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HP Shares Look Cheap in Wake of Hurd's Departure

Erik Kobayashi-Solomon

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, Co-Editor of Morningstar's OptionInvestor. Today it's my great pleasure to welcome Michael Holt, who is Senior Equity Analyst on the technology team covering hardware companies.

Mike, thanks for coming in today.

Michael Holt: Thanks for having me.

Kobayashi-Solomon: So yesterday I wrote an option strategy hoping to take advantage of the decline in Hewlett-Packard's share price on the departure of Mark Hurd, and I wanted to ask you a little bit about this. Right now, you've made the point that valuation metrics look really attractive for HPQ. Can you tell me a little bit about that?

Holt: Sure. Our fair value estimate is at $55. So now after the pullback yesterday, we're looking at almost a 25% margin of safety.

Kobayashi-Solomon: Right. We are about $42.

Holt: Exactly. And a couple of the other metrics are interesting as well. We've been looking at EV to EBITDA, and we're trading it like six times EV to EBITDA. Some of the other competitors in the industry are EMC, Cisco trading at 11 times, so it looks attractive there.

Kobayashi-Solomon: It does look attractive.

Holt: And also, just even P/E multiples. So at 10.5 times trailing earnings, 9.5 times forward earnings.

Kobayashi-Solomon: Yeah, certainly it does sound attractive. The thing though about valuation metrics is that they can be backward-looking, so maybe a great EV to EBITDA, but if they can keep that EBITDA going, then suddenly the valuation looks expensive.

Hurd, I think was instrumental in kind of setting a new course for Hewlett-Packard. Do you think that with his departure that they'll still be able to grow that revenue stream, to grow that income stream?

Holt: His departure is certainly a setback and that's why investors are reacting, but the strategy and foundation he put into place are going to survive his departure. And I think they have strong interim leadership, they were swift and decisive getting that set up, that's going to calm the waters a little bit. They also have very strong prospects in all their business units. And I think that's really what investors need to look at, not who is running the ship, but what the prospects are for the enterprise services, hardware, their printing segment. There's a lot of recurring revenue in there that's very stable in the short to medium term.

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Kobayashi-Solomon: And do you think that – I know the switch to Services has been a big part of Hurd's strategy. Do you think that's fallen off along that it can survive then without Hurd, the managers that are in place are strong enough to…?

Holt: They're definitely strong enough to survive without Hurd. They've brought in EDS and that was a major acquisition and that was a standalone business that was doing really well, and it's even better off now and its prospects still look bright.

Kobayashi-Solomon: Setting aside valuation for a minute, let's turn to the next thought. I think it's on everybody's mind, which is succession. The CFO has made an announcement that she will be the Interim CEO, but she is not interested in the job long-term. How deep is Hewlett-Packard's management bench? Do you think they'll have to go outside for a CEO?

Holt: Well, some people are speculating that they will look internal, just to kind of smooth the transition. I actually think that's not the case. There are a lot of long-tenured strong leaders for all these business units, and some of these business units are larger than most companies.

So there have very strong leaders, but when you look at the candidates with the longest tenure, a lot of those people were passed over five years ago when they brought Hurd in. And I think there is some benefit to keeping some stability at that next level down from the CEO, and then bringing somebody in who has the strong leadership skills.

What I think they'd really be looking for is somebody who has a track record of operational excellence, driving down costs, but also identifying acquisitions and integrating them.

Kobayashi-Solomon: So really operationalizing acquisition.

Holt: Absolutely.

Kobayashi-Solomon: Okay. So, I know this is a topic that a lot of analysts wouldn't want to go to, but yesterday Ellison, CEO of Oracle called the HPQ's Board, their actions the dumbest thing since Apple's Board fired Jobs. What do you think – I mean, did Hewlett's Board overreact? I mean, I've seen reports from a 1,000 to 20,000 worth of expense report, let's say oversights, and that took off over $7 billion from their market cap. Do you think that it was wrong for the Board to do this? What's your take on it?

Holt: Larry is always good for a good quote.

Kobayashi-Solomon: That's true.

Holt: But he may be right for all we know. But I think the important thing for investors is to focus on where they're going to go from here? The Board was in a tough position because there's been some scandals with the Board and the C-suite of this company before. So I think they felt their backs against the law, that they didn't have much room and really a zero-tolerance policy had to be in place.

And additionally, I think it's hard. Hurd was a very tough leader; cutting costs, cutting jobs, cutting wages, all these things. It's much tougher to do that if your credibility is in question.

Kobayashi-Solomon: That's true; hard to lead by example, if you're setting a bad example, right?

Holt: Exactly.

Kobayashi-Solomon: Well, Mike, thanks a lot for coming. I appreciate it.

Holt: Oh, thanks for having me.

Kobayashi-Solomon: And thank you for joining us. Please stop by the OptionInvestor website where you'll find many more great option ideas based on Morningstar's fundamental research.