HWP's Carly Fiorina is the cover of Barron's this weekend.
Picture-framing perfect photo.
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August 13, 2001
Barron's Cover
Carly's Challenge
The only way to save HP may be to scrap everything but its
printer business
By MARK VEVERKA
Call it Carly's Vietnam. Just as Richard Nixon inherited a
hopeless situation in Southeast Asia, so too did Hewlett-Packard
Chief Executive Carleton Fiorina find herself neck deep in the big
muddy known as the personal computer business, with no hope of
stemming the bloody losses and no hope for withdrawal with
honor.
Indeed, a surrender in the PC price wars would not only bring
shame to this once-proud company, it would also give rise to
claims of victory by Compaq Computer, with whom HP
competes fiercely in big retail outlets like Best Buy and Circuit
City.
But surrender she must. Fiorina, who
took over as HP's chief executive
with much fanfare in July 1999, has
little choice but to exit the PC
business if she hopes to remain
commander-in-chief at the venerable
technology concern beyond the three
years that she has allotted herself to
turn the company around.
There are multiple reasons for the
46-year-old CEO to retreat from
personal computers -- a business her
predecessor, Lewis Platt, just five
years ago declared HP would come
to dominate. First of all, PCs have
become a slow-growth,
commoditized business in which a
only a stubborn few are going to survive. And for all of the toil
and trouble expended to compete in consumer computers, HP is a
distant No. 4 in the business worldwide, controlling a meager 7%
share of the market. And as a high-cost producer of these
machines -- HP's operating margin on PCs is breakeven at best,
compared to a 7% margin for Dell Computer and 1.5% for
Compaq -- the battle will be futile.
Making matters worse, in the second quarter of this year, personal
computers saw a decline in units shipped for the first time since
1986. Only Dell managed to muster positive growth rates for the
quarter, according to industry researchers Gartner Dataquest
Group.
So if the company is going to survive as a major developer and
manufacturer of computer hardware and software over the long
term -- one of Fiorina's oft-stated priorities -- it is imperative for
her to concentrate the bulk of her resources and talent on
rehabilitating HP's high-end enterprise computing business. And to
do so, given the company's deteriorating financial condition,
Fiorina can no longer try to compete in a street fight with the likes
of Dell and Compaq in the consumer arena if she hopes to
challenge Sun Microsystems and IBM at the highest end of the
enterprise spectrum where tradition-rich HP belongs.
"The economics aren't there for HP. They should shut down their
PC business, or sell it off, if they can," says the CEO of a
mid-sized Silicon Valley software company.
And if the arguments for pulling out of the PC business are not
sufficient to stand on their own merit, there is perhaps an even
more compelling reason. HP's personal computer business is an
anchor around the neck of the company's most profitable
franchise: ink-jet and laser printers, and the steady -- and highly
lucrative -- revenue stream from consumables, such as ink and
toner cartridges.
Consider the numbers: HP's workhorse printing and imaging
division accounted for 127% of the company's $324 million
operating profits in the second quarter, according to Merrill Lynch
(see the following table). And while the printers themselves are
marginally profitable, the real money comes from ink and toner
and the like, which produced 93% of total imaging operating
profits and 118% of operating profits overall.
No surprise, then, that the business is under pressure from
lean-and-mean competitors, such as Lexmark International,
Epson and Canon. Making HP's challenge even greater is that
rival personal computer makers, such as Dell and Compaq, are no
longer crazy about bundling HP's printers with their PCs. In fact,
Dell and Compaq, the No. 1 and No. 2 PC makers, respectively,
are increasingly bundling Lexmark printers with their PCs instead
of HP's, says technology portfolio manager Paul Wick of J&W
Seligman. HP's position in the PC market impedes growth in
printer market share because their PC competitors have legitimate
disincentive not to sell HP printers.
"If you were Compaq or Dell, the odds are you would rather do
business with Canon, Epson or Lexmark. Those are the facts of
life," explains Wick, who owns Lexmark shares. (Lexmark, once
IBM's printer and typewriter division, was sold to private investors
in 1991 and taken public on its own in 1995.)
On the other hand, if Fiorina were to sell or close HP's personal
computer operation -- and some industry insiders scoff that her
only real choice is to close it down, as the business would have no
value to an acquirer -- the company's most profitable division
would be emancipated from its shackles of conflict. Then,
according to top personal computer executives, the world's biggest
box makers would be more inclined to bundle and push the sale of
HP printers.
Unfortunately for Fiorina, shuttering or selling the personal
computer unit alone -- and since HP outsources all of its PC
manufacturing, there's little to actually sell -- will not secure
continued success for the printing unit. In fact, it is time to devote
undivided attention to the unloved bulwark. Fiorina and her board
should no longer take HP's crown jewel, however unglamorous it
may seem, for granted. After years of siphoning proceeds from the
printer business to subsidize underperforming areas, it is
imperative that she start reinvesting in the high end of the digital
imaging business.
And if the company's lagging server, storage, software and
services businesses don't begin to gain market share as well as
mind share soon, stockholders soon could rightfully argue that HP
should jettison some or all of its enterprise efforts and focus solely
on printing and imaging.
No doubt, stripping
once-mighty HP down to a
mere printing and imaging
company that would compete
with Canon (its partner in
printers), Kodak, Fuji and
Lexmark would be a
significant blow to the
pocket-protector proletariat of
Palo Alto. What's more, it would be pathetically ironic if, 10 years
after IBM sold off its printer division, HP were to be reduced to
nothing more than a printing and imaging concern while Big Blue
has fully rebounded to offer complete computing solutions to its
corporate customers -- and huge gains for its shareholders.
Fortunately for Fiorina, that day is not yet upon her. But nor is it
so far off as to seem unfeasible, especially if the enterprise side of
the business fails to carry its own weight soon enough to avoid
being a drain on the printing operations.
Carly Fiorina arrived at HP two years ago, fresh off a stunning
performance as the head of marketing at Lucent Technologies,
which at the time was still regarded as a technology and
stock-market standout. But even as a flood of favorable media
stories cascaded down upon her, her job as savior and turnaround
artist, for which she garnered a $25 million signing bonus plus a
pay package worth at least $1 million a year, was shaping up to be
far more difficult than perhaps anyone imagined.
HP, after all, is a legendary technology company -- so legendary,
in fact, that the Palo Alto garage where founders William Hewlett
and David Packard started the firm in 1939 has been preserved as
a state landmark. And the vaunted "HP Way," which stressed trust
and openness, also encouraged decentralization to a fault. Indeed,
by the time Fiorina took over, HP had 83 separate business units,
each with its own profit and loss statements.
Fiorina quickly reduced that number to 16, and after the June
2000 spinoff of Agilent Technologies, the company's
measurement and testing division, HP reports only three major
segments to the Securities and Exchange Commission: Imaging
and Printing Systems, Computing Systems and Information
Technology Services.
But corporate culture is a difficult thing to change. So while
competitors, like EMC in storage and Siebel Systems in customer
relationship management software, rushed into new markets and
established themselves as leaders, Fiorina was faced with having to
make dramatic changes in a company beset by years of
self-satisfaction, apathy and missteps. Still, the general feeling on
Wall Street was that if Louis Gerstner could whip IBM in to shape
from the get-go, Fiorina should be able to do the same. Indeed, in
the nine months after she took over, HP's shares rose 50%, to an
April 2000 high of 76.50, as investors hitched their wagons to
what they believed would likewise be a rapid turnaround.
Yet Fiorina's initiatives now appear to be falling short, and she no
longer has the benefit of a burgeoning technology market to buy
her the time she might have needed to implement her vision of
both a consumer-oriented and enterprise-focused company.
And in the wake of missing her earnings target for the fourth
quarter of fiscal 2000 (ended October 31) -- and subsequently
guiding the Street down from lofty expectations set by her --
confidence in her leadership is starting to wane, and the long
knives are starting to sharpen despite the fact that she is in the
middle of trying to turn a battleship inside a bathtub. "She has
made zero changes that have actually changed the strategy and the
culture of the company," harps the software CEO quoted earlier.
That clearly overstates the case, but it shows how dramatically
sentiment in Information Technology has turned against her in the
last year. That change in sentiment, in turn, is beginning to take a
toll. In an unabashed display of bunker mentality, Fiorina, once a
media darling, declined to be interviewed for this article. In
addition, HP refused to allow any of its other top executives to be
interviewed by Barron's.
Not everyone blames her for
HP's current sad state, but
neither are they hopping back
on the Fiorina bandwagon. "I
think Carly is getting a bum rap
here," says Thomas Kraemer, a
server and enterprise hardware
analyst at Merrill Lynch. "I
don't know how you can slam
her for some of the poor
decisions she inherited,"
especially in computing, Kraemer says. "Quite honestly, the die
was cast for that business before Carly Fiorina and [Computing
Systems head] Duane Zitzner came on board."
Adds Goldman Sachs analyst Laura Conigliaro: "Keep in mind,
when she joined the company there were a lot of issues. Hewlett
had become really sluggish, and she tried to make changes quickly.
You certainly can't gauge [her performance] now. With the
economy rolled over, I'm not sure you can judge her."
But technology recession or no, the market will continue to judge
her. And despite recent setbacks, there are bullish musings by
some technology investors who argue that HP's shares are actually
a good buy at its current price of 25 -- down 67% from their April
2000 high.
The thinking goes like this: At 25, investors are paying fair value
for HP's printing and imaging business and are getting the
remainder of the company, which has a market value of $49
billion, free.
At first glance, that proposition sounds attractive, especially with
$3.6 billion in cash and $6.3 billion in "long-term investments" on
the books. But there may be a good reason that the non-printing
operations of the business are valued at zero. HP is not a market
leader in personal computers, PC servers, enterprise storage,
software, Information Technology services or UNIX servers.
What investors would actually be getting free might not be worth
anything.
Some analysts are even less charitable. Merrill's Kraemer, for
example, posits that HP's printing and imaging business is worth
$30-$35 a share as a stand-alone business.
But given the company's weakening position in servers and
software as a liability, in his mind, he thinks sustained losses in
those two groups could push the fair value of HP's shares in the
low 20s.
At the same time, Kraemer, who has a Neutral rating on HP,
worries about the ongoing strength of HP's printer operations. Unit
growth in printers has been disappointing for the past three
quarters across the industry, and he expects that unit growth will
continue to sputter at least through Christmas of this year.
Additionally, Kraemer notes that bad news often comes on the
installment plan. Because most of the money in printers and
imaging is made in consumables, slow growth in unit shipments
will have a negative impact on the overall number of printers in
use. That, in turn, will have a direct impact on consumables. In
other words, weak printer sales will inevitably produce weak
consumable sales.
It generally takes at least two quarters for a sluggish sales trend in
ink, toner and other suppliers to turn around, Kraemer explains,
adding that a prolonged slump makes predicting forward-looking
sales of consumables even more problematic.
Kraemer expects HP to earn $1.2 billion, or 63 cents a share this
year, on revenues of $45 billion. That's down from $3.6 billion, or
$1.72 last year, on revenues of $48.8 billion, and it's 10 cents
below the Street's consensus of 73 cents according First
Call/Thomson Financial. His fiscal 2002 estimate of $1.01 is seven
cents lower than those of his peers.
"The imaging business is an algebra problem," Kraemer says.
Thus, "The earnings problem we see should not be a surprise."
The other major threat to HP's printing franchise is much
longer-term, but no less ominous. Eventually, digital imaging is
expected to replace film photography and propel computer-based
printing into the next generation of innovation. HP has not been
pumping as much capital back in to its most profitable business
because it has had to subsidize other initiatives. "That is absolutely
true," notes Goldman's Conigliaro.
Indeed, as the company chart shows, HP has cut back its R&D
spending sharply since Fiorina arrived two years ago -- cuts that
have not been matched by IBM.
That could be absolutely devastating to the long-term viability of
the imaging business. In many ways, the printing operation is a
strange bedfellow to the enterprise computing business that Fiorina
is trying to resuscitate and build. Servers, storage, software and
services all fit hand in glove, while printers stick out like a sore
thumb.
"It's a very odd mixture," admits Conigliaro, "that is an obvious
reason for splitting up."
Fiorina, who once declared that "mind share is market share,"
hasn't had much luck at rebuilding either when it comes to
high-computing systems. While HP earned a reputation as
provider of cutting-edge systems for businesses during the great
migration from mainframes to minicomputers to high-end PCs, in
recent years the company has slipped dramatically. "HP has fallen
far behind both of its competitors, IBM and Sun, in market-related
mind share," says Conigliaro. "You just don't see HP that much
when it comes to getting most of the strategic opportunities."
Case in point: HP continues to lag in data storage, which has been
and will continue to be one of the biggest Internet-driven growth
areas in information technology. In fairness, HP originally suffered
from similar mistakes made by its enterprise foes IBM and Sun.
As data storage became more important to corporate computing
needs, each of the three computer makers underestimated the
difficulty of developing reliable and simple storage products. And
for the most part, each of the three has stumbled in this area to a
large degree, allowing storage giant EMC to grab market share
during much of the past decade.
But HP also made some questionable calls that continue to plague
the company today. Recognizing its weakness in storage, HP
teamed with EMC in the mid-1990s to provide mostly
EMC-branded storage products to companies that used HP's Unix
servers. The deal gave EMC entree to HP's coveted installed
users, but tended to favor EMC financially. EMC refused to allow
HP to sell EMC storage systems under the HP name, which may
have been one of the most astute decisions made under Executive
Chairman Michael Ruettgers.
In May 1999, realizing that it needed to grab a higher percentage
of the Unix storage spoils, which EMC was not willing to part with
now that HP's customers were impressed with EMC's brand and
performance, HP broke away from EMC to partner with Hitachi.
The Japanese conglomerate let HP put its brand on the box that
housed Hitachi's storage hardware, and HP added a layer of
software to the system.
But by then, unfortunately for HP, its own Unix customers had
grown fond of EMC and appreciated the company's trademark
round-the-clock service. EMC controls nearly 50% of the storage
market in the United States among users of HP Unix servers.
Gartner Dataquest ranks Hewlett-Packard No. 3 in Unix-related
storage, based on revenues, behind Sun and EMC.
It gets worse. Just last week, in what was one of the worst-kept
secrets in Silicon Valley, Sun and Hitachi announced an extensive
and elaborate partnership to co-brand and distribute their storage
and software worldwide. This is bad news for EMC, but it's
absolutely dreadful for HP.
HP's story in high-end computer servers isn't much rosier. It also
starts with missteps during the Lewis Platt era. (Platt took over as
CEO in 1992 and assumed the chairman's role from co-founder
David Packard a year later.) During the mid-1990s, HP made a
huge bet on an operating system for Windows NT servers. As it
turns out, Microsoft and Intel were late in delivering the system,
and it was slow to take off.
Then, just as HP began migrating away from Windows NT,
Internet use exploded. Sun Microsystems doubled-down its bet on
servers, IBM became more aggressive in the segment, and HP
was caught flat-footed in the midst of transition. As a result, Sun
and IBM became the dominant sellers of servers during the
Internet gold rush.
During the second quarter of this year, HP ranked No. 4 in total
server shipments worldwide, No. 3 in terms of server revenues.
IBM and Dell, meanwhile, still have momentum despite the
economic downturn; they were the only server makers to show
growth in both the U.S. and international markets during the
quarter.
Nor can HP's trouble in servers be altogether attributed to the poor
economy. Poor execution has been at least as troublesome. For
example, by the time HP introduced its latest high-end server,
known as SuperDome, last fall, Sun and IBM were already in the
marketplace. Since then, America Online and Amazon.com,
among others, have bought into the new line, but the company still
remains behind.
Software is another glaring weakness for HP, especially
compared to IBM which has a full stack of offerings that are
serviced by its own consulting staff. HP is simply not a significant
player in enterprise software. "Not only is it not a strength, but it's
tiny!" quips Conigliaro. "You normally don't pay attention to a $1
billion business within a $48 billion company."
HP has made some small software acquisitions, including the
buyout of a Web application software company. But it remains a
distant third in what appears to be a two-horse race between BEA
Systems and IBM to claim that critical Internet platform.
But in order to build a world-class information and technology
services practice -- a cornerstone of Fiorina's vision -- HP must be
able to offer soup-to-nuts software solutions. Earlier this year, it
appeared that Fiorina was going to make the kind of big play in
software that the company needed. It was rumored that HP was
kicking the tires of some beaten-down middleware start-ups, many
with laudable technology and sales forces. (Middleware is software
used to integrate different systems within and between
corporations.)
But in the end, HP failed to pull the trigger on any mergers or
acquisitions. Instead, it settled for partnership deals with solid
companies such as webMethods and Tibco, which, frankly, do
more for the software companies than they do for HP.
And last fall, Fiorina swung for the fences and appeared to clear
the wall. She struck an $18 billion stock and cash deal to acquire
the consulting arm of PricewaterhouseCoopers. It was a gutsy
move, fraught with risk and hurdles, but it was the kind of
audacious high-impact deal that she needed to transform the
company into a complete information-services company along the
lines of IBM. But in November, after revealing that HP had
missed its fiscal fourth-quarter numbers, Fiorina also announced
that the PricewaterhouseCoopers merger was off.
Pricewaterhouse Chief Executive James Schiro cited HP's sagging
market price as the culprit. Others contended that too many of
PWC's 30,000 highly paid consultants threatened to bolt from HP,
essentially killing the merger.
Whatever the reason, Fiorina is left with a business that lacks the
full stable of hardware and software upon which to build a total
Information Technology business from scratch. Information
Technology services accounted for about $7 billion, or 15% of
HP's revenues last year, compared with $33.2 billion, or 37.5% of
revenues, for IBM. Indeed, services is now the second most
profitable part of IBM's business, after software. Clearly, Fiorina
will need another Hail Mary pass -- and this time a successful one
-- if it is to reach the kind of scale necessary to make services a
significant driver of profits.
"For all the changes that have been made, says Conigliaro, "it will
take at least as many changes over the same number of years to
get the company positioned where it wants to be."
That, or one dramatic change -- shedding everything save for the
printer business -- are all that might get HP's shares moving in the
right direction again. |
