Technology Industry: HPQ/EDS, PCs and Prospects
Now that we've got all this machinery listed, cataloged and presented it might be time to apply a bit of it so that's what we propose to do with the Tech Industry news from the last few weeks. A lot of that's either gadgets, related to Telecom or the Yahoo Wars...all of which we'll come to in separate posts. Here we'll focus on a couple of things in the classic mainstream of the industry - where the primary big news that caught our eye in the last few weeks is HPQ's acquisition of EDS. Before we comment on that per se this is our time to talk about the industry in general.
When you look at the analysts consensus forecasts for Q4 it's the Tech industry they expect to save the day. Earlier this year the bottom-up estimates were 20% for Tech and 29% for Telecom. It'll be interesting to see how/when/where/if these other industries follow the financial guys who've been madly revising downward. There are two sets of problems you need to think about. First there are some major breakages in the logic regarding economic fundamentals. Second there are further breakages with regard to the analyst's methodologies.
But let's start with a chart on the NDX and, pardon the experimentation, it's a "Point and Figure" chart which may be as new to you as us but does offer up some interesting perspectives. A column of X's indicates a day where the price rose a pre-set amount and O's the converse - start a new column when certain limits are exceeded. The result is almost a pure price trend chart though dates are indicated by numeric/letter entries where 1=Jan...Oct=A and so on. And this one you really do need to click thru on. The chart on the left is a daily chart that runs back ~ Oct peaks while that on the right is a weekly chart that runs back to '06. Interestingly the shorter-term chart didn't quite break the uptrend this last week - the innate sentiment in favor of Tech is therefore intact. Yet on the longer-term chart there is a significant downtrend and the software suggests a bearish target of 1760 ! But that's only a 9% drop from here.
The Fundamental arguments that have floated around are that spending will still occur on Big Tech because it helps companies save money. Got some bad news for folks - I've made those decisions and sold to those who day and that is not the way they think. When things tighten up they cut capital budgets and live with what they've got. So here are the four exposures on fundamentals: 1) a slowing economy which is likely to tip over will lead to a downturn in capex with the normal lag; i.e. Tech spending will be pressured and the signs are already in the surveys. 2) For some players the "consumer shift card" has been played,e.g. Apple and iPod/iTunes. Please - consumer spending is going to be the first and is already headed for the basement. 3) Foreign sales are the next shibboleth - based on currency conversions and de-coupling. Well as a matter of fact many of the majors have shifte large chucks of business into the int'l economy - a major structural shift in fact. But it's still not their dominant businesses and they've enjoyed a revenue runup mostly based on currency effects not jumps in unit sales. 4) On top of which it turns out that not only is de-coupling mythological but the BRICs et.al. are experiencing their own unique set of problems in addition to slowing growth; e.g. Europe. C'est la vie for that arguments set - does the earnings estimate hold up ? Do you think it'll be "just" a 9-10% if it doesn't ?
The key to re-thinking earnings is coupling economic fundamentals with company performance analysis - which is where the analyst community should come in but, with some notable exceptions, generally doesn't. Earlier (Readings (Earnings): The Real Earnings Realities that Ain't...YET) we'd gone thru a long, careful and documented dissection of some of the characteristic flaws of analyst work that might be worth reviewing. Aside from the fact they are often wrong they also tend to lag the realities and all too often their work is biased because it's based on management prognostications. Which in turn are all too often looking backward to the last quarter instead of the readily discernible general trends that should govern business outlooks. In other words executives are telling folks how it is and was - not reading the tea leaves about how the currents are running. Which was, at the end of the day our whole point with the "Dashboard" series. 
Which leads us to this next chart which is a little more traditional and uses ETF's as proxies for various Tech sectors starting with the common index of IXN - Global Technology stocks which turns out to track the NDX almost exactly. On the top are IXN, IGV - Software and IGW-Semiconductors. The bottom is more Telecom oriented with IGN-Telecom Equipment, WMH-wireless provides and mfg., FDN - Internet players (GOOD, Yahoo, et.al.) and TTH - telecom service providers. On the whole everybody has enjoyed the benefits of the bear market bounce AND the tech mythologies, particularly software which'll power thru any possible downturn of course. This whole discussion reminds us of nothing so much as the discussions circa '05 about how the homebuilders were safe this cycle 'cause they'd been careful to maintain the health of their balance sheets and not over-invested in land. Think about the metaphor there for a bit...please !
If our economic outlook has any validity to it the estimates of Tech earnings are wildly overdone due to a lack of sensible business analysis coupled with grounded economic fundamentals. Potentially an textbook case in why our mantra makes sense. Which then leads us to the pick good companies who'll do well as survivors in any downturn and prepare yourself to pick them up as/when/if we go thru a significant adjustment. Which in turn leads to the HPQ/EDS news. Which was a real puzzler to a lot. There are two key questions, perhaps three here. First can Hurd apply his strategy-based execution improvement magic to EDS which sorely needs it having kept tripping over it's own feet for years. Two - out of necessity EDS targets the big companies for advanced and complicated services - is there enough HP business there to grow a well-running EDS's revenue ? Or, converesly, can EDS bring in HP behind it on it's client base ? HP has a large enterprise component but that's not been its' primary emphasis so this represents a real strategic addition, if not a shift. And, I guess, third, EDS has done very poorly at building an international presence and capacility unlike IBM, in particular, or Accenture. If that can be developed and leverged there some real potentials. In any case HP is both an extremely well-run company which also has a very thoughtful and considered strategy by line of business. IOHO they go on any value oriented investors shopping list, post downturn of course.
After the break, in addition to some excerpts, you'll find pointers to some recent vidclips on CNBC with some analysts who actually reinforce much of what we're arguing for here. Worth your time. Bon Appetit'.
Technology
Tech Vidclips |
| Tech's Wall of Worry Signs of more weakness ahead of the U.S. economy sent tech stocks lower today, and Dan Niles, of Neuberger Berman Technology Management, shares his insight.
Sector Spotlight: Technology Thoughts on the new tech four horsemen and whether investors should put money in tech, with Arnie Berman, Cowen and Co. and CNBC's Jim Goldman. |
Hewlett-Packard Agrees to Acquire EDS -- Hewlett-Packard Co. agreed to buy Electronic Data Systems Corp. for $13.2 billion to take on International Business Machines in computer services. The company said full-year profit and sales will top its earlier goals. Hewlett-Packard will pay $25 a share in cash, or 33 percent more than EDS's closing price May 9, before the companies disclosed they were in talks. Combining with EDS, founded by H. Ross Perot in 1962 with $1,000, would help Hurd more than double revenue from services as PC shipment growth slows worldwide. Hurd can cut ``a significant amount of cost out of EDS'' by reducing jobs and combining data centers, he said. The purchase will more than double Hewlett-Packard's annual sales in its services unit to almost $40 billion, making it as large a business as PCs. Research firm IDC predicts that PC shipment growth probably will slow to 13 percent worldwide in 2008 from 15 percent last year, dragged down by waning demand in the U.S., the largest market for the machines. The executive cut more than 15,000 jobs in 2005, and squeezed costs from data centers, pensions and real estate to save another $3 billion a year. He also has reinvested in the business, adding 2,000 salespeople last year and spending about $7 billion on acquisitions, mostly to bolster Hewlett-Packard's software business. Hewlett-Packard's services group reported sales of $16.6 billion in its latest fiscal year, compared with $22.1 billion for EDS. Even combined, that revenue would still trail IBM's.
- BizTech: Three Reasons H-P/EDS Might Fail, BizTech: H-P Aims to Be Big Services Player, BizTech: Leaders Love H-P/EDS, Deal Journal: A Look Back at EDS
- Talks Put H-P Veteran Livermore in Spotlight
Why HP's Deal Is a Head-Scratcher The tech giant's $14 billion purchase of EDS may not be enough to help it catch up with rival IBM. When Hewlett-Packard (HPQ) announced its $13.9 billion acquisition of tech services giant Electronic Data Systems (EDS) on May 13, pundits heralded it as a bold move by HP CEO Mark Hurd. In one stroke, it seemed, he had put HP on a stronger footing with market leader IBM (IBM) in the fiercely competitive tech services business. Together, HP and EDS will create a services giant with $38 billion in revenues, compared with IBM's $54 billion. Yet a closer look at the deal raises questions about Hurd's strategy and choice of dance partner. EDS, which was founded by H. Ross Perot in 1962 and pioneered the practice of taking over corporations' computing operations, was slow to respond in the early 2000s to the threat of nimble Indian rivals offering services at sharply lower prices. Revenues stagnated, and EDS racked up huge losses. Eventually, the company increased its overseas hiring, and bought control of an Indian company, MphasiS. But even now MphasiS operates independently, with its own sales force and customer base. So this deal may not change the game when it comes to one of the most important factors in tech services. The top-tier services companies need large, low-cost, global workforces, and their operations need to be tightly integrated so employees with diverse skills collaborate smoothly. IBM, Accenture (ACN), and Indian companies such as Tata Consultancy Services lead in this effort, while EDS and HP have lagged.
Job cuts likely in HP's overhaul of printing group Hewlett-Packard Co. is reshuffling a highly profitable division that makes computer printers and ink cartridges in a shake-up likely to trigger job cuts. In an internal memo sent Wednesday, the world's largest technology company said it will pare its printing and imaging group from five to three business units. The shift will meld together the imaging group's units responsible for ink jet and Web solutions aimed at consumers and small businesses and will combine its laser jet and enterprise operations catering to corporate customers. The reorganization, expected to take effect Aug. 1, will enable HP to "reduce complexity and eliminate duplication" while focusing the printing and imaging division on its biggest growth opportunities, according to the memo from Vyomesh Joshi, who oversees the affected operations. As part of the overhaul, HP will "rebalance resources as necessary in order to meet the needs of the new structure," said company spokesman Ryan Donovan. He declined to estimate how many workers might be laid off. Job cuts have been a recurring theme at HP since it hired Mark Hurd as chief executive three years ago.
Brazil Buys More PCs Than TVs, Bolstering Hewlett, Dell as U.S. Sales Slow Brazil ranked as the fifth-largest PC market last year as bank credit offers, installment plans and growing prosperity fueled purchases, especially among low-income consumers. The shift is a boon to Hewlett-Packard and Dell Inc., the world's top PC makers. A tax break for PC makers has allowed them to cut prices and compete with unregulated sellers whose so-called gray- market machines dominated the market. ``You have a consumer market that's exploding as people have more access to credit,'' said Mario Anseloni, managing director of Hewlett-Packard's Brazil division. ``That's transforming the whole economy.'' Demand in Brazil is helping PC makers expand revenue as U.S. spending slows. Hewlett-Packard, which generates two-thirds of its sales outside the U.S., may disclose fresh evidence of the trend today when it reports second-quarter results. Sales grew 11 percent to $28.3 billion in the period, according to a preliminary report last week.
Lenovo profit up 133% Lenovo Group, the world's No. 4 PC maker, said Thursday that earnings for its latest quarter rose 133% as strong sales in China and Europe offset slower growth in the United States. Profit totaled $140 million for the three months ending March 31, the Beijing-based company said. Total revenues rose 13.5% to $3.7 billion. Yang said Lenovo will focus on boosting sales in developing countries and expanding its retail business. Sales in China, which accounts for about one-third of Lenovo revenues, rose 18% to $1.29 billion in the quarter. Sales in Europe, Africa and the Middle East were up 30% at $879 million, the company said. Sales in the United States and the rest of the Americas rose just 9% to $1 billion, Lenovo said. For the full fiscal year ending March 31, earnings rose 201% to $484 million, Lenovo said. Full-year sales rose 17% year to $16.4 billion. Lenovo has reported similar improvements in results in previous quarters, with profit growing faster than revenues, which it says is due to cost-cutting. The company said it boosted its gross profit margin last year from 13.5% to 15%. Lenovo bought IBM Corp.'s personal computer unit in 2006 and said last year it had completed integrating the acquisition into its own business. Lenovo had the right to use the IBM name on some products but said earlier it plans to discard it this year.