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Hewlett Packard Enterprise: The Cost of Its Cycle of Life Is Clear

By Alex Dumortier, CFA - May 25, 2016 at 11:38AM

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Hewlett Packard Enterprise Co will spin off its Enterprise Services unit in a repudiation of HP's former "go-go" acquisition strategy.

U.S. stocks are higher in early afternoon trading on Wednesday, with the S&P 500 (^GSPC 1.05%) and the Dow Jones Industrial Average (^DJI 1.05%) (DJINDICES: $INDU) up 0.62% and 0.79%, respectively, at 12:30 p.m. ET. Shares of Hewlett-Packard Enterprise Co are outperforming, up 9.42%, on the announcement following yesterday's close that the company will spin off its Enterprises Services unit.

Shrinking your way to greatness

Following years of dubious, if not downright disastrous acquisitions (Autonomy, anyone?) by parent company HP Inc, Meg Whitman continues to un-bundle the mish-mash of businesses  her predecessors assembled. Hewlett-Packard Enterprise Co itself only separated from HP in October, but the next step is to spin off HPE's Enterprises Services unit and to merge it with Computer Science Corporation in a tax-free transaction.

Just as Warren Buffett described in the case of investment bankers in his 2014 letter to Berkshire Hathaway shareholders, it's rather comical to see executives justifying a complete reversal in the strategy that only a few years prior was being touted as the path to greatness. Or rather, it would be comical if shareholders didn't have to pay the price.

This's how HPE CEO Meg Whitman described the planned transaction in yesterday's press release:

The "spin-merger" of HPE's Enterprise Services unit with CSC is the right next step for HPE and our customers. Enterprise Services' customers will benefit from a stronger, more versatile services business, better able to innovate and adapt to an ever-changing technology landscape.

Enterprise Services was created by combining legacy services activities at HP and integrating the 2008 acquisition of EDS, the outsourcing services company founded by H. Ross Perot. Here is then-HP CEO Mark Hurd on that deal:

The combination of HP and EDS will create a leading force in global IT services. Together, we will be a stronger business partner, delivering customers the broadest, most competitive portfolio of products and services in the industry.

Note that in both cases, the resulting business will be "stronger," but for different reasons, naturally: versatility vs. breadth.

(To be fair to Whitman, she was not behind HP's acquisition strategy.)

Hewlett-Packard's cycle of life

Grow, acquire, stagnate, divest: Perhaps that is the cycle of life for large companies in rapidly mutating industries such as technology. Hewlett-Packard Enterprise now wants to shrink its way to growth.

I can't help but be reminded of a Dilbert cartoon strip in which the hapless boss character announces to Dilbert and two of his co-workers: "I've got some good news and some bad news. The bad news is that huge companies like us can't compete against small and nimble companies. The good news is that at this rate, we'll be the smallest company around."

The facts changed

Perhaps it is simply the case that when the facts change, you change your mind. The facts certainly did change for HP as the industry changed -- and the extent of the damage wrought by its botched acquisition strategy became clear.

If it isn't clear, bear in mind that HP's purchase of EDS in 2008 was valued at $13.9 billion in enterprise value. HP Enterprise now reckons  the value to its shareholders of the "spin-merger" is $8 billion: $4.5 billion attributable to the 50%  stake in the combined company, a cash dividend of $1.5 billion, and the assumption of $2.5 billion in liabilities. That's a near-40% haircut, and it doesn't even account for the fact that Enterprises Services was more than just EDS's business.

Is "un-bundling" now the right strategy for HPE? The market appears to think so based on today's price action. For those not involved in the stock, though, it's an opportunity to reflect on just how much shareholder value can be destroyed during a company's cycle of life.

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