HPE Strategy Clear As Mud

started in a garage in 1938, and with the recent realignments, including the spin-merges of services and software, it could find itself back there if the new and improved enterprise business does not progress as management expects. Annual revenue surged from $39.33 billion in 1998 to $127.25 billion in 2011 when the management philosophy was ‘bigger was better’. However, between the split of the PC/printer business (HP) and the enterprise component () and the various sell-offs and joint ventures, has gone from annual revenues of around $60 billion (hardware – $20.4 billion; software – $4 billion; and services – $34.9 billion) in 2012 to an estimated $28 billion in 2017 (both services and software will continue to enrich HPE’s coffers, albeit as joint ventures with CSC and Micro Focus, respectively).

The services spin-merge essentially shifts the 2008 acquisition of Electronic Data Systems ($13.9 billion) to CSC. The Micro Focus partnership offloads a number of less-than-successful HP software acquisitions, including: Vertica (acquired in 2011 for an unknown amount), plus pieces of Mercury Interactive ($4.5 billion in 2005), Opsware ($1.6 billion in 2007), and Autonomy ($10.2 billion in 2011 of which HP wrote off $8.8 billion a year later).

Since coming on board in 2011, President and CEO Meg Whitman, following two other presidents in less than 12 months, has taken a company with the IT industry’s highest annual revenues but significant debt and questions about its future, and turned it into to two smaller but still large businesses, a drastically improved financial base, and questions about its future. She took over the enterprise business after the first split, and reported a 6% drop in revenues but higher earnings for the most recent quarter. That’s been good news for investors — like me — but for how long is a growing concern.

A more detailed breakdown of this quarter’s results paint a troubling picture. By segment:

-Enterprise Group revenue declined 8% to $6.5 billion with revenue from servers down 4%, storage down 8%, and networking down 22%;

-Enterprise Services revenue fell 5% to $4.7 billion driven by 4% decline in Application and Business services and 6% decline in Infrastructure Technology Outsourcing revenue;

-Software revenues fell 18% to $738 million with License revenues falling 28% and professional services falling 8%; and,

-Financial Services revenue was up marginally by 1% to $812 million, while Intersegment net revenue was $541 million.

HPE has been doing well fueling the growing movement to the cloud, which is outgrowing the overall IT market by more than 4x. It has been successful in supplying servers to big off-site cloud operators, while also meeting the needs of clients using hybrid legacy and cloud services, and remains first in servers worldwide, with 25% of the market at the end of the second quarter, according to IDC. Crawford Del Prete, chief research officer of IDC, is impressed: “when you look at how well comparatively they’ve executed, given the turmoil they’ve been through over the past 10 years, it’s pretty remarkable.”

Back in 2011 Whitman said PSG and enterprise are “better together”, burying the split proposed a few months earlier by her predecessor, Léo Apotheker. Fast forward to May 2013, and she said “you can feel the turnaround taking place at HP”, following the latest quarter’s results. “We are setting up the company for the long term,” and she was “encouraged with where we are.”

With the cash expected from the CSC ($1.5 billion) and Micro Focus ($2.5 billion) deals,Whitman said HPE is well positioned for acquisitions. “We now have a war chest … [to] make acquisitions in a very focused way.”

Focused, as in the SGI acquisition announced last month. With revenues of $533 million for fiscal 2016, SGI is expected to help HPE expand its share ot an HPC market — $11 billion annually — that will averge 6-8% growth over the next three years, and was valued at .

“I think you can look for more small acquisitions like Aruba and SGI. It’s entirely consistent with the strategy we laid out a year ago,” she said. “I’m seeing the value of focus every single day. The next four or five years are going to be all about speed, focus, agility and innovation in areas that are increasingly narrow.”

Whatever her intentions — or pretensions — about HPE’s focus, Whitman’s continued Dell-bashing about arch-rival Dell has been consistent. Ever since Dell announced its plan to buy EMC last October, she has tried to dump FUD onto the deal as if she were driving a manure spreader, recently blogged analyst Charles King, Pund-IT..

Whitman decried the size and complexity of Dell’s plan, saying it would result in “chaos” and insinuated that financing the deal would “keep them from better serving their customers.” She also said that Dell is getting bigger, leveraging up, and mostly doubling down on legacy technology while our strategy is to get smaller. In fact, Whitman claimed that HPE’s spin-offs and “spin-sales” of underperforming business units, including PCs, professional services and application software have placed it “two years ahead of the game.”

King called spreading fear, uncertainty and doubt a tactic that can be ‘easily overturned with superior offerings, negating any short term benefits FUD-happy executives and companies might capture.’ He added that it is also ‘a remarkably out-of-date mechanism to rely on in sophisticated, data-driven IT markets and among companies that need to adapt quickly to changing circumstances.’

If Whitman has been busy dumping on Dell, analyst Rob Enderle has been returning the favor. Back in May he called the CSC deal ‘another nail in the coffin’. Whitman was positioning the spin-off, at a little over half the price of what it cost, as a merger, not a divestiture.’ It is a merger, just not for HP which, under Whitman, is showcasing what can happen when financial types run a company they don’t understand.’

HPE is being operated largely by financial types who have surrounded Whitman, tell her what she wants to hear, and have put the firm on a path of selling off the assets to ‘artificially inflate’ stock price. Enderle said if you sell off parts of a company, execute stock buybacks, and inflate dividends, you can increase the perceived value of a stock, but you are reducing the firm’s ability to execute. ‘Basically, these practices bleed a company until it lacks the resources to invest in the future, lacks the resources to execute in the present, and lacks the resources to execute a turnaround.’

Whitman isn’t the first HP CEO who has ‘lost complete touch with reality’, wrote Enderle in a subsequent blog. ‘Carly Fiorina, for example, thought the HP board reported to her. Mark Hurd thought an HP-paid mistress was a perk. Leo Apotheker actually thought he was CEO — even though apparently no one else at HP shared that view.’

Rather than software, which turned out to be the next big merger/sale, Enderle thought servers would be next up. He said IBM couldn’t sustain its Intel-based server business after it sold off PCs, so he guessed HPE could try to sell servers to HP Inc., but HP Inc. is ‘up to its eyeballs in debt already, thanks to being gifted with all of the company debt in the divestiture, so I doubt it has the resources to buy it.’

He said Oracle would be next in line because Hurd knows the business and it would strengthen Oracle’s offering; however, he also knows what it is worth, and would offer less than Whitman is willing to accept. Third would be Lenovo, but with two parallel large acquisitions almost complete, it likely feels it can take the business organically.

Enderle was equally uncharitable when it came to HPE storage, networking, and software, if for different reasons. ‘HP’s storage is crap’ and while networking was its most powerful asset when Whitman took over, she slowly got rid of all the top networking execs, and although it still has a great deal of potential value, it likely has a ‘sell-by date after which it won’t be worth much.’ As for the software business, which did end up being ‘moved’, turning HPE into a sofware company is the idea that ‘just hasn’t died a well-deserved death.’
In his latest HPE blog, Enderle noted that the company’s focus on financial metrics is putting it at great risk, at least in the storage and server markets. After a conducting a number of customer reviews of HP shops that have suddenly switched to EMC solutions, he found that doing layoffs and replacing experienced expensive people with novices, will drop you into a ‘death spiral because customers will become frustrated and move to vendors that are more focused on their needs than a profit margin that forces more layoffs and cost cutting.’

There are other analysts more optimistic about HPE’s recent actions and prospects. ‘TBR notes that HPE’s growing hyperconverged portfolio will give HPE the chance to hone in on systems software,’ wrote analyst Molly Gallaher Boddy, Technology Business Research. ‘As part of a broader hyperconverged play, software will no longer act as a stand-alone business for HPE but as an enabling layer for the company’s server and storage units.’

The significant drop in 2Q16 software revenue — 18% year-to-year — HPE’s decision to rid its portfolio of noncore software allows the company to focus on its larger corporate hybrid IT initiatives while moving toward a more profitable business, she stated. The company’s recent focus on hyperconverged technologies ‘best highlight the role software will play in HPE’s evolving — though steadily contracting — portfolio.’

Just prior to the software spin announcement, Forrester Research analyst Glenn O’Donnell predicted that such a deal would play into the direction the company has taken since it separated from HP Inc. “Selling the software business fits in with the strategy of breaking into smaller pieces, which is the company’s plan now,” he said. “There’s a lot of merit in that position, as a lot of those software components are not necessarily at the core for them.” He also thought — as it turned out — that the deal could raise a “good amount of cash” and focus on their hardware offerings.

“HPE is betting on [being] smaller, while a rival like Dell is betting on [getting] bigger,” O’Donnell said. “The market will determine which one wins.”

A month ago Frost & Sullivan recognized HPE’s networking unit, Aruba, and its ClearPass platform, as the “Most Scalable” and “Best NAC Wired and Wireless” solution. “The Aruba ClearPass NAC and policy management platform is highly scalable and sets the market’s bar for NAC scalability,” said Frost & Sullivan Network Security Senior Analyst Christopher Kissel.

I have several concerns about HPE’s recent actions and stated — for whatever credibility can be given to HPE’s strategic pronouncements — directions. First, although much can be said in favor of being small and nimble, the current evolution of the IT industry is for big companies to buy small and nimble companies that have innovative technology and/or reach but who lack the resources to become credible suppliers to large public and private sector organizations looking for more. HPE seems to be trying to move from one status to the other, and appears to be stuck somewhere in the middle, too large to be nimble,  innovative and be acquired, and too small to be credible.

Second is the company’s focus on hardware, while spinning off software and services, two of the areas we’ve seen a lot of interest in lately. In an increasingly software-defined, utility/service-based world, hardware is a race-to-the-bottom business where success balances on a razor’s edge. Certainly the notion that hardware doesn’t matter in a cloud world is foolish — there has to be hardware to support the cloud — but hardware has become much more tactical than strategic, and far less a competitive advantage in most cases. HP/E has always had a good reputation for engineering, but does that really matter in a commodity world?

Finally, there are the company’s strategic inconsistencies. While the senior management — especially the board — has proved unequal to the task of running this company successfully prior to Whitman’s ascension, there are almost as many questions today about its future, as there were five years ago.

She has done a masterful job of increasing focus, slashing debt and a bloated workforce, and improving the company’s financial position, certainly from a shareholder/financial analyst perspective.

Whitman said technology is moving at “lightning speed,” and the winning companies are going to be “the nimble, the fast, and the focused,” a day after HPE’s Q3 financial report. She defined the business in three areas:

-“The tradition data center is under pressure, but it is still 85 percent of the spend. Our objective there is we have to gain share.

-“Then there is a growing segment [of] what we call the software defined data center. … It’s used for private clouds.

-“Then third, … Hewlett Packard Enterprise should own compute at the edge,” she said, which refers to connecting the so-called “internet of things.”

This sounds reasonable, but then again there are the rumblings that HPE might also be trying to go private, that Whitman is a potential candidate for a position in a Hillary Clinton cabinet, and a ‘huge mass of customers jumping ship’ could start within months. Any one of these scenarios, or yet another spin/merger and HPE may find itself smeared with the fear, uncertainty and doubt that it has been tossing at Dell recently. Which may only be appropriate, because, at least at times, HPE’s strategy is as clear as mud.

Author: Steve Wexler

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