PC business has been a distraction for investors and management, occupying an outsize proportion of focus while contributing only 13 percent of operating income," wrote Morningstar Inc. analyst Michael Holt. "As a PC assembler without any ability to differentiate its products, even the best execution would deliver minimal upside."
Yet turning around HP will be far more complicated than cutting out a low-margin business and adding a more attractive one, and many observers were concerned about the risks inherent in HP's plans. "Undertaking one of the most significant business transformations in a company's history is not an easy task," wrote Bank of America Merrill Lynch analyst Scott Craig on Aug. 19. "We view these as necessary steps for HP to move into high margin, high growth segments, but many moving parts in HP's transformation will likely raise execution risks."
Indeed, one mustn't forget the fact that in order to build its offerings to enterprises, HP struck a raft of big-ticket acquisitions last year, many of which are likely to still be wending their way through complicated integrations. HP closed its $2.7 billion acquisition of networking equipment maker 3Com Corp. in April 2010; its $2.3 billion purchase of data storage company 3Par Inc. was completed in September 2010; and its $1.5 billion purchase of network security provider ArcSight Inc. closed Oct. 22.
The Palm acquisition, which closed July 1 last year, obviously no longer counts on this list, since it has been all but scratched. The erasure of this deal, which was lauded at its announcement three months earlier as "transformational" and a "winning combination" by HP executives, is causing reverberations, both within HP and certainly in the larger marketplace.
The discontinuance of webOS marked another victory in the mobile market for Apple. After pledging to go after Apple's iPad just months before, HP is now crying uncle because it couldn't compete in a mobile market flooded with iPhones and iPads.
"Our webOS devices have not gained enough traction in the marketplace with consumers, and we see too long a ramp-up in the market share," Apotheker said during an Aug. 18 conference call originally scheduled to discuss HP's third-quarter results, in which the company lowered guidance for the third quarter in a row.
During the call, Apotheker used the same "transformational" description about the Autonomy deal used last year to describe the Palm transaction.
HP agreed to buy Autonomy for $10.2 billion, a hefty valuation of about 8 times estimated 2012 sales versus the industry norm for software deals of 3 times to 5 times sales. The target, which has joint headquarters in Cambridge, U.K., and San Francisco, develops enterprise search and content management software, a highly competitive segment dominated by the largest software companies in the world, including IBM, Oracle Corp. and storage technology vendor EMC Corp.
While the company has snared an attractive list of customers, including Coca-Cola Co., Nestlé SA and the Securities and Exchange Commission, it bears noting that Autonomy reported $256 million in revenue in its most recent quarter. Compare that with HP's PC unit, which reported quarterly revenue of $9.59 billion, a significant chunk of the company's overall third-quarter revenue of $31.2 billion. The disparity was not lost to some analysts on the call.
"I hear you when you say this is a potentially transformational move, but it's less than 1% of your revenues," Sanford C. Bernstein & Co. analyst Toni Sacconaghi commented to Apotheker regarding the Autonomy deal. "It's going to cost you more than 15% of your market cap."
HP probably was driven to disclose its strategic review because of a concern over leaks, as the company is likely to have already put out feelers about its PC business (some reports put HP in Asia shopping the business earlier this year). But the lack of a concrete plan for the PC business -- HP said it would take 12 to 18 months to decide whether to sell, spin out or keep the division -- could create problems with customers wondering about its future, leading some analysts to shave their estimates for the unit.
"There has been no concise and direct message about where they are going with this," says Gartner Inc. analyst Mark Margevicius. He argues that jettisoning the PC business risks destroying the cross-selling opportunities the business created for HP's servers, printers and services.
"You can't just jettison the PC business," Margevicius says. "It has tentacles in so many other important areas of HP's business."
HP's transformation plan marks not only the first test of Apotheker, but the first big move of its new board. HP in January replaced four longtime directors with five new board members, including former eBay Inc. chief Meg Whitman, Booz & Co. CEO Shumeet Banerji and former Alcatel-Lucent SA chief executive Patricia Russo.
The previous group of HP directors was roundly criticized last year for removing former chairman and CEO Hurd, who was pushed out in August following a sexual-harassment investigation and still got as much as $53 million in severance. The former board had also stumbled earlier when it hired private investigators to check out leaks to the media. This led to the dismissal of then-HP chairwoman Patricia Dunn. Many criticized the board's discipline when it outbid Dell Inc. in a high-priced bidding war for 3Par last year.
Rodman & Renshaw's Kumar, who is not shy about criticizing HP, had expressed hope that a new CEO and a new board makeup would present the company with the opportunity for a renewed discipline and a fresh start. Now he's not so sure.
"Knee-jerk reactions like this reflect poorly on HP's board and management," he says.
Not long after Kumar made those comments, the company said that it was changing its mind yet again. "Despite announcing an end to manufacturing webOS hardware, we have decided to produce one last run of TouchPads to meet unfulfilled demand."