Breaking Up Is Hard To Do: HP and the New Spinoff Bubble

It's not you, it's me. Well, actually, it is you, but I was raised to deflect controversy.

When Meg Whitman finally announced the long rumored split of HP into two separate units, it was not, let us stipulate, from a position of strength. She was brought in to run HP by a fractured board whose previous attempts at management change had, to be charitable about it, resulted in less than optimal outcomes.

If there is one thing she has evidently learned in her long and largely laudatory career, it's that there comes a point when you need an exit strategy. Her predecessors had always avoided what many in the company considered ' the final solution.' That moniker will understandably be offensive to some, but it was used to convey, in part, the steep decline from the days of Dave Hewlett's and Bill Packard's respect for the employee and aversion to layoffs versus the latter day disregard for the human capital otherwise known as people who invent stuff and then make it work.

But with the capital markets growing impatient with the lack of anything beyond minor, incremental avoidance of failure (as opposed to actual success), desperate times required desperate measures. The solution, however, may prove as difficult to achieve as whatever that previous strategic goal might have been.

Many people in tech become incensed when their noble calling is conflated with fashion. They find it demeaning, even if Apple has demonstrated conclusively its laudatory financial results. And given the historic link between tech and finance, it is worth noting that there is also a fashion sense to finance. But we're not referring to bespoke suits, yellow ties and suspenders. Conglomerates and scale and aggregation become the thing, until some dog whistle blows that only those on Wall Street can hear, and then suddenly, focus and specialization become the rage.

They make money either way, it's the transaction that counts. When it comes to either option, but particularly, in this case, spinoffs, those responsible for actually making the surviving enterprises work often find that this is not quite as neat and clean as the world has been assured it will be. Intangibles that combined to make certain processes and systems mesh are torn asunder. Relationships are severed. Confusion over roles and responsibilities cause conflict. Cultures change, as do managers. Suppliers are nervous. Customers are wary. In short, it becomes, for at least a while, something of a Potemkin Village, with a handsome facade whose insides to not always match the gleaming front.

This may have been the best of a slew of bad options facing HP. But it is part of a trend whose drivers often have less to do with organizational effectiveness than with other, frequently more personal ends in mind. And either way, it is hard to do. JL

James Stewart reports in the New York Times:

This year is likely to top the record of 66 spinoffs reached in 1999 and 2000, the peak of the technology bubble

When Hewlett-Packard’s chief executive, Meg Whitman, announced this week that the company would split, she said the two new companies would be “a lot more nimble, a lot more focused.”

Would that it were so easy.

“Nimble” and “focused” are hardly the first words that come to mind at the mention of HP. “Chaotic” and “hapless” are more like it. HP has lurched from one strategic plan and ill-fated acquisition to the next under a rapid succession of chief executives and board members.

To her credit, Ms. Whitman has brought some desperately needed stability since taking over in 2011 after the brief but disastrous tenure of Léo Apotheker. HP’s stock has nearly tripled since bottoming in November 2012. But at nearly $35 a share this week, it’s still far from the peak of over $53 that it reached during the tenure of Mark Hurd, who is now co-chief executive of a rival, Oracle.

In spinning off its computer and printer operations into one unit, to be called HP Inc., which will use the HP logo, and putting everything else into another, called Hewlett-Packard Enterprise, the company is joining what’s shaping up to be a corporate stampede toward spinoffs. In the last week and a half, eBay, where Ms. Whitman spent a decade as chief executive, said it would spin off its PayPal unit, and the software and information management company Symantec said it would split into two companies. This year is now on track for 66 or more corporate spinoffs, according to Joe Cornell, who follows spinoffs as president of Spin-Off Advisors in Chicago and publisher of a newsletter, “Spin-Off Research.” This year is likely to top the record of 66 spinoffs reached in 1999 and 2000, the peak of the technology bubble, according to Mr. Cornell’s calculations.

Estimates for this year show the number of U.S. company spinoffs returning to record levels.

Number of completed U.S. company spinoffs

70

60

50

40

30

20

10

0

’85

’90

’95

’00

’05

’10

’14

(est.)

Source: Spin-Off Advisors

The surge in popularity has been fueled by activist investors and hedge funds pushing for breakups as well as academic research supporting the notion that the parts are often more valuable than the whole. A study by two Pennsylvania State University professors, James Miles and J. Randall Woolridge, of 174 spinoffs from 1965 to 1994 found that the stock prices of those companies rose an average of 76 percent in the five years after they were spun off, compared with a 31 percent gain in the Standard & Poor’s 500-stock index. And they found that spun-off companies were three times more likely to be acquired.

“Different businesses may need different capital structures and more entrepreneurial management,” Professor Woolridge said this week. “The spun-off company will often be totally different from a culture standpoint. It can get a better board that understands the business and can get the capital structure right. We found that the spun-off companies tend to grow revenues and profits faster.” HP also noted that the two new companies would have distinct customer bases, which they can now focus on, and will rank as the 48th and 49th largest corporations in America.

Still, the averages mask the wide variation in performance among companies that have been spun off. For every Motorola Mobility, the cellphone maker spun off by Motorola in 2011 and promptly acquired by Google (and then Lenovo), there’s a Delphi, spun off by General Motors in 1999 only to end up in bankruptcy six years later.

So where is HP likely to fall on the spectrum? The prospects have some analysts worried. “It’s debatable that HP is doing this from a position of strength,” Toni Sacconaghi, a senior technology research analyst at Sanford C. Bernstein, told me this week. “That doesn’t inspire much confidence.”

Investors initially cheered the news, but on further reflection, they seemed to share Mr. Sacconaghi’s reservations. HP shares rose nearly 5 percent after the announcement on Monday, but by Thursday, they were lower than before the news was disclosed.

Mr. Sacconaghi noted that many of the most successful spinoffs have involved separating slow- (or no-) growth commodity businesses from higher-growth, more entrepreneurial operations. Time Warner and News Corporation are among the media companies that have spun off print operations, hoping to achieve higher multiples and stock prices for faster-growing cable, film and digital media properties. Those recent examples have yielded mixed results so far, with shares in both News Corporation (the print operation) and Fox lagging the S.&P. 500. Time Inc. shares have dropped over 4.6 percent since they were spun off in June, trailing the S.&P. 500’s slight gain. But Time Warner shares have outperformed, gaining over 8 percent.

HP’s strategy doesn’t fit the slow growth-fast growth paradigm since both of the new companies have been slow- to no-growth operations. Personal computers and printers, the core of the new HP, are perceived as mature businesses. HP Enterprises, in theory, should be the faster-growing, more entrepreneurial of the siblings. But in the most recent year, HP’s revenue from personal computers has been growing faster than its enterprise businesses.

Especially worrisome to several investors I spoke to is the decline of HP’s Itanium server business, where service contracts and maintenance operations generate significant revenue and profit. The installed base of Itanium servers is dwindling as customers replace them with cheaper alternatives. In August, HP reported an 18 percent decline in revenue for its business critical systems unit and a 6 percent drop in enterprise services. By contrast, a bright spot in HP’s results was personal systems, which includes personal computers, where revenue was up 12 percent. HP said that viewed broadly, personal technology could again be a growth business, with HP at the forefront.

“This doesn’t fit the playbook of your typical spin out,” Mr. Sacconaghi said. “Here the growth profiles really aren’t that different.”

And there are risks. HP will lose economies of scale, which was one of the main reasons the company gave when it reversed its decision to spin off its personal computer business just three years ago.

“There really are synergies in distribution and sourcing,” Mr. Sacconaghi said. He noted that when HP reversed its decision, it cited a potential loss of synergies amounting to as much as $1 billion. Adding printers may enable HP Inc. to maintain greater scale, and “maybe they can mitigate the damage,” Mr. Sacconaghi said. “But even if it’s half that, that’s still 5 to 6 percent of their operating profits.”

Moreover, it’s unclear how HP Enterprises will finance growth once it loses the cash flow from personal computer and printer sales.

There’s also a whiff of desperation surrounding the plan. HP was rumored to be interested in acquiring Rackspace to gain a foothold in trendy cloud-based computing services, a field now dominated by Amazon and Google. But nothing came of that. There was talk HP might acquire another aging technology giant, the data storage provider EMC (which is under pressure from activist investors to spin off one of its own units, the software maker VMware.) Nothing concrete has materialized. (An HP spokesman declined to comment on any potential deals.)

Something could still happen. HP said it possessed material nonpublic information, so a large deal could be in the works. That has made investors nervous given HP’s dismal track record, most recently its disastrous $11.7 billion acquisition of Autonomy. (Still unresolved are HP’s claims that it was defrauded when it bought the British software maker in 2011.)

But what alternative to a spinoff did HP have? Now in the third year of her original five-year recovery plan, with promised growth in 2016 looking increasingly elusive, Ms. Whitman needs an exit strategy. “The market didn’t indicate any confidence in the status quo,” Mr. Sacconaghi said. “HP was already the cheapest technology stock in the S.&P. 500 based on a price-to-forward earnings basis. How can it get any worse? With two separate teams crafting a vision, maybe Wall Street will gain confidence and valuations will go up.”