HPQ - HPE = +25%

October 23, 2015 09:00 AM
HPQ - HPE = +25%

HPQ - HPE = +25%

In early October 2014, Hewlett-Packard Co. (HPQ) announced a plan to split into two distinct, publicly-traded companies. The company expects the spin-off to occur by Nov. 1, 2015. The transaction is expected to be tax-free to shareholders of HPQ. The spin-off, named Hewlett Packard Enterprise Company (HPE), is expected to trade on NYSE under. Hewlett-Packard provides products, technologies, software, solutions and services to individual consumers, small- and medium-sized businesses and large enterprises. 

HPE will consist of infrastructure, software and services businesses. The infrastructure business consists primarily of servers, storage arrays, networking equipHment and related services. HP Enterprise is the industry leader in x86 servers and maintains substantial market share in storage and switches. In fiscal year 2014, HP Enterprise generated net income of $1.6 billion from revenues of $55 billion. 

HP Inc. (post-split) will include printing and personal systems, and HP is the leader in both markets, but we believe that PCs and printers are under increasing competitive and secular pressures. HP Inc. is less capital-intensive than the Enterprise business and, given a negative cash conversion cycle, should look appealing from free cash flow and ROIC metrics. Plus portions of HP Inc. benefit from a relatively steady annuity like revenue model. Following the spin, HP Inc. will continue to trade on the NYSE under the symbol “HPQ.” We value the sum-of-the-parts for HPQ at $58.8 billion ($33) per share. HPQ’s stock is currently trading at $26.50 (Aug. 25), suggesting a 25% upside. 

We consider HPQ’s separation to be a catalyst that will transform HPQ’s position in consumer and enterprise markets. Beyond the obvious benefits of distinct management and financial flexibility that each business will enjoy, the separation could be HP’s ultimate opportunity to establish a stronghold in consumer and enterprise markets. Although HP has traditionally shown excellence in its products and services over time, shrinking margins and tough competition from low cost manufacturers have encroached HPQ’s market share in its Personal Systems business. 

Despite the associated mild dis-synergies, the separation leaves HPQ with leaner operations and a lighter balance sheet. On the other hand, HPE is set to focus on much needed industry demands like cloud and mobility transformation. 

Based on peer group median multiple of 8.2x FY16 EBITDA, HPE’s market capitalization is expected to be $41.9 billion or $23 per share of HPQ. Based on peer group median multiple of 4.6x FY16 EBITDA, we value HPQ Stub’s enterprise value at $19.3 billion (or about $10 per HPQ share).

About the Author

Joe Cornell is a chartered financial analyst, a finance MBA and the author of McGraw-Hill’s “Spin-Off To Pay-Off.” As the founder and publisher of Spin-Off Research (www.spinoffresearch.com) he is widely-regarded to be among the foremost experts in this specialized area. @spinoffresearch