About a year ago, tech giant Hewlett Packard announced that it was splitting into two almost equally-sized companies: Hewlett Packard Enterprise Co (NYSE:HPE) and HP Inc (NYSE:HPQ). HPE deals in data center technology, including servers, networking, storage and software, while HPQ is a company that sells PCs and printers.
Hewlett Packard split the businesses so that each company could focus on its core competencies without being encumbered with too much rigmarole from the other subsidiary.
The split appears to have worked amazingly well as far as unlocking shareholder value goes. HPQ stock is up 11% over the last 12 months, while HPE stock has racked up handsome gains of 61%, easily outpacing the S&P 500, which has managed a modest 3% gain over the period.
HPE stock has clearly been the more successful of the two spawns. But will further spinoffs by the company yield similar results?
What Will the Next Hewlett Packard Enterprise Spin-Off Do?
Now Hewlett Packard Enterprise has been saying that it’s not done getting into shape, and wants to turn back the clock by focusing more on its roots as a hardware maker. The company has decided to spin-off its software business by selling it to U.K. software maker Micro Focus (OTCMKTS:MCFUF) in a deal valued at $8.8 billion. The deal is expected to close in early 2017.
However, HPE has avoided betting the whole farm with the deal. The company has instead opted for a rather kooky arrangement that involves combining the software business with Micro Focus then taking a majority 50.1% ownership stake while receiving a $2.5 billion cash payment from Micro and a $700 million restructuring charge.
This has now become a famous ballgame by Hewlett Packard Enterprise chief executive Meg Whitman: merge with your rival to hedge your bets and effectively kill off the competition. The CEO announced a similar plan to spin out its troubled consulting services unit by merging it with rival Computer Sciences Corporation (NYSE:CSC).
After selling the software business, core HPE will see its annual revenue dwindle from more than $50 billion to just $28 billion. The company recently provided three separate views of what we should expect fiscal year 2017 to look like:
- Combined (as the company is structured today including a full year of the Software and Enterprise Services business) — revenue flat-to-lower; earnings-per-share of $2.00 to $2.10 and free cash flow of $3.6 billion to $3.9 billion.
- As reported (partial year revenue contributions from Software and ES) — EPS of $1.45 to $1.55; operating net cash balance of $8 billion and shareholder returns (dividends and share buybacks) of $3 billion. Meanwhile, free cash flow is expected to enter negative territory with a loss of $1.8 billion, though the company expects it to approach normalized levels in FY 2018.
- Future HPE (zero contributions from Software and ES) — modest revenue growth, EPS of $1.25 to $1.35 with $2.1 billion to $2.4 billion free cash modeled.
Hewlett Packard Enterprise included guidance for shareholder returns in the second case scenario presumably because it’s the one most likely to unfold in fiscal 2017. You will notice that the company’s free cash flow will be stretched beyond the breaking point as the company tries to placate jittery investors with generous shareholder returns. The fact that HPE stock has climbed another 2% since the company issued the guidance 10 days ago says that this has gone down well with the investing universe.
The ”Future Hewlett Packard Enterprise” scenario given by the company suggests that the company might eventually sell its entire stake in the software business.
Bottom Line on HPE Stock
The future Hewlett Packard Enterprise will be mostly a hardware manufacturer that focuses on data center and cloud, a $100 billion market that’s currently growing at 1% to 2% CAGR. The company will continue being a player in high-growth areas such as all-flash arrays, private cloud and high performance computing.
HPE also intends to continue being a big enterprises service provider, driven by customers’ need for consulting for hybrid IT infrastructure. Hewlett Packard Enterprise estimates that the services market is currently worth $116 billion and growing at 3% to 4%.
In a nutshell, HPE stock is looking to return to growth, albeit modestly, starting FY 2017. That’s a considerable improvement given that the company’s topline contracted 6.5% during the last quarter.
Given that the new Hewlett Packard Enterprise might still be able to double-dip into profits from the merger between its software business and Micro, as well as CSC, the new-look for the company appears to give better growth visibility than the current outfit. This might allow HPE stock to continue making sustained long-term gains.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
