Sharks need to swim

HP: Hewlett-Packard’s recently jettisoned boss worked hard to please Wall Street. Mark Hurd won over investors by aggressively buying rivals and cutting costs. The total return to shareholders under his tenure was more than 140 per cent. But he may have left his successor with thin pickings.

Many old-line tech companies have experienced revenue stagnation. So, Hurd’s deal and efficiency prowess suited the climate well. Alongside figures using standard accounting procedures, the company publishes earnings adjusted for restructuring costs, amortisation of purchased intangibles and acquisition related charges, which analysts prefer and which HP regularly beat. These pro-forma results doubled under Hurd.

The adjustments, however, flatter HP. If a company depends on acquisitions, there are costs that come along with that strategy. It’s worth noting that cash flow from operations rose by about two-thirds under Hurd, restrained partly because as HP grew it needed more working capital. This growth is still impressive, but not as good as earnings — and the two should broadly move in tandem. Snaffling up rivals such as EDS and Mercury Interactive worked over the short run. The model may not be sustainable, however. HP’s deep-pocketed rivals have shown an increasing penchant for deals, which could raise the prices of targets.

Further cost cuts in its existing business looks tough too. And, with big companies invading each others’ turf — for example, Cisco and Oracle now produce servers that compete with HP’s — it may be harder to turn a decent profit.

HP also has put most of its eggs in the efficiency basket. Research and development funding fell by 20 per cent during Hurd’s tenure. Last year, it spent about 2.5 per cent of sales on creating new stuff. Rivals Apple, Cisco, Dell and IBM averaged more than 6 per cent. HP may need to spend more to compete. That means the company’s shares may not be the bargain they appear to be. Trading as they do at less than 10 times estimated pro-forma earnings for the current year, according to Thomson Reuters, they’re nearly a 20 per cent discount to IBM’s. With standard accounting, the gap disappears and perhaps any reason to invest in HP before Hurd’s legacy can be fully understood, particularly by whoever replaces him.