Don't let it get away!
Keep track of the stocks that matter to you.
Help yourself with the Fool's FREE and easy new watchlist service today.
Has Hewlett-Packard (NYSE: HPQ ) lost its mind?
Late yesterday evening, after cooler heads had called it a day and headed home for some quiet time with the spouse and kids, the PC giant announced what is, quite possibly, its dumbest move yet: buying 3Com (NYSE: COMS ) .
I know, I know. I'm supposed to be in favor of HP's acquisition spree. Last summer, I praised Mark Hurd's decision to gobble up EDS, a move that promised to leapfrog Accenture (NYSE: ACN ) in worldwide IT market share, not to mention making HP a true force to be reckoned with, second only to IBM (NYSE: IBM ) . But this week's news isn't a case of HP getting bigger and badder. This time, HP's just getting bloated and worse.
Consider: When HP bought EDS, which had lower margins than HP's service division's margins, it already had deep experience and a proven ability to post strong margins in IT consulting. This lent every confidence that HP could improve the new business and reap great gains as it brought "EDS's" profit margins up to snuff.
Not so with 3Com. Here we have a hardware maker like HP, but one that earns less than one-quarter of HP's 9.2% operating margin, achieves barely one-fifth of HP's returns on equity, and isn't even growing as fast as HP's expected 10.7% five-year growth rate.
Maybe this would be a good idea if HP were getting 3Com for a bargain price, but that's simply not the case. When HP bought EDS last year, it paid roughly 60% of its own price-to-sales ratio to capture its prize. This time, HP is shelling out a net $2.7 billion for 3Com -- a ratio of 2.1 times sales, when HP's own shares command only 1 times sales. This time, HP is overpaying for an inferior product.
Now, I know what you're going to say: "But Rich, Cisco (Nasdaq: CSCO ) threw down the gauntlet when it stepped into the server market! HP has to retaliate by threatening Cisco with a credible rival in networking."
But the key word there is "credible." Can anyone honestly argue that 3Com is a worthy opponent to Cisco? Cisco's more than 25 times as big as 3Com by sales, and earns a profit margin five times as large. Maybe a combined HP-3Com can upset Brocade (Nasdaq: BRCD ) , but I don't expect giants like Cisco or Juniper (Nasdaq: JNPR ) to lose any sleep over this deal.
HP buying 3Com isn't a threat to Cisco. It's an exercise in diworsification, plain and simple. Make no mistake: HP shareholders will rue the day HP logged on to 3Com.