Splitting HP signals end of an IT conglomerate; enables separate actions; opens door for sell-off
Technical Business Research, Inc
OCT 20, 2014 01:46 AM
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TBR perspective

The age of the conglomerate IT vendor that sells everything from hardware to management consulting is over. Hewlett-Packard's division from a single $115 billion conglomerate into two publically traded firms acknowledges execution failures in winning share and increasing profitability across divergent and often competing business units. The change marks the latest in a string of divestitures and business model shifts across the business landscape where "all-in-one" firms such as IBM, Dell and Cisco have exited, gone private or sold off units. After four years of attempting to create a more integrated and "one" HP, CEO Meg Whitman stopped fighting the tide and split the firm into two companies: HP Inc. (HP), a $57.2 billion PC and printer company, and Hewlett-Packard Enterprise (HPE), a $58.4 billion enterprise-focused servers, services, software and cloud company. Each business has roughly the same operating profits and margins (HP: $5.4 billion, 9.4%; HPE: $6 billion, 10.2%). Business growth rates are also nearly equal, as HP rose 1.7% and HPE grew 0.4% in the trailing 12-months after 2Q13.

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HP's strategy is threefold: 1) abandon the conglomerate strategy; 2) enable two very different businesses to find their own ways; and 3) make it easier to partner, merge or even potentially sell one business or the other. HP has not been effective in gaining synergies from its conglomerate approach, facing internal battles between business silos and external challenges in defining solutions across a vast portfolio. HP's objective for the new businesses is to create an opportunity for the two to be more agile and effective than the unified company was in business and partnering. The split also opens the door for potential sales of one or the other business (potentially to Dell, Cisco, IBM or EMC), as the price for a separate unit is more manageable than HP as a whole.

Driving the split is the tremendous disruption among IT buyers, triggered by changing customer needs and buying patterns. Enterprises have begun shifting budgets from buying fixed gear to services-focused, converged and cloud-based models that package compute and applications. The shift has been more rapid and extensive than many vendors projected. It impacted hardware businesses most strongly, but also professional services, outsourcing, software and applications. At the same time, customers have also changed how they buy, adopting more self-service, scalable models that decreased overprovisioning, shelfware and big-bang deployments. The resulting business model disruptions drove IBM to sell its PC and x86 hardware lines to Lenovo, drove Dell to privatize and prompted Cisco to exit the consumer networking space.

The immediate challenge for HP is developing two separate companies, each with legacy customers, partners and portfolios, which both quickly differentiate as more agile, more responsive and more market-focused businesses than their business unit forebears. The challenge is not so much organizational as cultural and process-driven. The speed that the old HP operated at is not nearly as fast as the speed at which the new businesses will need to move. Can the executives, portfolio teams, sales and overall culture change enough over the next year to allow the two new entities to explode on the market? HP's depth of preparedness for and the subsequent speed at which the two units operate will indicate how well the businesses will fare in the market.

Every traditional IT vendor faces the same pressures and the same needs for change. TBR believes the current, largely separate nature of HP's diverse Printing and Personal Systems (PPS) group as well as Enterprise Group (EG) does not significantly add value or eliminate cross-business inefficiencies. Instead, HP is setting each new entity free to find its own way. The move to divide will nominally provide HP more agility to react to demand, but more importantly, will enable each firm's go-to-market messaging to directly appeal to its targeted customer base: HP to consumers and SMBs and HPE to large enterprises.

TBR expects the split to effect numerous changes, including:

·   Broader and more beneficial alliances

o HP has the opportunity to work more closely with Microsoft and Google around new devices. (HP works closely with Google on Android-based consumer devices and with Microsoft on business-oriented tablets and other devices.)

o EG works closely with Microsoft, including broad adoption of Microsoft's Azure platform.  

·   More-focused marketing and overall go-to-market strategy:

o HPE will focus on businesses, especially large enterprise.

o HP will market and sell to consumers as well as businesses.

o Each company will have more freedom to restructure as it sees fit. One or the other company may move toward a merger or privatization, something that would be more difficult for the larger combination.

·   Changes in investment tactics

o Each company will have more flexibility in investing its resources where there are opportunities, without taking into account the concerns, issues or competition for resources of the other company.

o TBR believes HP will tailor its emerging market strategies by company.

Benefits

Dividing HP's assets into two distinct organizations has numerous benefits to the company, stockholders and partners. For each HP company, marketing and go-to-market messaging will become easier and clearer to stakeholders. The separation of its PPS group from its EG business will give HP more market appeal as a vendor-agnostic IT provider, both to customers and partners. Financially, those with HPQ (NYSE) stock will be given one share of HP and one of HPE per share of HPQ, allowing freedom to buy and sell either company's stock based on individual preferences. The potential upside for shareholders is significant, as one or the other firm can improve performance and not be weighed down by the other, resulting in higher share price.

The separation also provides HP more partner opportunities, such that each of the entities is not as likely to have portfolio overlap with partners. For example, we expect HP will work closely with Google now that HPE is individual, since Google and HPE compete directly in the cloud space. Inversely, HPE will be able to strengthen its alliance with Microsoft now that HP has been separated, as Microsoft and Google often go head-to-head. The split also gives an advantage to channel partners that seek to mix and match offerings from various vendors, piecing together solutions for customers that combine HP, Dell, IBM and Lenovo PCs, software and/or services.

Risks

Customers: The split will not have a big impact on customers outside of a few very large and strategic accounts. On the direct sales side, current HP sales and engagements are already split among different sales teams that sell point products and offerings into customer organizations. Only the largest accounts have overall account managers, and these teams coordinate the underlying sellers. Overall synergies between what is HP and HPE are immaterial. The greater hazards for HP are the buying synergies, where PCs, servers, networking and printers are purchased by one business. Since much of this revenue is generated by the channel, HP risks confusion across its partner base.

Channel: Currently, EG derives 70% of revenue from the channel, and PPS derives up to 80% of revenue from channel partners. HP partners are siloed into different PartnerOne levels across portfolio areas. A Gold Volume PPS partner may be a Silver EG partner, and so on. The partners have, in the past, been incented to drive cross-portfolio sales, so the opportunity will be eroded specifically where HP generates a majority of revenue. While there are perceived benefits for channel partners, lack of clarity on the future of the partner programs is creating confusion among partners. Channel partners that seek to sell HP products, services and solutions together will have questions around bundling the solutions and who pays for them. Other questions are: Will HP incent the channel to package HP solutions, and if so, how? How will HP provide support to partners? Finally, there is the possibility of partners and/or customers switching to Lenovo or Dell as a consequence. Though we expect change will occur over the next year and nothing will be immediate, the speculation alone and discussions around the what-ifs could deter customers as HP works out its messaging.

HP: TBR estimates the cost of the split (between legal, unwinding contracts; headcount reductions; and new programs) to be over $1 billion. The cost will reduce acquisition potential and the available cash for the two new firms. Another impact is to free cash flow, which has ranged between $7 billion and $8 billion. The new firms will, at best, each split the free cash), which will have a strong impact on the size and scope of potential acquisitions as well as in financing. How HP allocates its more than $17 billion in long-term debt across the firms is another risk, as the core firm could overallocate debt to one firm or the other, essentially handicapping performance even before they are operational.

Threats

Customers: HP will also face the same threat it applied to Lenovo throughout much of 2014. Just as HP and Dell blitzed the enterprise market with messages of uncertainty around the transition of IBM's x86 server business to Lenovo, TBR expects Dell and Lenovo will attempt to displace HP customers over the next year. The extent to which these competitors can flood HP's customer base with uncertainty is limited, as current customers are not likely to see any material negative impact to HP's enterprise portfolio or ability to service its products. However, although PPS and EG already operate relatively independently through the channel, Dell and Lenovo can counter with a refreshed message of a one-stop shop, from PCs to servers.

Ownership of HP Labs, Technology Services and the Internet of Things (IoT) and their initiatives between the two companies remains unclear. HP Labs is the hub for any and all R&D initiatives at HP, building on innovative ideas for HP and HPE. Dividing HP Labs or assigning it to one of the two companies will lead to a decline in thought leadership for one or both companies as financial and personnel resources become more limited.

HP Inc. overview and implications

HP's PC and printing sides of PPS have complementary strengths TBR believes will contribute to HP's success. The PC market will continue to grow slowly, keeping pace with global economic and population growth, but HP is the most profitable PC vendor in the market, apart from specialty vendor Apple. The printing market is shrinking as consumers and businesses print less each year, but HP's printing supplies business is highly profitable, generating dollars that can be invested in beyond-the-box products and services. HP will likely continue to work with HPE for traditional service delivery, but HP has the opportunity to explore entirely new products and service packages, including Device as a Service.

This year, HP will devote energy to proving to its commercial customers and channel partners that it will have smooth operations during the transition and improved products and services after. Some customers and channel partners will choose other vendors nevertheless. However, once the separation is complete, HP will have more ability to experiment with new products and business models.

Hewlett-Packard Enterprise overview and implications

Enterprise Group

HP's Enterprise Group has centered on messaging around the differentiation of its hardware in an increasingly commoditized market. Due to the breadth of HP's enterprise portfolio, the HP Enterprise arm will continue to grapple with moving from hardware-centric to solutions-focused messaging following the split. However, TBR believes the vendor's enterprise business will be more aligned with the evolving large enterprise customer, which looks increasingly at managing a heterogeneous environment, focused on workloads and operational results versus working with a single vendor across the end-to-end picture — from PCs to servers.

Currently, EG is mostly independent from PPS, including both management and sales. Just as the impact to internal operations should be relatively minimal, the impact to channel partners will be similarly minimal from an operations standpoint. Because the status of partners is tied directly to either (or both) EG and PPS units, TBR expects partners will continue to carry separate accreditations for HP's enterprise and PC groups.

Regardless of the split, HPE still faces wide-ranging threats from an evolving data center market that now leans progressively on cloud service providers for a portion of their computing and storage requirements. Although commoditized hardware will continue to be the foundation of large-scale cloud deployments, the competition for supplying these environments is fierce and includes both OEMs and ODMs, such as Quanta.

The success of HPE hinges partly on its perception as an open, solutions-centric vendor that supports widely heterogeneous data center environments. Although HP, like other OEMs, needs IP-driven differentiation to preserve market share, the ability to deliver and support vendor agnosticism remains critical. The enterprise unit's separation from the PC unit will help with that perception, but HPE will need to show significant innovation to stay relevant in a period increasingly defined by software-defined IT — where hardware is less relevant.

An additional obstacle for HP to overcome during the split will be to effectively divide the Technology Services (TS) group between the two companies. While TS resides in EG, support, warranty, attach and managed services related to PPS offerings may need to migrate to HP. TBR expects the realignment and transition of TS to take likely five years to resolve as contracts close or come up for renewal. This also reiterates the importance of ensuring attractive service-level agreements such that customers remain confident in the company. HP has made clear that managed print services will be housed under HP, but the company has yet to state outright where support desk and other PC-related services will reside or if transitioned to HP, how it will handle that transition financially and strategically.

Cloud

HP's Helion focused the company more on cloud over the past six months than ever. Helion created a dedicated HP Cloud group with its own solutions and targets for strategic partnerships and M&As. Similar to Enterprise Services, there will not be significant change for HP Cloud other than partnering opportunities and a more succinct go-to-market approach. TBR believes the emergence of HPE will position the company to better execute on its cloud initiatives, allowing it to be seen as a technology- and platform-agnostic cloud provider. We expect HP and, subsequently, HPE will continue to look for strategic acquisition opportunities in cloud, particularly around open source, to complement their portfolios and the recent announcement of HP's pending acquisition of Eucalyptus to differentiate an HP cloud market position. Breaking ties from the PPS group will enable HP to partner with cloud vendors that previously would have had overlapping portfolios, particularly in the devices arena.

Enterprise Services

We expect HP Enterprise Services will still be able to work closely with TS consultants to jointly serve customers' needs. Freeing up HPE from the PPS business provides not only more partner opportunities, but will allow HP Enterprise Services to offer customers more heterogeneous solutions and bundles by not tying them as closely to HP devices. Customers' buying behaviors have shifted to multivendor environments that best meet their needs, factoring in legacy IT, future road maps and cost. HP Enterprise Services' ability to manage any IT environment, whether based on HP, third-party or proprietary infrastructure that is hosted or on-premises behind customer firewalls, will only shine brighter as a result.

Software

TBR expects HP Software will continue, under HPE, developing business solutions for cloud, big data, security and mobility to meet enterprise needs for the "new style of IT." The most immediate change HP Software must address is its loss of scale, which HP often touted as one of its greatest assets. HPE will have less negotiating power alone, and it will have to develop go-to-market messaging and a value proposition that goes beyond flexibility and agility to continue competing with the likes of IBM, Oracle, Cisco and EMC. Conversely, a smaller, more nimble HPE has the opportunity to target partnerships and acquisitions to more quickly build its software portfolio and strengthen the cohesion of its software marketing stance.

For more information and to contact TBR analysts:

Stuart Williams, Vice President of Research (stuart.williams@tbri.com)

Ezra Gottheil, Principal Analyst, Devices (ezra.gottheil@tbri.com)

Christian Perry, Content Manager, Data Center (christian.perry@tbri.com)

Cassandra Mooshian, Cloud Analyst (cassandra.mooshian@tbri.com)

Jack Narcotta, Devices Analyst (jack.narcotta@tbri.com)

Andrew Smith, Analyst (andrew.smith@tbri.com)

Technology Business Research, Inc. is a leading independent technology market research and consulting firm specializing in the business and financial analyses of hardware, software, professional services, telecom and enterprise network vendors, and operators. Serving a global clientele, TBR provides timely and actionable market research and business intelligence in a format that is uniquely tailored to clients' needs. Our analysts are available to further address client-specific issues or information needs on an inquiry or proprietary consulting basis.

TBR has been empowering corporate decision makers since 1996. For more information please visit www.tbri.com.

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