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HP's New and Steady Hand

By Peter Burrows Talk about role reversal. On Aug. 16, Hewlett-Packard (HPQ) -- the tech giant known in recent years for its boardroom dramas and execution mishaps -- delivered a rock-solid third quarter, sprinkled with several upside surprises.

And all this coming just days after Dell (DELL), the computer maker that's been knocking HP around for the past decade, spooked investors by issuing a rare mea culpa to explain why revenue growth might disappoint in the quarter ahead (see BW Online, 8/12/05, "Dell's Shortfall, Dell's Challenge").

BLISSFULLY BORING. What's going on? If current trends continue, it may be the start of HP's return to its roots. Throughout his conference call with analysts, new CEO Mark Hurd ticked off evidence that HP is getting back to one of the traits that made it one of the most profitable companies in the world: no fuss, blissfully boring execution.

Clearly, that's what investors seem to want. Says Goldman Sachs analyst Laura Conigliaro: "So far, there's nothing to criticize. He's steady at the wheel, and he seems to be somebody that is right out of the mold of what you'd expect from [the old] HP -- slow, relentless progress."

In all, third-quarter sales rose 10%, to $20.8 billion. Earnings, excluding the tax hit due to HP's decision to repatriate $14.4 billion in overseas profits before the U.S. government raises the rate on such earnings (another pragmatic call), rose 46%, to $1.1 billion. That soundly beat consensus expectations and helped drive a 6.5% rise in HP's stock, to $25.25. And the company pulled all this off in a quarter in which it announced a 14,500-person layoff and shook up its executive management team.

RESISTING TEMPTATION. The emphasis on operations shines through HP's latest financials. The personal computer unit, long a money-loser, built on recent momentum to post its best operating margins since HP bought Compaq in 2002, showing few ill effects from the price-cutting that hurt Dell and Gateway (GTW). That was partly because HP finally began to execute its plan to balance market-share goals with profitability.

Indeed, the PC profits came despite unit growth of just 14% -- below overall PC industry growth of 16.6%, according to market researcher IDC. But that seemed to be fine with investors, who cheered the $163 million HP posted in PC operating profits, up from a miserly $23 million the year before.

"They finally had the fortitude" to resist slashing prices to keep share, says Conigliaro. "And they're not going to get penalized for it [by investors] -- they're going to get rewarded." She notes that HP also was helped by much improved performance in the more profitable notebook PC market, where a revamped product line's revenues grew 31% over the previous year.

PRINTING PROFITS. HP's troubled $4 billion high-end computing unit also showed broad improvement, growing 20% over a disastrous quarter a year ago. While software remains an obvious trouble spot, performance even improved for a storage-gear business that has been hemorrhaging market share in recent years. Overall, profits for the Enterprise Storage & Server unit jumped to $150 million, from a $211 million loss a year ago.

And HP continued an aggressive push for market share to reassert its status as king of the printer business, posting double-digit unit growth while staying just within its target of delivering operating margins of 13% to 15%.

The numbers explain only part of Wall Street's reaction. During its tumultuous past decade, HP's stock price has been weighed down by management's lack of credibility. That explains why HP has for years traded at a 10% to 30% discount to IBM (IBM), for example.

SIGNS OF THE TREND. Hurd is addressing that credibility gap on many fronts. Regarding strategy, he's trading in the shoot-for-the-sky (some might say pie-in-the-sky) plan of former CEO Carly Fiorina, for a more pragmatic approach. Hurd nixed a high-profile but financially insignificant deal to resell Apple's iPod music player.

Now, BusinessWeek Online has learned that HP is in talks to sell its ProCurve networking unit (see BW Online, 8/17/05, "HP: Exiting Network Gear?"). And while Hurd says he isn't considering any blockbuster changes in direction, he does seem focused on growing where HP is strong -- namely, in printing and imaging.

That explains the $230 million purchase of Scitex Vision on Aug. 11. Scitex makes large-format printing gear used to create billboards, bus advertisements, and the like -- a niche in a $200 billion-a-year industrial printing industry that HP has targeted in recent years, but in which it has made scant progress.

CARLY'S LEGACY. Of course, Fiorina also made impressive progress in her first few quarters on the job, and some of the initiatives paying dividends today were started under her watch. (She had been planning to sell ProCurve as well and had started the work to fix the PC unit.)

And Hurd has "far more work to do," as he says frequently in calls with analysts. That includes figuring out how to stem falling margins in the printer business, which has brought in almost all of HP's profits in recent years. And HP has farther to go to complete its metamorphosis from a high-cost innovator, to a lean-and-mean maker of high-volume tech gear.

Ironically, HP's remaining weaknesses may well be an important advantage going forward -- if Hurd can continue his early progress, that is. Just compare his opportunities relative to Dell's. For years, the rival's low-cost model enabled it to happily gather market share in PCs at its leisure. But given its most recent quarter, when aggressive price-cutting failed to entice enough new buyers, analysts worry that Dell will struggle somewhat to maintain its hypergrowth without sacrificing earnings.

KILL OR CURE. HP, on the other hand, still has more than enough areas for improvement, both strategically and operationally. Take its cost structure. "HP has made some pretty significant improvements, and that can continue. But Dell doesn't have as much room to improve, since there's not as much cost to take out," says Christopher Foster, an analyst with Technology Business Research.

The moral, says Foster: HP's remaining fat gives Hurd the opportunity for further gains, "so long as the gastric bypass doesn't kill the patient."

Burrows is BusinessWeek's West Coast Computer editor

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