Hewlett-Packard: Split-Up Offers Opportunity

06/09/2015 7:00 am EST


Angelo Zino

Senior Equity Analyst, S&P Capital IQ

An upcoming split can be considered a great opportunity for investors in this leading global provider of personal computers, printers, enterprise service and storage, and software, explains equity analyst Angelo Zino of S&P Capital IQ in The Outlook.

Hewlett-Packard (HPQ), our latest focus stock, carries S&P Capital IQ’s highest investment recommendation of 5-Stars, or strong buy. We believe that the pending split of the company will unlock significant shareholder value.

HPQ is in the midst of splitting itself up into two companies, Hewlett-Packard Enterprise (to focus on servers, storage, networking, software and services) and HP Inc. (to focus on PCs and printers).

Meg Whitman will run Hewlett-Packard Enterprise while Dion Weisler will become CEO of HP Inc. The spin-off is expected to be completed by November 1 and to be tax-free.

We positively view the pending transaction, as we see it unlocking significant shareholder value and opening up strategic opportunities for both companies.

Our strong buy recommendation also reflects our view that the PC demand is nearing a trough following a steep correction in early calendar year 2015.

However, we note more than $2.5 billion in total costs related to the HPQ separation will temporarily negatively impact both company free cash flow.

While we see further revenue declines in FY 2015 (Oct.), largely reflecting PC and foreign currency headwinds, we see stabilization in FY 2016.

We believe the PC landscape is likely to contract about 5%-7% in calendar year 2015 but think the industry should see notable improvement in the second half.

Despite challenges related to top-line growth, we expect HPQ to focus on improving profitability.

At the end of January, the company had reduced its workforce by 44,000 employees since announcing its 2012 restructuring plan, with plans to complete the program with an additional 11,000 employees by FY 2015 year-end.

We see opportunities to reduce its workforce once the separation of the two companies is complete, providing further upside potential to margins.

We believe free cash flow is an important metric for investors to look at when valuing Hewlett-Packard. In fiscal year 2015, we expect free cash flow to decline to $3.5-$4 billion to reflect cash-related separation activities and recent currency trends.

By FY 2016, we see free cash flow bouncing back towards $6.5 billion and potentially significantly exceeding $7 billion by FY 2017. At current levels, that implies an attractive price/free cash flow of less than 10x based on next fiscal year’s estimates.

With HPQ solidifying its balance sheet in recent years—following M&A blunders by regimes prior to Meg Whitman—we see the potential to return more cash to shareholders in future years while also being opportunistic with acquisitions.

Over time, we expect the company to return at least 50% of free cash flow to shareholders.

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