By Ben Elgin When Hewlett-Packard nailed its fourth-quarter 2003 financial targets on Nov. 19, execs hailed it as evidence its 2002 merger with Compaq Computer was a resounding success. The results speak for themselves, HP (HPQ) crowed: Despite weaker-than-expected profit margins, it doubled fourth-quarter net profit to $862 million and eked out operating profits -- as promised -- in its divisions that sell corporate info-tech gear and PCs.
HP's sanguine analysis, however, hasn't been widely embraced. On Dec. 8, Sanford Bernstein & Co. declared in a report that HP would have been substantially more profitable in 2003 had it remained a stand-alone company. Meanwhile, investors continue to value HP stock below its competitors. Trading at around $22, its price-earnings ratio for the next 12 months trails that of IBM (IBM) and Dell (DELL) by 18% and 85%, respectively, according to recent research by Smith Barney.
To prove its merger a success -- and finally win over investors -- HP must not only boost profit margins, it must rekindle its top-line growth. And to that end, it's starting with its weakest link. Hoping to improve its business selling tech gear to corporations, on Dec. 9 HP announced a major restructuring. It will fuse together its enterprise and IT-services businesses, under the leadership of HP services boss Ann Livermore.
FULL PLATE. On the surface, the move further allows HP to approach corporate customers with a single face, then leverage the businesses off each other. It also puts the struggling enterprise arm, which saw revenues dip 5% in 2003, under the purview of Livermore. Sure, her services group posted flat sales in 2003, but she's credited with driving the remarkable 36% fourth-quarter growth in HP's high-end managed-services business. "Ann Livermore has shown herself to be successful with pioneering new businesses," says Goldman Sachs analyst Laura Conigliaro.
Livermore now has a lot on her plate. Consider this: Even with HP's solid fourth quarter, it delivered only a 1% revenue increase on the year. Over a similar time period, Dell and IBM posted top-line growth of 17% and 9%, respectively. Although many investors expected HP to lose some sales due to the merger, their patience is running thin.
"We'll give them another one to two quarters grace period to pick that up," says Maira Thompson, a senior portfolio manager at Clark Capital Management Group, which owns about 100,000 HP shares.
PAPER CUTTER. The challenge ahead isn't lost on HP. In recent weeks, it has launched a number of new business endeavors, in addition to the management reorganization. Analysts predict the moves, coupled with improving IT spending, will lift HP's revenues 6%, to $77 billion, in 2004. That, however, will require skillful execution. "This is not a revenue story [yet]," says Conigliaro.
HP's top line is just as dependent on sustaining growth in its healthy printing and imaging business. On Nov. 18, the company extended the unit's reach into the $24 billion digital-copier business. Taking a similar approach to Xerox (XRX), HP is aiming to help companies assess their overall document-management habits, including copiers and printers, and offer new strategies for trimming costs.
Because most companies fail to track expenses associated with copying and printing, they unwittingly spend $800 per employee each year on such costs, according to HP. That number, according to analysts and HP, can be trimmed by at least 30%. "This is one of the last bastions of big savings in IT," says Peter Grant, principal analyst at Gartner.
TOO BIG TO IGNORE. The big question: Can HP gain traction against such competitors as Xerox and Ricoh? After all, many copier purchases are not made by the IT managers who are well known to HP, but rather facilities execs or department managers. These are relationships that copier companies have spent decades building up. "It could be a tough, uphill road for HP," predicts Rob Stewart, marketing vice-president for Xerox' office division.
That said, HP's thrust to educate its customers, coupled with its dominant No. 1 position in the printer market, make it tough to overlook. If it can convince CIOs at client companies to take a look at overall document-management costs, it could bring more copier purchases under its customers' IT umbrella.
HP insists it can win an additional 10% of this market in three years -- which, by itself, would add a couple of billion dollars to its top line. That's the kind of bold move it needs to keep its $23 billion crown jewel copier business growing at 10%-plus each year.
"HP is in a good position. But there's not a huge amount of latent demand," says Angele Boyd, group vice-president at researcher IDC. "It will take some education." Sparking growth inside the $73 billion company will be no easy task. But it's a job HP must accomplish to realize the promise of its Compaq merger - and to satisfy its investors. Elgin covers the tech industry from the San Mateo bureau of BusinessWeek