Last month, I pointed out what I thought was an amazing statistic: Hewlett-Packard
You know what happened next: The urge to do something dumb.
After offering to buy U.K. software company Autonomy for $10 billion in cash, HP management signaled in a conference call that it would effectively can its share repurchase plans for the near future. Buying Autonomy is a better use of its capital, it reckons.
The problem: HP purchased Autonomy for more than 25 times earnings before interest, taxes, and depreciation (EBITDA). With HP's stock now trading at less than three times EBITDA, the opportunity cost of the cash used to fund that acquisition is massive. Taking a look at the bottom line, management is essentially bypassing purchasing shares of a company trading at about six times earnings (its own) for one trading at 50 times earnings. Value investor Vitaliy Katsenelson elaborated in a recent blog post (emphasis mine):
"There are many ways to illustrate how expensive and meaningless to HP's future this acquisition is: $10 billion is about a fifth of HP's market capitalization, while [Autonomy] will contribute 0.7% to HP's revenues, and 2.7% to its earnings; and HP paid 10x revenues and about 25 times earnings. ...
"Any investment HP makes today should be compared against an opportunity set that includes its own stock, which at 6x times earnings results in about a 16% yield (cost of capital). In fact, if HP used $10 billion to buy its own stock, its earnings per share and dividend would jump by 16%. Autonomy will not be able to match this return, by a long mile."
Technology is a fickle industry. Management feels pressure to do something big. But milking the cash flow of a slow-growing business is preferable to squandering it in the name of change. Other tech companies such as Microsoft
Vitaliy concludes: "HP's stock sold off not because the company disappointed Wall Street but because Wall Street grew tired of the overpriced 'must-have' acquisitions."
Fool contributor Morgan Housel owns shares of Microsoft. Follow him on Twitter @TMFHousel. The Motley Fool owns shares of Microsoft, Google, and Apple. The Fool owns shares of and has created a bull call spread position on Cisco Systems. Motley Fool newsletter services have recommended buying shares of Cisco Systems, Google, Apple, and Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Microsoft. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.