Wednesday, August 11, 2010

Steer Clear of HP Until Next CEO

By Eric Jackson, Senior Contributor08/11/10 - 05:11 AM EDT

With Mark Hurd out as the CEO of Hewlett-Packard(HPQ), many are trying to argue that the stock is a great long play here trading at $42. I think you're better off steering clear of it for now until there's greater certainty about what's going to happen with the next CEO.

In the aftermath of the surprising departure of Hurd on Friday, and the 8% drop in the stock on Monday, some HP bulls have been stating that now's the time to get a position in the stock. Their argument goes as follows:
  • HP is a great franchise with many solid businesses. It's bigger than Mark Hurd.
  • It's cheap. It trades at 8 times current year's earnings and 9 times next year's.
  • Since the stock has really performed well in the last few years, you can continue to rely on it being a steady performer in the years to come.

I agree that HP has a good set of businesses that are market-leading. There are several scenarios I could envision in which it will hire a great new CEO who is able to ramp up this company and its stock price in the coming years. We could well look back on this moment in time and say it was a great time to enter the stock.

However, there are way too many question marks and risks hanging over the company at the moment to jump into a long position. The risk/reward -- as of today -- still strikes me as unattractive to get long the stock. If they make a bad hire as CEO, the stock could be an attractive short opportunity.

So, here are the reasons for not touching HP at the moment:

  • HP has solid positions in its markets today, but many of those markets (like PCs, printers, and technology services) could well see a drop in business in the next few years if they're managed poorly.

    Now that Hurd is out of HP, the HP bulls are saying the company is bigger than Hurd. Yet, when Hurd was around, they only wanted to talk about HP as if he was the only employee at the company. Hurd is all about execution, we used to hear them say. So, if Hurd is now gone, how will HP execute?

    Companies are more than their leaders but they model themselves to their leaders and they drift with no leaders. We're in a drift-zone until a new CEO is announced and that took seven weeks after Carly was sacked.

  • The stock may be cheap relative to others but what is most important for any new investor in the stock is that question about whether it is cheap today relative to where the stock will be a year or two from now. If HP bungles this transition and squanders its lead in several of its businesses, the stock could easily drop another 20%.
  • HP's stock actually hasn't performed well recently. Investors only think it's performed well because of the Mark Hurd "halo effect" that's gone on -- think of it like a "Vulcan mind trick."

    As I said in my article on Saturday, HP's stock went up 137% in the first 2.5 years of Hurd's tenure but dropped 20% in the last 2.5 years. Over the same most recent 2.5 years, IBM's (IBM) stock went up 20%. If you think you can always rely on HP to deliver stock growth, you're wrong.

But let me emphasize the top three reasons for not owning HP at the moment:

  • We have no clue who the next CEO will be. I'm pretty sure Todd Bradley will be the top internal candidate, although Ann Livermore will get consideration. I'm sure they'll also look at some outside candidates, too. My guess is that they'll pick Bradley as a safe choice but I'm not convinced he'll be a savior for the stock. They could hire another Carly -- heaven forbid. Do you want to put your wealth (in the form of HP stock) in the hands of this board to do the right thing?
  • When you cheat on the small stuff, you tend to cheat on the big stuff. Although some Hurd apologists and friends say that HP is making up the whole expense-gate issue to avoid the bad press associated with a sexual harassment, the fact is that he reported charging $243,000 in personal meals to HP shareholders in 2008 and then had the temerity to demand that he be grossed up another $75,000 so that he wouldn't owe any taxes to the IRS on that benefit.

    The current expenses allegations that the board used to unanimously ask him to resign are entirely consistent with those reported facts. What it tells me is that this is a guy who has entitlement issues: $43 million in total comp in 2008 wasn't enough for him. He also needed every last penny of expenses covered for him -- even when they were for personal expenses.

    I've tended to find that people who fib about the small stuff tend to fib about the big stuff -- like all the micro (and legal) decisions that go into managing the numbers every quarter. We might have a few more dead bodies which will soon wash ashore from the EDS, 3Com and Palm acquisitions.

    I smell one-time charges coming from excessive earnings management that might have gone on over the past three years. Usually, when a new CEO comes in, once they get a sense of the books and how the past regime has run those books, they like to put everything into the kitchen sink so they can free themselves from the burdens of how they've done things in the past.

  • Who's going to finish the job integrating the EDS, 3Com, and Palm acquisitions? The master integration-and-execution guy is gone. We're going to see if the rest of the team is up to the task. These are all big and complex companies. It will take real work to integrate them successfully and the Palm group might never be able to deliver new products to captivate the market's tastes.

    Is this the new stream-lined HP or the old bureaucratic HP that's never really changed since Carly? I think it's likely there will be more charges ahead.

The HP bulls like to point out that the company raised full-year guidance when it announced Hurd was leaving on Friday. I'm surprised it also didn't announce that it was doing a stock buyback. This upped guidance doesn't do anything to change my view at all. HP's been sandbagging - precisely so it could up the guidance when it needed to (as it did in reaction to this scandal).

In my view, this stock won't trade on rest-of-the-year guidance but as for what its earnings will be in 2011 and 2012, the jury's still out on that.

Do you trust this HP board to be on the ball and hire a great new CEO? Take a wait and see approach.


[** This post is an excerpt of the full article, which is available on by clicking here. Free Site.**]

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