HP And Dell In The Convergence Device Race

In my most recent post on both companies, I looked at the changing business mix at HP (NYSE:HPQ) and Dell (NASDAQ:DELL) and suggested that they should either get out of the PC business altogether or strengthen their offerings in it by getting into convergence devices with a Palm or RIM acquisition. HP recently bought Palm for $1.2 billion. Let’s take a look at how this affects their outlooks.

HP last week reported strong second quarter results that beat estimates. Revenue was $30.8 billion, up 13%. Net income was $2.2 billion or$0.91 per share compared to $1.7 billion or $0.71 per share last year. HP exited the quarter with $14.3 billion in gross cash after repurchasing shares for $1.8 billion and paying dividends of $196 million. Q1 analysis is available here.

Imaging and Printing Group (IPG) revenue increased 8% to $6.4 billion. Personal Systems Group (PSG) revenue increased 21% to $10 billion with Notebook revenue up 17% and Desktop revenue up 27%. Services revenue increased 2% to $8.7 billion. HP Software revenue declined 1% to $871 million and Enterprise Storage and Servers (ESS) revenue was up 31% to $4.5 billion.

HP will be closing the 3Com deal this quarter. HP Networking, which is reported in the Corporate Investment segment, recorded organic growth of 31%, or 58% growth, including a partial quarter of 3Com results. HP reported double-digit growth in every region, with the Americas and EMEA each growing 11% and Asia Pacific increasing 19%.

For the third quarter, HP expects revenue of $29.7 to $30 billion and EPS of $0.87 to $0.89. For the full year, it expects revenue growth of 8 %to 9%. It reduced its EPS outlook to $3.76 to $3.81 from the earlier guidance of $3.79 to $3.86.

During the earnings call, CEO Mark Hurd said that after closing the Palm acquisition, the company expects to use the Web OS and the Palm app store beyond smartphones in slates and Web-connected printers. Dell, on the other hand, is going the organic way in the smartphone market. It launched an Android-based smartphone, Aero in China earlier this year and said it would add more models. During the recent earnings call, the company said it would be launching a smartphone in India later this year. Dell is launching a five-inch tablet in Europe and the United States in the second half of this year. Called Mini 5 aka Streak, the tablet will run on the latest version of Android operating system version 2.0 or higher. It will have a touchscreen, a 5 MP camera, a separate front-facing camera for video conferencing, WiFi, and 3G connectivity. Dell also hopes to include a SIM card option that would also enable users to make phone calls from the device.

Dell also reported strong first quarter results that beat estimates driven by global growth in its enterprise solutions. Dell acquired Perot Systems for $3.9 billion last year. Q1 revenue was up 21% to $14.9 billion. Net income was $441 million or $0.22 per share compared to $290 million or $0.15 per share last year. Dell resumed its stock repurchase program with a $200 million stock repurchase and ended the quarter with $11.9 billion in cash.

Virtualization, cloud computing, and increased data storage needs are some trends that are driving Dell’s server business, which increased 39% in the quarter. Storage revenue was up 4% to $554 million with EqualLogic storage products growing more than 75%. Revenue from services, driven by the $3.9 billion acquisition of Perot Systems, increased 53%. Mobility revenue was up 18%. Regionally, BRIC revenue grew 60% with India growing 90%, Brazil 81%, Russia 79%,  and China 44%.

Dell expects a normal, seasonal sequential demand pick-up in the low single digits in its second quarter. With a cash balance of $11.9 billion, Palm was definitely affordable for Dell, and it is a missed opportunity for an easy entry in the convergence device race. According to IDC, media tablet shipments will grow from 7.6 million units in 2010 to more than 46 million units in 2014,  indicating a CAGR of 57.4%. In comparison, IDC expects that 398 million portable PCs will be shipped in 2014.

Dell is trading around $13.35 with market cap of $26 billion and a 52-week high of $17.52 on April 23. HP is trading around $46.43 with market cap of about $109 billion and a 52-week high of $54.75 on April 16.

My sense is that the PC/convergence device space is vertically integrating. Apple is the quintessential example of this integration, building its computers and gadgets on its own OS. HP’s acquisition of Palm is an acknowledgment of the fact that Windows is falling behind in the mobile space, and HP needs more control over their destiny in this critically important segment. Dell is betting on Android in this race. RIM is still out there and independent, although outside its excellent email system, its software strength is minimal. Nokia has Symbian. The convergence device space, as I predicted in 2007, is going through massive changes. Expect more to come.