Hewlett-Packard’s Cloud Lag Spurring Lowest Valuation: Real M&A

Hewlett-Packard Co. (HPQ), which paid the highest multiple on record for a computer company six months ago, now needs to spend as much as double the historical valuation for software takeovers to catch up in cloud computing.

Red Hat Inc. (RHT), Informatica Corp. (INFA) and Tibco Software Inc. (TIBX), which Goldman Sachs Group Inc. says may be targets as Hewlett- Packard adds software, trade as high as 42 times earnings before interest, taxes, depreciation and amortization. That compares with the median 18 times for software and Internet acquisitions in the last five years, according to data compiled by Bloomberg. Leo Apotheker, 57, started as chief executive officer in November after an interim CEO paid a record 325 times Ebitda for 3Par Inc. following a bidding war with Dell Inc. (DELL), the data show.

The former SAP AG (SAP) CEO inherited a company that trades at the lowest valuation relative to earnings among the largest U.S. technology companies and faces slowing sales growth over the next two years. While Apotheker said this month he will follow a “disciplined” approach to acquisitions for Hewlett-Packard, he may be forced to pay up to offset cuts in development spending by ousted CEO Mark Hurd and close the gap with Oracle Corp. (ORCL) and International Business Machines Corp. (IBM) in cloud computing, which lets users consume software and data over the Internet.

Photographer: Ryan Anson/Bloomberg

Hewlett-Packard Co. Chief Executive Officer Leo Apotheker. Close

Hewlett-Packard Co. Chief Executive Officer Leo Apotheker.

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Photographer: Ryan Anson/Bloomberg

Hewlett-Packard Co. Chief Executive Officer Leo Apotheker.

“It’s a difficult place,” said Mark Bronzo, who helps manage $25 billion at Security Global Investors in Irvington, New York. “Although he says he’s going to be patient, the pressures from the shareholders and the pressures to keep up with their competitors are going to force them to probably pay a premium.”

Build, Buy, Partner

Bill Wohl, a spokesman for Palo Alto, California-based Hewlett-Packard, the world’s largest computer maker, declined to comment on potential acquisitions.

“With an eye toward the strategy laid out by our CEO, we intend to build, buy or partner,” Wohl said. “Our M&A strategy is consistent with our overall company strategy.”

Kerri Catallozzi, a spokeswoman for Red Hat, and Debbie O’Brien, a spokeswoman for Informatica, declined to comment. Holly Burkhart, a spokeswoman for Tibco, didn’t return phone calls requesting comment.

After retreating 20 percent in the last year before today for the third-steepest drop in the Dow Jones Industrial Average, Hewlett-Packard was trading at 9.8 times profit as of March 25, the cheapest among U.S. technology companies with market values greater than $20 billion, data compiled by Bloomberg show.

Hewlett-Packard fell 39 cents, or 0.9 percent, to $42.14 at 4:15 p.m. in New York Stock Exchange trading.

Hurd Departure

The shares posted the biggest one-day drop in six years on Aug. 9 after Hurd announced his resignation and the company said he violated its standards of business conduct. As CEO for more than five years, Hurd boosted sales and oversaw a doubling of the stock amid cuts in research and development costs and more than $24 billion in acquisitions.

Following Hurd’s exit, Hewlett-Packard spent $2.1 billion including net debt on data-storage company 3Par after an 18-day bidding war against Dell. The 325 times Ebitda that interim CEO Cathie Lesjak, 52, offered for 3Par was the most expensive valuation for any computer takeover greater than $500 million, according to data compiled by Bloomberg. Hewlett-Packard also paid $1.5 billion, or 57 times Ebitda, for ArcSight Inc. in a deal that was announced in September, the data show.

Apotheker started as CEO less than two months later. He said on March 14 in San Francisco he plans a “disciplined” acquisition approach while shopping for targets in areas including security, data analysis and cloud computing.

Slowing Sales Growth

With sales growth projected to slow to 4 percent this year and next from 10 percent in the year ended in October and the company lagging behind rivals such as IBM and Oracle in supplying the infrastructure for cloud computing, Apotheker is aiming to build a cloud computing service that would let software developers write, test and run applications securely in its data centers using a suite of Hewlett-Packard technology.

To do that, the company needs to buy, build, or strike partnerships for database software, data analysis applications, software development tools and security software, Shane Robison, Hewlett-Packard’s chief technology and strategy officer who heads mergers and acquisitions, said in an interview March 15.

“The message is growth, and if they’re going to go for small, high-growth companies, they’re going to have to pay up,” said Jayson Noland, an analyst at Robert W. Baird & Co. in San Francisco. “Hopefully not as much as 3Par.”

Hewlett-Packard may have a high interest in Red Hat, the largest seller of Linux software; Informatica, the Redwood City, California-based corporate-software company; and business- software developer Tibco in Palo Alto, according to research from Goldman Sachs.

Red Hat

Including net debt, Raleigh, North Carolina-based Red Hat traded at 41.7 times Ebitda before today, more expensive than all but three of the companies in the Standard & Poor’s 500 Index, according to data compiled by Bloomberg. Informatica commands a multiple of 30.1 times, while Tibco trades at 24.5 times. Red Hat had a market value of $8.9 billion, compared with $4.9 billion for Informatica and $4.4 billion for Tibco, the data show.

Even without a takeover premium, all three are at least 38 percent more expensive than the median 17.7 times Ebitda multiple for acquisitions of software and Internet companies greater than $500 million in the last five years, data compiled by Bloomberg show. Software and Web companies globally trade at a median of 14 times Ebitda, more than 50 percent cheaper than Red Hat and Informatica, the data show.

‘Pay Up’

“It’s going to be difficult to get anything cheap,” said Alan Gayle, senior investment strategist in Richmond, Virginia, for RidgeWorth Capital Management, which oversees $45 billion. Apotheker will probably “have to pay up for anything that he gets and he’s going to have to effectively leverage this quickly so that it’s not too much of a drag on earnings,” he said.

Informatica or Tibco may draw the interest of IBM, Oracle and SAP, according to Goldman Sachs. Oracle, San Jose, California-based Cisco Systems Inc. (CSCO), Dell and CA Inc. (CA) may covet Red Hat, Goldman Sachs’s research showed.

Representatives for Armonk, New York-based IBM, Oracle, Cisco, Dell, SAP and CA of Islandia, New York, declined to comment.

Hewlett-Packard trades at 0.8 times revenue after posting sales of $126 billion last fiscal year, the highest revenue of any large U.S. technology company. That makes it the only one valued at a discount to sales besides Dell. Hewlett-Packard’s 7 percent profit margin is also the lowest after Round Rock, Texas-based Dell, data compiled by Bloomberg show.

‘Need Growth’

“They need growth,” said Mark Demos, a fund manager at Fifth Third Asset Management in Minneapolis who helps oversee $18 billion. “They need to be relevant in where the technology landscape is heading. People would agree that maybe IBM, Oracle, other companies are perhaps better positioned than them.”

Hewlett-Packard may focus on bidding for midsized software companies like Tibco and Informatica, or smaller companies such as closely held Ab Initio Software Corp. and Engine Yard Inc., said Brian Marshall, an analyst at Gleacher & Co. in San Francisco, who recommends Hewlett-Packard shares.

“We genuinely love being a private company,” said Sheryl Handler, CEO of Lexington, Massachusetts-based Ab Initio. “By being a private company it lets us focus all of our attention on making our customers successful.”

Engine Yard of San Francisco specializes in tools that let developers create websites with the widely used Ruby on Rails programming language, and could be for sale, CEO John Dillon said in an interview March 15. Hewlett-Packard needs tools for software developers to create applications that run on its cloud, he said.

‘Somebody Like Us’

“I would buy somebody like us,” Dillon said. “I do think we’re a pretty good acquisition target.”

Hurd showed financial prudence in deals such as the $13 billion takeover of Electronic Data Systems Corp. in 2008, Baird’s Noland said. Including net debt, the price of 5.3 times Ebitda was the cheapest for any Hewlett-Packard acquisition of a public company, data compiled by Bloomberg show.

Hewlett-Packard’s 3Par deal was criticized by Oracle Co- President Safra Catz during the company’s earnings conference call last week. Redwood City-based Oracle announced in April 2009 it would buy Sun Microsystems for $5.7 billion, including net debt, or 8.3 times Ebitda, data compiled by Bloomberg show.

“Had we paid for Sun based on the HP-3Par multiple, it would have cost us nearly $140 billion,” Catz said. “Don’t worry. We wouldn’t do that.”

‘Big Splash’

Apotheker and Robison ruled out buying large makers of business applications and database software, while the new CEO also said they wouldn’t pursue a blockbuster deal like the $17.6 billion purchase, including net debt, of Compaq Computer Corp. completed in 2002.

“I don’t believe I’m the type of a person who wants to make a big splash,” he said on March 14.

The companies Hewlett-Packard goes after may be smaller, closely held software makers with niche technology specialties that will command lower prices than public companies, said Abhey Lamba, an analyst at ISI Group in New York.

Apotheker, who studied economics at the Hebrew University of Jerusalem, was appointed CEO Sept. 30 and started Nov. 1 after resigning as Walldorf, Germany-based SAP’s chief in February 2010. The 22-year SAP veteran oversaw the largest maker of business-management software’s first revenue drop since 2003.

‘Catching Up’

Hewlett-Packard, which has $9.9 billion in cash and near cash items and $20.4 billion in total debt, is rated B3H, the eighth-highest level of investment grade, according to Bloomberg’s Company Credit Ratings. It could add $7 billion to its long-term debt without lowering its debt ranking, according to Bloomberg’s ratings, which analyze borrowers based on indebtedness, profitability and other financial ratios.

“They have a little catching up to do,” said James Dunigan, chief investment officer in Philadelphia for PNC Wealth Management, which oversees $108 billion including Hewlett- Packard shares. “They are going to go out in a disciplined way. That doesn’t mean that he’s not going to write a check that people may say wow, that’s more than they thought.”

Overall, there have been 5,478 deals announced globally this year, totaling $550.4 billion, a 21 percent increase from the $454.9 billion in the same period in 2010, according to data compiled by Bloomberg.

To contact the reporters on this story: Aaron Ricadela in San Francisco at aricadela@bloomberg.net; Rita Nazareth in New York at rnazareth@bloomberg.net.

To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net; Tom Giles at tgiles5@bloomberg.net.

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