Here’s Why Intel Shouldn’t Copy Hewlett-Packard’s Layoff Strategy

Hewlett-Packard has been cutting costs to help improve its results despite a lack of revenue growth, but such a strategy is still inappropriate for Intel.

May 27, 2014 at 8:10PM

With shares of Hewlett-Packard (NYSE:HPQ) soaring on continued cost cutting despite an unfavorable revenue growth picture, a common sentiment among some frustrated Intel (NASDAQ:INTC) shareholders is that the company should – in the absence of a revenue growth story – start cutting costs by laying off employees. While this may seem like an attractive measure in the short term to juice earnings per share, this would be a long-term mistake.

HP is soaring, but it's not very richly valued
Take a closer look at HP's stock price increase. While the shares have roughly tripled from their $12 trough hit back in 2012, it's important to note that HP has "soared" because the stock was – in hindsight – ridiculously undervalued. After the initial pessimism after it took a rather large writedown as a result of its botched acquisition of Autonomy (that totally tanked GAAP net income), the market began to realize that the stock was dirt cheap at a mid-single digit multiple of free-cash-flow.

Today, even after tripling, the stock trades at a hair under 12 times GAAP net income. The good news is that HP is still "cheap," but the bad news is that because the company is still fundamentally grappling with a multi-year revenue decline, the market doesn't really want to pay a premium for the stock. Further, given that HP has juiced its bottom line by cutting expenses (the company announced that it would be laying off yet another 11,000 to 16,000 employees), investors may worry that HP may be cutting more than just fat (although to HP's credit, R&D spending seems to be trending up despite the cuts).

Intel is trying to become a growth name
Unlike HP, which seems to be more trying to become a "cash-cow" type of business, Intel has pretty clear ambitions to return to meaningful financial growth. The company's revenue peaked in 2011 at about $54 billion and has sort of hovered in the $53 billion-$54 billion for the last several years. This has largely been due to the fact that the company's PC Client Group business has been in decline while the firm's Data Center Group has been growing well enough to offset that decline.

While this "balancing act" can keep Intel's revenue roughly flat, it is unlikely that Intel can deliver meaningful revenue/profit growth or multiple expansion without growth in adjacent markets. The company's "Internet of Things" group is actually growing quite nicely, but it's still too small to alone drive growth in the face of a weakening PC Client Group. The Mobile & Communications Group offers the largest potential for upside, but of course this requires a very significant R&D investment.

Cost cutting is not the answer
Intel could lay off a bunch of employees and then eventually bring its cost structure down, boosting earnings. Done carefully to trim dead-weight, this is OK, but cutting into the company's core talent (either on the R&D side or the SG&A side) would be a long-term death sentence for the company. Sure, it could plod on for years while generating a ton of cash, but share price appreciation would be hard to come by as it would become increasingly difficult to grow net-income.

The dilemma that Intel faces is that it is just so wildly successful in the PC and server/data-center markets that in order to drive meaningful growth from current levels – especially in the face of the decline in PC-related revenues – it needs to tackle a big, adjacent market. That, whether investors like it or not, is ultra-mobile computing which requires high levels of R&D spend and is generally a cutthroat business. Intel's only way out of this revenue decline is pushing through into mobile. It's not going to be pretty -- nor is it going to be easy, but it's really the only way.

Foolish bottom line
If Intel reports continued revenue stagnation/declines in 2-3 years, then perhaps it will be time for Intel's management to reevaluate its growth ambitions. However, despite the lack of success the company has had so far with its mobile products (which have driven up R&D considerably), the products are becoming better with each iteration and hopefully will begin to drive profitable growth. Investors can't wait forever, but it's still far too soon for Intel to throw in the proverbial towel on its growth ambitions.

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Ashraf Eassa owns shares of Intel. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. 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.

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