Tech giant Hewlett-Packard recently split into two companies -- HP (NYSE:HPQ) and HP Enterprise (NYSE:HPE). HP will sell PCs and printers, while HP Enterprise will sell commercial computer systems, software, and tech services. Former CEO Meg Whitman now leads HP Enterprise, while Dion Weisler, who worked at rivals Acer and Lenovo before joining HP, has become the new HP CEO. HP investors received one share of HP Enterprise for every share of HP.
By splitting its business in two, analysts estimate that each half of HP can generate over $50 billion in sales next year. However, some investors are skeptical that the two new companies will fare much better on their own than as a single company. Let's take a closer look at the big split and which half might experience stronger growth.
Challenges for HP
Demand for PCs and printers has been painfully sluggish over the past year. Research firms IDC and Gartner both expect PC sales to remain weak this year before stabilizing next year. According to IDC, HP's worldwide shipments fell 5.5% annually in the third quarter of 2015. In printers, HP was late to enter 3D printing, a rare pocket of growth in the stagnant printer market.
During HP's final quarter as a single company, PC sales fell 13% annually to $7.5 billion due to double-digit declines in desktops and workstations. Printer sales fell 9% to $5.1 billion due to a widespread shift toward sharing digital photos and documents online. Sales of higher margin printing supplies dwindled 6% as both commercial and consumer hardware posted double-digit declines. The printing business only generates about 40% of the new HP's sales, but it accounts for nearly 80% of its operating profit due to higher margins than the PC business.
Splitting with the enterprise segment should give HP more freedom to boost R&D spending, which only amounted to 3.5% of its revenue last quarter. Without having to consider the needs of the enterprise business, HP can raise its R&D spending to compete more effectively against Lenovo's newer PCs and its rivals in 3D printing. Barron's recently declared that HP shares might climb into the "high teens" next year if it can maintain profitability in its printer and computer businesses while boosting shareholder value with dividends and buybacks. HP claims that it will return 50% to 75% of its free cash flow to shareholders with $865 million in dividends and the remainder in buybacks.
Challenges for HP Enterprise
Meanwhile, HP Enterprise faces a tough uphill battle in the enterprise market. Last quarter, HP's enterprise services revenue fell 11% annually to $4.98 billion as demand for IT outsourcing, apps, and business services all declined. However, IT hardware revenue inched up 2% to $7.01 billion as stronger demand for x86 servers and networking equipment offset weaker demand for high-end servers, data storage solutions, and tech services.
HP Enterprise's earnings look somewhat similar to IBM's. But whereas IBM sold its x86 server business to Lenovo and focused on growing its cloud business, HP sells x86 servers but shuttered its public cloud platform in October. Whitman stated that the business was too capital intensive to compete against established cloud platform leaders. However, HP still intends to maintain a presence in the "hybrid cloud market", which combines private and public clouds for companies that aren't ready to move all their data to the public cloud yet. Gartner estimates that about half of all large enterprises will have hybrid cloud deployments by 2017.
Deutsche Bank analyst Sherri Scribner recently noted that while the services segment still needs to evolve, margin improvements could boost earnings over the next three years as recurring revenue stabilizes its long-term growth. Scriber notes that HP Enterprise's tech services business will grow alongside hardware sales and provide "a steady recurring revenue and cash flow stream for the company". Like HP, HP Enterprise plans to return over half of its estimated free cash flow in fiscal 2016 to shareholders, with $400 million in dividends and the rest in buybacks.
The road ahead
Based on HP's own forward earnings estimates, both HP and HP Enterprise are trading at around eight times forward earnings. Neither company has set exact dividends yet, but the aforementioned free cash flow guidance indicates that HP will pay a higher dividend, estimated to be a 3% to 4% yield at current prices. HP Enterprise should pay a lower dividend and commit more of its free cash flow to buybacks and acquisitions. In other words, HP could be better for dividend investors looking for more stability, while HP Enterprise could be a better choice for more growth-oriented investors.
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