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Investors stop giving Fiorina the benefit of the doubt
By Scott Herhold
Mercury News
It looked like Hewlett-Packard should have had a pretty good day in the market Wednesday. On Tuesday evening, the company announced that it had beaten consensus earnings per share by 2 cents in its most profitable quarter since its acquisition of Compaq Computer last year.
Instead, HPQ had a horrendous day Wednesday, losing 15 percent of its value before finishing the day at $15.37, down $2.81. You have to wonder how much worse it would have been if Chief Executive Carly Fiorina confessed that business stunk.
What gives? Well, two things, or maybe three. But keep in mind that behind all of them is Wall Street's skepticism that mergers of this size can work very well.
First of all, HPQ's revenue was significantly below expectations -- $17.9 billion instead of $18.5 billion. And savvy buy-side analysts often look at a tech stock's revenue before its profit, on the grounds that management can play lots of games with earnings.
True, Fiorina trotted out reams of numbers in an attempt to prove that Hewlett-Packard was gaining market share in servers and personal computers. She is nothing if not a consummate saleswoman. The battle over the merger proved that.
But this time it didn't work. Given the relative performance of, say, Dell, a lot of analysts simply weren't buying her view of the world. The respected Andrew Neff of Bear Stearns, for example, put out a note saying that in PCs, for example, HP's business was down 18 percent on a year-over-year basis, while Dell's revenue was up 21 percent.
Now it is true that HP has made substantial efforts to contain costs. The company's reported gross margins, for example, ticked up to 26.5 percent this quarter, up from 25.9 percent the quarter before. And its days sales outstanding, a measure of how fast it collects its bills, is 40 days, a relatively good figure in tech.
But little things throughout the HP quarterly report made investors nervous. In the words of Goldman Sachs analyst Laura Conigliaro, the quarter was ``far from clean.''
Take the most innocuous of these first. HP changed the way it reports its income by segment -- PCs, enterprise servers, etc. -- to more nearly match the way Compaq used to do it.
In effect, this meant that some costs that used to be attributed to various divisions -- the cost of HP Labs, for example, or various corporate governance functions -- are now reflected in a category labeled ``other.''
There's some persuasive reason for this. But to some investors, the new numbers felt a tad too convenient. They showed that the company's PC division, for example, made a profit of $33 million, instead of losing money. HP officials argued that the PC division would be profitable even without the new accounting. But the suspicion lingered that HP was grooming the numbers for public consumption.
A more serious issue was the company's cash flow. In her report, Goldman's Conigliaro pointed out that while HP's earnings almost doubled from the quarter before, its cash flow from operations had fallen from $1.5 billion to $791 million. (Goldman, incidentally, has done investment banking for HP and was a prime adviser in the merger fight.)
Now there are explanations: The accounts payable had declined and inventories increased. But for a company that takes a variety of one-time charges, the cash issue didn't settle stomachs.
Finally, there was the little matter of vacations. Like other tech companies, HP forced its employees to take vacations during its last quarter. That meant the balance-sheet account for accrued vacations and employee benefits declined from $2 billion to less than $1.7 billion.
Again, there's nothing illegal about this. In fact, you can read it as smart management. (Vacation is expensed before it's taken and then entered as an accrued benefit.) But skeptics saw it as a way of reaching into a cookie jar -- or a reserve -- to cover current expenses. For the skeptics, it was one more reason to distrust HP's earnings numbers.
After a white-hot battle, Carly Fiorina won her crusade to merge with Compaq last year. Now she has to prove her claim that it makes sense. Wednesday's trading proved that investors have stopped giving her the benefit of the doubt.
Scott Herhold's Stocks.comment appears every Monday and Thursday. Write him at the San Jose Mercury News, 750 Ridder Park Drive, San Jose, Calif. 95190; e-mail sherhold@sjmercury.com; phone (408) 920-5877. |
