HP Debt at Riskiest Level to Dell in Decade: Corporate Finance
Hewlett-Packard Co. (HPQ) debt is the riskiest in a decade relative to Dell Inc. (DELL) as Chief Executive Officer Meg Whitman struggles to transform the world’s largest computer maker in an age of tablets and smartphones.
The cost to insure Hewlett-Packard bonds with credit- default swaps grew to 54.9 basis points more than its largest rival on Oct. 3 after being cheaper a year ago. The gap grew 15 points as Whitman said income would be below analyst estimates and that her company lacked “competitive focus.” Moody’s Investors Service said yesterday it may downgrade the firm.
Hewlett-Packard is suffering from falling sales of computers and printers and a debt load that’s climbed above the industry average this year. A “deteriorating outlook” kept the company from using savings to fund investment in businesses such as security, according to an analyst presentation.
“It appears that the CDS market is expecting Hewlett- Packard’s performance to deteriorate further,” Joel Levington, managing director for corporate credit at Brookfield Investment Management Inc. in New York, said in an e-mail. “There is substantial investor skepticism around HP’s ability to turn around the business units.”
Bonds of Hewlett-Packard have dropped 0.64 percent this week, more than the 0.17 percent decline for all investment- grade technology firms, including Dell, according to Bank of America Merrill Lynch index data. Borrowing costs of 2.82 percent compare with an average yield of 2.24 percent for the industry.
Hewlett-Packard’s $1 billion of 4.375 percent bonds due in 2021, which yielded as little as 3.59 percent in February, have dropped 2 cents on the dollar since Oct. 2 to 101, yielding 4.23 percent at 10:13 a.m., according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That compares with a rate of 3.07 percent for Dell’s similar- maturity, 4.625 percent notes.
The company’s leverage, or ratio of total debt to earnings before interest, taxes, depreciation and amortization, is rising. Hewlett-Packard’s $29.7 billion of debt exceeds earnings by 2.17 times, up from 1.43 times in the three months ended July 2011. That’s higher than an average of 1.5 among competitors, which is up from 1.45 a year ago.
“It’s going to take longer to right this ship than any of us would like,” Whitman said at a meeting with analysts as the shares plunged to the lowest price in a decade. She blamed the computer maker’s challenges on management upheaval and a paucity of investments in new products.
Earnings excluding some items for the 2013 fiscal year, which begins next month, will be $3.40 to $3.60 a share, the company said in an Oct. 3 statement. Analysts on average had estimated profit of $4.16 a share, Bloomberg data show.
Hewlett-Packard, whose market value has dropped by more than $15 billion since Whitman assumed the helm a year ago, now trades at 0.24 times revenue, lower than all global competitors with market values bigger than $5 billion except Fujitsu (6702) Ltd., according to data compiled by Bloomberg. Fujitsu has a price-to- sales ratio of 0.14.
While Hewlett-Packard retains a “pretty decent” credit profile, declining revenue, weaker margins and spending on acquisitions such as its $10.3 billion takeover of Autonomy Corp. last year have combined to push leverage higher, according to Dave Novosel of Chicago-based Gimme Credit LLC.
The company is rated A3 by Moody’s and BBB+, one level lower, at Standard & Poor’s, compared with ratings of A2 and A- at Dell. Hewlett Packard was downgraded from the double-A tier in 2001 as the technology bubble ended and cut to its current levels after Whitman took over.
“It’s definitely a weaker credit,” Novosel said in a telephone interview. “There will be a turnaround, but what that means is that HP is not going to get to the types of margins and growth that it was enjoying two years ago.”
While Hewlett-Packard has almost $11 billion of bonds maturing through 2014, the average yield on similarly-rated debt with a 10-year maturity is about 2.86 percent. That compares with an average coupon of 4.39 percent on the company’s maturing obligations, signaling it may be able to refinance at a lower rate.
Hewlett-Packard and Dell have dueled for leadership of the PC market for more than a decade. Dell wrested the title of top maker from Hewlett-Packard in 2001 by relying on its ability to peddle machines at lower prices by purchasing parts at bargain prices and selling direct to customers.
A year later, Hewlett-Packard retook the crown when former CEO Carly Fiorina acquired Compaq Computer Corp. in 2002 for $17.6 billion.
The rivals are now contending with weak computer demand in a market increasingly pinched by high-end products such as Apple Inc. (AAPL)’s iPad and competition from Asian manufacturers for low- cost machines.
“I don’t have confidence that the secular decline in the PC business is going to turn around,” Ping Zhao, an analyst at debt researcher CreditSights Inc. in New York, said in a telephone interview. Hewlett-Packard’s personal computer unit accounted for more than 30 percent of the company’s $127 billion in revenue last year, Bloomberg data show.
Hewlett-Packard’s bonds will likely underperform similarly rated technology companies, Zhao wrote yesterday in a report.
Dell has been more successful in adapting by focusing on areas such as selling servers and storage machines to large companies, according to Aaron Rakers, an analyst at Stifel Nicolaus & Co. It’s also less burdened by debt, with a leverage ratio of 1.75, Bloomberg data show.
“You don’t have to look much further than the balance sheet,” said Rakers, who rates Hewlett-Packard “hold” and recommends buying Dell shares.
Hewlett-Packard, whose $26.5 billion of bonds outstanding have an average maturity of 5.11 years, may need to tap debt investors for an additional $2 billion to $4 billion, according to Barclays Plc analysts Hale Holden and Jonathan Kahnowitz. That influx of supply, combined with “market skepticism” about deteriorating earnings, may widen spreads on the company’s bonds, the analysts wrote yesterday in a report downgrading the securities to “underweight.”
Relative yields on Hewlett-Packard bonds have already increased 8 basis points this month to 2 percentage points, Bank of America Merrill Lynch index data show. Dell’s have declined 1 basis point to 148 in the same period.
The spread on Hewlett-Packard’s $1.5 billion of 2.6 percent notes due in 2017 has widened 37 basis points to 2.12 percentage points since the debt was sold in March even as relative yields on similarly-rated corporate debentures narrowed 50 basis points, according to Trace and Bank of America Merrill Lynch index data.
That doesn’t bolster Hewlett-Packard’s chances of obtaining the “mid-single-A” credit rating that Chief Financial Officer Cathie Lesjak said was “a top priority” on Oct. 3. Credit- default swaps linked to Hewlett-Packard imply a rating of Ba2, five levels below where Moody’s currently ranks the company, according to Moody’s Corp.’s capital markets research group.
The ratings firm said in a statement yesterday that the company’s earnings outlook meant leverage could be higher than it had expected. Moody’s said in March that the rating could be lowered if Hewlett-Packard maintained an adjusted leverage ratio above 2 or if margins linked to earnings before interest and taxes dropped below 7 percent for an extended period of time. That measure fell to 6.96 percent in the third quarter, Bloomberg data show.
Ebitda generated in the past 12 months has declined for four straight quarters to $13.7 billion as of July 31.
Swaps linked to Hewlett-Packard have almost doubled this year to 297 basis points at 11:07 a.m., according to prices compiled by Bloomberg. The contracts, which pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, are 16 basis points from the record-high 313 basis points set in July. Swaps on Dell are up 109 basis points this year to 246.
“If you’ve got a company in HP’s case where the Ebitda is declining and there is really not a whole lot of room for them to reduce debt, to be able to do what Moody’s says is needed to retain the A3 rating is difficult,” Monica Erickson, a Los Angeles-based money manager and credit analyst at DoubleLine Capital LP, which oversees more than $45 billion, said in a telephone interview. “They’ve got a lot of work to do to turn things around.”
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