The Cuts Aren't Over at HP

CEO Mark Hurd says the company's operational and information technology costs are still too high

Mark Hurd is not done cutting at Hewlett-Packard. Not by a long shot.

The HP (HPQ) chief executive officer has already seen the company through a huge restructuring that reduced headcount by more than 15,000 and overhauled its retirement plan. And at a meeting with analysts in New York on Dec. 12, Hurd made it clear that there is still more work to be done.

"We are a company transforming, not a company transformed," Hurd said more than once during his remarks. And it's clear there are many targets he has in mind. Real estate is one—HP has "too much" of it, according to Hurd. Operational and information technology costs are too high, he said. "We still have a lot of heavy lifting to do."

Trying to Boost Sales

Take IT costs. Analyst Lou Miscioscia of Cowen & Co. in New York estimates that HP spends 4% of sales on IT infrastructure. "That's high compared to other companies who spend about 2% to 3%. If they cut it down to those levels, that could mean $900 million in savings," he says.

But as any first-year MBA student knows, cutting costs doesn't translate into increasing revenue. Hurd says that calls for flooding the zone with a batch of new sales personnel. Hurd wouldn't say exactly how many the company has hired or will recruit, saying only that so far "hundreds" have been brought in, and that their results are being tracked closely. "We track sales by person, not only to see how much they're selling but what else they have in their funnel," Hurd said.

So between cutting costs and boosting sales personnel, is that enough for HP? Not to American Technology Research analyst Shaw Wu, who says he's keeping his neutral rating on the stock for now. "Everything they said is pretty much in line with expectations," Wu says. "We expected more cost-cutting and more attention to sales. But at some point HP needs to reinvest and build up some new revenue streams. Until then it's going to be mostly a cost-cutting story."

Symantec Buyout Not Likely

Goldman Sachs analyst Laura Conigliaro sees HP shares—now just under $40—at her $47 target if it can bolster its revenue through 2009. "Our price target assumes that HP will be able to add on roughly $5 billion or so to its revenue for each of the next couple of years," she wrote in a research note issued after the market closed on Dec. 12. "If macro or company-specific factors turn down enough to impede that, it will have negative implications for margins regardless of expense savings."

Then again, maybe a quiet and predictable story of consistent cost-cutting is exactly what HP needs right now in the wake of the spying scandal that cost former Chairman Patricia Dunn her job and rocked HP's board and executive suite (see, 10/9/06, "Controlling the Damage at HP"). Hurd will no doubt be delighted to talk about slow, steady sales growth instead of corporate spying scandals.

One thing that appears unlikely is an HP buyout of Symantec (SYMC), which had been the subject of persistent rumors of late. Hurd said HP's acquisition strategy will tend to focus on smaller companies such as the deal announced Dec. 6 in which HP said it will acquire Knightsbridge Solutions, a 700-person IT consulting firm, and VoodooPC, a small Canadian vendor of high-end gaming PCs. "We will do targeted M&A deals, but you should not expect huge deals," Hurd said, apparently putting the Symantec rumor to rest for the time being. HP's last big deal was for software concern Mercury Interactive, which cost $4.5 billion (see, 7/29/06, "Mercury's Star Rises").

Passing the Finance Baton

Bob Wayman, making his last appearance at an analyst meeting as HP's chief financial officer, held steady on the company's outlook for its current fiscal year, which ends in October, 2007, and gave the first peak at the forecast for fiscal 2008 ending October, 2008. The company expects to report sales of about $97 billion in fiscal 2007 and to go above $100 billion in fiscal 2008, Wayman said, in line with company goals of increasing revenue within a steady range of 4% to 6% annually. Operating margins in 2008 will come in between 9% and 9.5%, which would imply profits of between $7.6 billion and $8.2 billion, or $2.78 to $2.98 on a per-share basis.

Succeeding Wayman on Jan. 1 is Treasurer Cathie Lesjack, who left a good impression on Merrill Lynch (MER) analyst Richard Farmer. Their meeting was the subject of a research note published Dec. 6. "Cathie came across as someone who shares CEO Mark Hurd's philosophy of underpromising and overdelivering," Farmer wrote. "Our first impression: She appears articulate and knowledgeable about HP's operations, given her 20-year history with the firm…Cathie stated that HP intends to use its cash first to fund organic and inorganic growth, and then return excess cash to shareholders through buybacks. As before, HP does not plan a special dividend."

Clearly, there is progress being made. The operating margin range expected for 2008 is way ahead of the 6% range HP turned in for 2005. And that leaves the picture looking anything but dour at HP for the next eight quarters or so. "Hurd is a master of setting attractive expectations and then overdelivering on them," says Cowen's Miscioscia. "Even just hitting those expectations, the picture is pretty attractive."

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