Last year's split with HP (NYSE:HPQ) has been a boon for shareholders of HP Enterprise (NYSE:HPE). With its stock soaring 56% year to date, short-term investors may think it's time to capture some gains, and for those who opted to stay on the sidelines, it may seem as though it's too late to jump onboard the HP Enterprise train.
But don't be too quick to discard HP Enterprise, despite its strong performance in 2016. With some big changes on the horizon and its relatively inexpensive valuation even after its stellar run, HP Enterprise still warrants a long, hard look for long-term investors in search of growth.
Three is better than one
CEO Meg Whitman's pledge to become a more agile tech powerhouse in fast-growing markets including cloud infrastructure, software as a service (SaaS), the Internet of Things (IoT), and data analytics took a major step forward in May of this year with news that HP Enterprise would spin off, then merge, its Enterprise Services group with software giant Computer Sciences Corp (NYSE:CSC).
In addition to an expected bump in both operating margin and free cash flow, the deal with CSC includes a $1.5 billion one-time cash dividend for existing HP Enterprise shareholders, and an estimated 50% stake in the new company. In fact, the agreement with CSC made so much sense, Whitman decided to do it again.
In an effort to boost margins and cash flow even further, HP Enterprise recently announced it would spin off its "non-core software assets" with U.K.-based Micro Focus (NASDAQOTH:MCFUF), creating "one of the world's largest pure-play enterprise software companies." And HP Enterprise shareholders will gain a 50% share of yet another global tech powerhouse.
In addition to improving margins and cash flow, along with investors owning parts of three IT powerhouses following the mergers with CSC and Micro Focus, HP Enterprise's already rock-solid balance sheet will benefit. The merger with Micro Focus also includes a $2.5 billion cash payment to HP Enterprise, which will open the door to a world of opportunities.
HP Enterprise ended its 2016 fiscal year with just shy of $13 billion in cash and equivalents, up from $9.8 billion a year ago. The boost in ready cash was largely due to Whitman's strict management of expenses, as evidenced by HP Enterprise shaving approximately $2.2 billion in costs last year, and that's after factoring in one-time gains for divestitures.
When the Micro Focus merger closes in late March, assuming all of the necessary conditions are met, HP Enterprise will add another $2.5 billion to its balance sheet. Perhaps another dividend boost will be in the cards, or likelier still would be more niche acquisitions like HP Enterprise's recently completed $275 million deal for big data analytics provider SGI. With a balance sheet like HP Enterprise, who knows? Another dividend hike and more targeted, solution-specific acquisitions could be in the offing.
What's not to like
It may seem like a head-scratcher given HP Enterprise's performance in 2016, but it remains one of the cheapest stocks in its sector, trading at a mere 13 times trailing earnings. And HP Enterprise is valued at a paltry 11.5 times future earnings. Analysts' general blase attitude toward HE Enterprise may have something to do with its valuation.
With a consensus price target of $25 a share -- all of 5% above current levels -- and what amounts to a "hold" rating, pundits clearly aren't enamored with HP Enterprise. But analyst negativity or its stellar stock price run in 2016 shouldn't dissuade long-term investors from giving HP Enterprise stock a serious look.
And considering HP Enterprise stock will soon include ownership in three tech leaders, rock-solid fundamentals, and the fact it's a screaming value relative to its peers, existing owners should maintain their positions, if not add to them.
Tim Brugger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.