HP Succumbs, But Likely to Acquire

Hewlett Packard Co (NYSE:HPQ), the leader in the PC market with annual revenue of $118.4 billion, had been reporting strong quarters till now and had seemed to be recession-proof. Not any more. Yesterday, the company reported a mixed first quarter, missing revenue estimates but meeting earnings estimates. It experienced growth only in the Services segment, which was helped by the EDS acquisition. Its outlook was also disappointing.

Net revenue in the first quarter was up 1% to $28.8 billion versus analyst estimates of $31.93 billion. Net earnings were down 13% to $1.9 billion or $0.75 per share. Excluding charges, EPS was $0.93, in line with estimates.

Gross margin was 23.4%, down 130 basis points from 24.7% in Q108 mainly due to the integration of technology services provider EDS, which has lower gross margins. Cash flow from operations was $1.1 billion, and HP ended the quarter with a strong balance sheet including total gross cash of $11.3 billion. The company bought back shares worth $1.2 billion in the quarter and paid dividends of $193 million. HP also took several steps to reduce costs in the quarter. It reduced its headcount by 9,000, extended the December holiday shutdown, and reduced travel and eliminated other discretionary spending.

By segment, Personal Systems Group (PSG) revenue declined 19% to $8.8 billion, with revenue from notebooks and desktops declining 13% and 25%, respectively. Last quarter there was 21% growth in Notebook revenue.

Imaging and Printing Group (IPG) revenue declined 19% to $6 billion and printer unit shipments decreased 33%. Supplies revenue declined 7% as lower end user demand more than offset the benefit of recent supply price increases.

Enterprise Storage and Servers (ESS) revenue was down 18% to $3.9 billion. Storage revenue declined 7% with the midrange EVA down 7%. Revenue from Industry Standard Server declined 22% and Business Critical Systems declined 17% while ESS blade revenue increased 4%.

HP Services (HPS) revenue increased 116% to $8.7 billion, mainly due to the acquisition of EDS. Within Services, Q1 revenue was $3.9 billion in IT outsourcing, $2.5 billion in technology services, $1.6 billion in application services, and $743 million in BPO.

HP Software revenue declined 7% to $878 million, with Business Technology Optimization revenue declining 4% and Other Software revenue down 14%. HP Financial Services (HPFS) revenue was down 1% to $636 million.

By region, in the Americas revenue grew 11% to $12.4 billion but declined 3% to $12.0 billion in EMEA and 11% to $4.4 billion in Asia Pacific. Revenue from outside of the United States accounted for 65% of total revenue, and revenue in the BRIC countries, accounting for 7% of revenue, declined 22%.

Assuming that current market conditions will persist, HP expects second quarter revenue to decline 2 to 3%. That implies revenue of $27.4 billion to $27.7 billion, far below analyst estimates of $30.95 billion. HP expects GAAP EPS to be in the range of $0.70 to $0.72 and non-GAAP EPS between $0.84 and $0.86. Analysts expect Q2 earnings of $0.89 share.

For the full year FY09, HP expects revenue to decline by 2 to 5%, GAAP EPS between $3.19 and $3.31 and non-GAAP diluted EPS in the range of $3.76 to $3.88.

Despite its lackluster performance this quarter, you have to give credit to HP and to Mark Hurd for withstanding the recession till now and especially for executing well on the EDS integration in this tough economy.

The stock is currently trading around $34 with a market cap of around $82 billion. It hit a 52-week low of $28.23 on November 13.

I expect HP to be one of the few companies who will be acquiring attractive smaller businesses to round out its portfolio. In fact, I would not be surprised if a Palm or a RIM feature in that portfolio.