CEO Meg Whitman sells Wall Street on two things being better than one.
Jacob Kepler/Bloomberg—Getty Images
By Stephen Gandel
October 6, 2014

For Hewlett-Packard, breaking up, apparently, will be easy to do.

At least that’s what investors seem to think. On Monday, shares of Hewlett-Packard (HPQ) jumped nearly $2, or 5.5%, to $37 on the news, announced over the weekend, that the company was going to split in two. That means investors think the company, which is still combined and will likely stay that way for nearly another year, is $3 billion more valuable because it will be splitting up.

Indeed, it’s not just at HP where investors have fallen in love with the idea of a breakup. These days, it appears busting up companies is the easiest way for CEOs to boost the value of their businesses. Last week, shares of eBay (ebay) rose $4, or nearly 7%, on news that the auction site and its payment processing unit PayPal were splitting up. Back in July, the stock of computer storage company EMC (EMC) rose $1.35, or 5%, to what was then its highest price of the year, on rumors, not confirmed news, that it was thinking of spinning off VMware, a software unit. EMC—which had been in negotiations with HP about a possible merger at the time—has still not announced the alleged split, yet its shares haven’t dipped.

Wall Street, of course, has a long history of getting taken in by financial engineering. Executives often defend the deals by saying that separated companies will perform better. And in eBay’s case there seemed to be a strong business justification for a split. PayPal should have a much easier time signing up websites to use its service once it is not owned by eBay, a rival to some of PayPal’s largest would-be customers. eBay has a reputation for being a place where shoppers should proceed with caution. That’s not something you want from a payment system.

In HP’s case, it’s not clear what the business motive for the split is. It may be true that HP’s corporate computing business doesn’t have a lot of overlap with its personal computer and printing divisions, but that also makes it unlikely that the two divisions are holding each other back. HP CEO Meg Whitman says the split is needed so the two companies can be more nimble. But even when they are broken up, the two companies will remain, by most scales, behemoths, with over $55 billion in sales each.

IBM’s personal computer division, which was sold to Lenovo about a decade ago, has done better on its own. But that was a sale, not a spin-off. And IBM (IBM) hiving off the computer unit doesn’t appear to have saved the company. The tech giant’s shares have been a laggard over the past few years, and some are saying the company may need to be restructured again.

But the main problem is that once HP’s businesses are sent off on their own, they may not be as valuable as investors currently think. On Monday, HP had a market capitalization of $69 billion.

HP says on that its personal computer and printer segment would have had sales of $57 billion in the past year if it were considered a standalone entity. That’s roughly the size of computer maker rival Dell when it went private last year. That deal valued Dell at $25 billion, or a little less than half its sales. But Dell has an operating margin of 21% and operating profits of $12 billion. HP’s operating profits are less than half that, just $5.4 billion in the past year. Adjust for that, and HP’s computer business could be worth around $12 billion.

The rest of HP’s business, with $58 billion in revenue, is likely to compete with EMC, IBM, and Oracle. Among that group, the new HP, which will be known as Hewlett-Packard Enterprises, will be middle of the pack in terms of revenue; double the size of EMC and larger than Oracle (ORCL), but about half the size of IBM. Shares of the three companies trade, on average, for 12 times their operating profits. Based on that, HPE, which generated $6 billion in operating profits in the last year, would fetch $72 billion.

But EMC, IBM, and Oracle are currently a lot more profitable than HPE would be, at least according to HP’s estimates. Oracle, for instance, has an operating profit margin of nearly 40%. IBM’s is 20%, and EMC’s operating margin is 17%. HPE’s operating margins, by HP’s estimates, would be just over 10%. And HP’s estimates, which, according to a footnote on a slide of a presentation that HP presented to shareholders Monday morning, does not include certain costs, including its “Corporate Investments segment” and expenses that the division currently has but the company anticipates will be eliminated once the breakup is complete. So it’s likely that $6 billion is a pretty rosy estimate of what HPE’s true profits could be.

What’s more, despite an improving economy, HP appears to be flying its merger into a headwind. Operating cash flow at IBM and Oracle are expected to grow this year. HP, though, is predicting its cash flow will drop by about $1 billion in the next year. And HP has a history of being overly optimistic when it makes estimates.

So, what could HP’s enterprise division be worth? Based on its lower profitability, just under $30 billion. Add that to the $12 billion for its personal computer and printer division and the two mini-HPs could be worth a combined $42 billion on their own, or about $17 billion less than HP’s current $69 billion market value.

It looks like Wall Street’s wacky split-up math on HP is that two minus one equals three. Eventually, investors will realize that breakups aren’t all they are cracked up to be.

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