Inside HP’s latest earnings report – It’s China or bust

Updated Nov. 24, 2009 at 3:13 p.m.

Inside HP’s latest earnings report – It’s China or bust

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By Josh Farina, Technology Business Research

Editor’s note: Josh Farina is an analyst with Technology Business Research in Hampton, N.H.

HAMPTON, N.H. - With a strong economic recovery already underway in China, HP (NYSE: HP) has made key strategic moves to strengthen its presence there.

(On Monday, HP reported that its earnings jumped 14 percent to $2.4 billion, or 99 cents per share, in the three months ended Oct. 31, The AP reported. That compares with $2.1 billion, or 84 cents per share, in the year-ago period. Excluding one-time items, net income totaled $1.14 per share. Sales fell 8 percent to $30.8 billion, or dropped 5 percent if currency fluctuations are stripped out. By both metrics, the results exceeded the expectations of analysts polled by Thomson Reuters.)

Most notable is the acquisition of 3Com – which holds a leadership position in the network market in China. A majority of 3Coms research is done in China, which leads TBR to believe HP will transition at least some of its ProCurve research activity to China.

The acquisition of a leading network vendor in the Chinese market further demonstrates HP’s focus on expanding in Asia Pacific, where the company recently assigned Adrian Jones to lead the Enterprise Storage and Server group.

TBR believes Jones’ prior experience as head of HP’s Americas channel organization will help accelerate the expansion of the company’s partner network in Asia Pacific at the same time HP adds to its product portfolio with the acquisition of 3Com.

Also demonstrating HP’s focus on the China and Asia-Pacific region is HP’s investment in its Chongqing, China PC manufacturing facility, which HP intends to use to increase its local presence in China and take advantage of the growing Chinese PC market; in 3Q09 HP’s PC revenue grew 40% over the prior year quarter. HP reported 3Q09 revenue from China increased over 20% versus 3Q08.

Spoiling for the fight

While HP had a relatively good year considering economic conditions (despite an 8% decline in revenue versus the year-ago quarter, HP managed to cut costs and deliver 14% growth in operating and net income in 3Q09), the company remains focused on where it is going, not where it has been.

HP is laying the groundwork to take advantage of pent up demand once the economic recovery goes into full swing. Consumers have been quicker to start spending more freely than businesses have as the economy has shown signs of improvement. HP is addressing both consumers and business with new offerings. For consumers, HP has a number of new offerings and programs in time for the holiday season, including offering discounts and a donation option, with its “Create Change” program, for customers purchasing HP products from hpshopping.com.

HP is also offering financing deals for consumers purchasing PCs from HP direct. HP recently expanded its Total Care portfolio aimed at SMBs and is intended to help SMB customers build an IT foundation to support anticipated growth as the economy recovers. The expanded portfolio crosses HP’s business units: with new PCs, printers, servers, storage and networking.

Delivering “one solution” for data centers

Another check in the pro column of HP’s acquisition of 3Com is the expansion of HP’s high-end networking solutions, which 3Com will bring to HP. 3Com’s H3C brand of core and edge switches will enable HP to plug portfolio gaps in the high end of its networking offerings.

The addition of 3Com comes just in time for HP’s renewed focus on being able to deliver “Converged” Data Centers that deliver an integrated server, storage and networking environment, all run by a common set of management tools. Both HP’s Insight Manager toolset and the HP Software Business Technology Optimization (BTO) portfolio will combine to enable customers to manage their IT assets from the hardware layer all of the way up to managing the business performance of applications – a key requirements for CIOs tasked with targeting their reduced IT dollars on improving business performance.

The increased focus on delivering integrated “systems” to customers comes in the face of increased competition from both IBM and Cisco, each of which have announced strategies for attracting a greater share of customer IT dollars by providing complete solutions for data centers. While IBM relies on its mix of mainframes, x86 servers, storage, and broad software and services portfolio to build unique systems for customers, Cisco has partnered with BMC and EMC to deliver a blended “best-of-breed” set of solutions. TBR believes customers must carefully evaluate the benefits of an integrated solution over vendor-lock-in for net-new data centers as the trade-offs are measureable.

HP Software – still waiting

While other segments of the HP business continue to respond to the economic recovery, HP Software revenue declined 16% year-to-year. One reason for the decline is the drop in services revenue among the business groups shifted into the unit at the start of the fiscal year last November. As customers hold off on new software purchases, the demand for services declines.

Additionally, with the increased profitability reported for the quarter, TBR believes the product mix is led by software, which has higher margins and also follows the historic seasonality of the segment. With more software in the mix and lower overall revenue, the amount of billed services for HP Software has declined sharply. TBR expects that overall HP Software and Solutions revenue will increase in coming quarters now that EDS is fully integrated, with the coming 3Com acquisition, and with growth being targeted in China.

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