HEWLETT-PACKARD CO. $47 (New York symbol HPQ; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 2.5 billion; Market cap: $117.5 billion; WSSF Rating: Above average) is one of the world’s leading makers of computers and electronic devices. Products include printers and digital cameras (27% of 2007 revenue, 41% of profits); personal computers (34%, 18%); business computers (18%, 19%); computer services (16%, 17%); financing, software and other (4%, 4%). Hewlett’s profits grew from $1.16 a share (total $3.6 billion) in 2003 to $2.68 a share ($7.3 billion) in 2007, largely due to a successful restructuring plan following its 2002 acquisition of Compaq Computer. Revenue rose from $73.1 billion in 2003 to $104.3 billion in 2007. Right now, most of Hewlett’s growth comes from sales of cyclical, low-margin computers and printers. It now aims to expand its higher-margin businesses. This includes computer consulting, which helps businesses manage their computing hardware and software needs. These services give Hewlett predictable revenue streams, and generate profit margins two to three times higher than hardware sales. That’s why Hewlett recently agreed to pay $13.9 billion for Electronic Data Systems Corp. (New York symbol EDS), a provider of computer services to large government agencies and corporations. Major clients include the U.S. Navy, General Motors, the UK Ministry of Defense and Royal Dutch Shell. The deal should close by the end of 2008.
EDS helps Hewlett compete with IBM
EDS will raise Hewlett’s annual revenue from computer services, from $18 billion to $41 billion. It will also increase Hewlett’s recurring revenue, from 33% of total revenue to 40%. The amount of electronic data that businesses must process and store continues to grow rapidly. Hewlett’s acquisition of EDS will give it the size to compete for new contracts with industry leader IBM. As well, the purchase will also give Hewlett access to EDS’s high-quality client base, and expand sales of its server computers and other hardware. EDS recently completed a major restructuring plan. But based on its success in integrating Compaq, Hewlett should find plenty of ways to cut costs in the combined operations. EDS’s broad overseas operations will also help shield Hewlett from a slowing economy in the United States. While overseas customers already account for two-thirds of Hewlett’s revenue, EDS’s ownership of Indian computer outsourcing company MphasiS will help Hewlett expand in Brazil, Russia, India and China. Right now, these four fast-growing countries supply just 10% of Hewlett’s revenue.
Strong balance sheet cuts risk
Hewlett held cash of $11.6 billion or $4.72 a share at April 30, 2008, so it will have to borrow some of the money it needs to complete the takeover. Longterm debt of $7.7 billion is just 7% of Hewlett’s market cap, so it can afford to take on more debt. The takeover will probably force Hewlett to scale back its aggressive stock repurchases. It spent $10.9 billion on buybacks in fiscal 2007, and is still authorized to buy back a further $4.5 billion. Hewlett will probably use any extra cash to pay down debt instead of raising its $0.32 dividend (0.7% yield). Hewlett is also focusing on expanding its software operations, mostly through acquisitions, and is now the sixth-largest software company in the world. Owning its own software makes it easier of Hewlett to design custom-made computer systems for its clients. Hewlett’s biggest software purchase to date was its November 2006 purchase of Mercury Interactive Corp. for $4.9 billion. Mercury’s products help businesses test and improve their Internet sites. Demand for products like these is growing strongly as more businesses conduct transactions on the Internet.
Hardware business is also expanding
The company also continues to do a good job expanding hardware sales. Hewlett recently passed Dell Inc. as the world’s leading maker of personal computers. It now has 19% of the overall market. Hewlett also accounts for 23% of the faster-growing market for notebook computers. In fact, notebooks now account for over half of its personal computer sales. Demand for computers should continue to grow, particularly as spreading prosperity makes them more affordable. Continually expanding Internet use will also spur computer demand. Hewlett maintains its leadership in many areas through a strong commitment to research. It typically devotes around 3.5% of its revenue of roughly $42 a share to research projects. The company now has over 31,000 patents, and generates extra revenue by licensing some of its technology to other companies. Examples include imaging technology for cellphone displays, and low-power memory chips for electronic devices.
Low p/e for a global leader
Thanks to its successful cost-cutting, Hewlett’s stock has more than doubled in the past five years. It now trades at just 13.2 times the $3.57 a share it should earn in fiscal 2008. That estimate excludes EDS. That’s especially cheap for a worldwide leader like Hewlett. Hewlett-Packard is a buy.
