HP's New Soft Spot for Software
Hewlett-Packard's $1.3 billion software business swung to an $85 million profit last year, from a $49 million loss a year earlier. That's just the warm-up. Within two years, HP says it can reach $2 billion in sales and triple profits.
It plans to do that by snapping up more companies and retooling its sales force to package combinations of servers, software, and consulting services. The bigger aim isn't just bolstering results but also taking on IBM (IBM) as a key supplier of business software. "Software is key to differentiating our hardware and differentiating our services," says Shane Robison, HP's executive vice-president and chief strategy and technology officer. "Software is important across the board.…The one company we're focused on as a competitor is IBM."
The latest arrow in HP's quiver is PolyServe, purchased on Feb. 26 for an undisclosed amount. PolyServe's software can improve the performance of database software used in conjunction with power-efficient blade servers. HP (HPQ) holds nearly 42% of the market for blades, which yield more profits than standard servers based on Intel (INTC) chips, and it wants to widen its lead.
On Feb. 5, HP scooped up Bristol Technology, whose software helps companies assign multistep operations like processing insurance claims and ordering products with the computer systems best equipped to handle them. On Dec. 20, the company bought Bitfone, which makes software for updating companies' PDAs and cell phones with new applications. Next up could be a software maker that specializes in identifying trends from massive volumes of data. A prime candidate, analysts say, is Teradata, the NCR Corp. (NCR) unit that's positioned for a spinout.
In a panel discussion at a venture capital conference in San Francisco on Feb. 27, Robison said chief information officers are more concerned these days with squeezing efficiency out of their fleets of servers, PCs, and cell phones than in buying machines that sport the latest microprocessor. HP's software portfolio could help. "We have a whole new area we can focus R&D," he said.
HP is trying to use its considerable software investments to sell more high-margin products in areas such as blade servers, data analysis systems, and consulting services aimed at making corporate computer centers more efficient. In an IT market in which companies are getting maxed out on equipment, software can provide an entrée to new sales. The software push comes as HP Chief Executive Mark Hurd looks for growth from mobile computing, data-center management, and new kinds of printing services, while continuing to pare costs (see BusinessWeek.com, 12/13/06, "The Cuts Aren't Over at HP").
HP could keep top-line growth and profit margins climbing by selling customers software for automating tasks in data centers, ferrying computing workloads to the right machines, and crunching the numbers for their sales and operations—and packaging it all with hardware and consulting. "These software products are the leading indicator for sales in other parts of HP," says Stuart Williams, a senior analyst at consulting company Technology Business Research. "This is if you buy the whole kit and caboodle from HP."
If HP's software gamble pays off, it could help the company meet Wall Street expectations that it can add to profits and increase sales to $104 billion in 2008, vs. $91.7 billion last year.
"The highest margin thing HP can sell, other than printer cartridges, is software," says Brian Farrar, a managing director at Innovation Advisors, a Chicago investment bank that advises technology companies on mergers and acquisitions. "Software is really a hedge against some of their other businesses, which are in danger of becoming commodities."
By Robison's math, increasing research and development spending on software—already the target of almost 70% of the company's $3.6 billion annual R&D budget—provides better returns than hardware investments because the expenses are fewer. "You have effectively more money to spend with the same absolute dollars by doing more in software," he says.
However efficiently HP allocates R&D spending, taking on IBM in software is a tall order. Corporate technology buyers haven't traditionally thought of HP as a supplier of complex software that can manage data centers and chart companies' processes. They turn to IBM and others for that. Moreover, HP's new attention to software could move it into territory traditionally occupied by heavyweights Microsoft (MSFT), SAP (SAP), and Oracle (ORCL), whose software HP's consultants help customers install. "They need to be very careful about managing those relationships," says Williams. And disk-drive giant EMC (EMC) is becoming more focused on software that can manage companies' storehouses of data, which could prove troublesome for HP's fledgling Neoview data warehouse software, developed under the eye of HP CIO Randy Mott, an expert in the field.
Then there's the question of whether HP needs to move even faster in a software market where many of the most successful midsize companies are getting bought. Despite its software shopping spree—HP has bought eight companies in the last year and a half alone—some investors say HP could be doing even more with its $10.4 billion in cash and $105 billion market cap, evidence of a turnaround Hurd has orchestrated. "They're just not being as aggressive as they need to be in this M&A market," says Murray Beach, president of Boston Corporate Finance, an investment bank that advises tech companies. "It's a three-horse race in this world right now between IBM, EMC, and HP. And HP has been the slowest to move." To shore up its portfolio, HP should acquire software companies in areas including Sarbanes-Oxley compliance, content management, and business intelligence, Beach says.
Meanwhile, IBM made four key software acquisitions in the second half of 2006, augmenting areas including document management, security, and capital goods tracking. That's on top of the 16 software firms Big Blue claimed in 2005. Thanks to its cash-cow mainframe business and newer Java software, IBM generates about a fifth of its $91 billion in revenue from software and keeps more of those sales as profits. HP's distractions with the fallout from a corporate spying scandal last year may have held it back, says Beach. "They could have bought any of the things IBM did," he says, "and probably should have."
Not that HP isn't bulking up. Its $4.5 billion acquisition of Mercury Interactive, which closed Nov. 7, effectively doubles the size of its software business (see BusinessWeek.com, 7/29/06, "Mercury's Star Rises"). Software sales shot up 81%, to $550 million, during HP's first quarter, which ended Jan. 31. Without Mercury's software for managing corporate data centers, sales would have risen just 7%. HP says the combination of Mercury with older brands can reach sales of $2 billion.
By the end of the 2008 fiscal year, which begins Nov. 1, HP forecasts 10% to 15% sales growth from software and profit margins of 18% to 22%. New branding that emphasizes the HP name and healthier commissions for software sales are part of the plan.
"We're investing very heavily in being front-and-center on the agenda of CIOs," says David Gee, vice-president of marketing for HP software. Investors credit HP's computer and printer businesses with sparking a renaissance at the company, he says. "I want us to get credit for our software as well."
A revamped management team is another component. Senior Vice-President Tom Hogan, former CEO of business software maker Vignette (VIGN), and a veteran of IBM, marks one year on the job as head of HP software next month. On Feb. 5, HP brought on board Vice-President Sam Greenblatt, a CA Inc. (CA) alumnus charged with incorporating software into all of HP's products.
That isn't limited to business products. In 2005, HP bought online photo-printing company Snapfish, and Robison points to company-developed software that lets users of HP notebooks watch DVDs without booting up Windows as a feature that differentiates its products.
On the other end of the scale, HP is trying to crack the market for data-warehousing software. The company moved Neoview software into Hogan's group last month; customers include retailer Bon-Ton Stores (BONT) and Chinese cell-phone giant China Mobile. On Dec, 6, HP announced it would buy Knightsbridge Solutions, a consulting company with expertise installing data-warehouse systems. Analysts say HP could be interested in acquiring a business-intelligence software company, or perhaps even Teradata. "That's a real opportunity," says Farrar, though he gives Oracle or IBM the edge if Teradata gets sold.
Vice-President Gee says HP's $2 billion revenue target for software is just the start, and contends that IBM's mainframe software could be a liability in the long term, since its upkeep is tied to pricey consulting. "I'd play with our hand any day of the week," he says. An IBM spokesman says the company has an edge in its ability to quickly absorb acquisitions and from the large ecosystem of software vendors whose products are compatible with its technologies.
HP has a long way to go before it catches up with IBM in software. As it pulls out the stops to try to get there, the market might be in for even more pruning.