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Is bulked-up HP ready for battle?

Hewlett-Packard has shaved costs and returned its businesses to profitability following the Compaq merger, but analysts say it's unclear whether it can compete against IBM or Dell.

Ina Fried Former Staff writer, CNET News
During her years at CNET News, Ina Fried changed beats several times, changed genders once, and covered both of the Pirates of Silicon Valley.
Ina Fried
5 min read
Although Hewlett-Packard is finally getting settled into married life, some analysts say the company still needs to figure out what it wants to be when it grows up.

While the company has managed to shave considerable costs and return all its businesses to profitability after the Compaq Computer merger, analysts say it is still unclear whether the combined entity is much better positioned to compete against IBM or Dell.

"Our primary concern is our sense that HP is back where it was prior to its acquisition of Compaq: a great printer franchise with a suboptimal long-term outlook for the computer business," Bear Stearns analyst Andy Neff said in a research note last week. "Essentially, we?re looking for something that can convince us that HP can show consistent growth--but we have concerns."

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What's new:
The hard work of absorbing Compaq seemingly behind it, HP plots a course of future growth.

Bottom line:
While HP's printing business remains strong, some analysts wonder how the company's other units will fare. To date, they say, HP has been more follower than leader in its computing businesses, and the same may prove true of its forays into consumer electronics.

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HP executives will try to address these issues Tuesday in a meeting with financial analysts in New York. The company is likely to trot out the heads of each of its business units to talk about gains in PCs, services deals and high-end computer gear, such as servers and storage.

While concerns linger, analysts expect the company itself to be quite upbeat, since it's coming off a quarter in which all five of its business units posted profits. While CEO Carly Fiorina was reserved in July when HP missed expectations, she said confidently in November that the company had hit its stride, with the company posting sales considerably ahead of expectations.

In addition, there seems to be a sense that much of the hard work of bringing together HP and Compaq, which merged in 2002, has been done.

"The big blowups that people anticipated happening from the merger haven't happened," said Shannon Cross, a financial analyst for Cross Research.

HP will be looking to prove to the financial community that it has emerged from the merger a stronger company and that it is capable of growing its business as technology spending improves.

"We've done the heavy lifting," said HP spokesman Brian Humphries. "We've integrated the two companies. We've put a deliberate portfolio (of products) together. Wall Street is now looking to understand if we can continue the momentum of the fourth quarter."

Bumps in the road
But not everyone is convinced that the company's fortunes have significantly improved. Outside of its printing business, HP tends to be more follower than leader, Neff said.

"It entered the workstation market because Sun was in workstations," he said. "It entered the PC business because IBM was in PCs. It started to go direct because it wanted to be like Dell. It bought Compaq because it wanted to be like IBM."

Neff said HP's recent hints that it plans to enter into consumer electronics areas, such as the digital music player market, again shows the company following rivals such as Dell, Gateway and Apple. "However, when companies want to be like other companies, they often underperform, since the other companies typically determine the rules of the game," Neff said.

Cross said that HP has not clearly shown how its disparate business units have really begun to work together. "I'm still not really sure how their divisions are truly working together and how much they have that's integrated at this point in time."

Another topic likely to come up at the event is a recent management exodus, with executives leaving to take other jobs, to retire, or in the case of former Compaq CFO Jeff Clarke, for less-than-clear reasons.

Beyond the personnel issues, analysts raise other issues about the company's execution, including a desire to better understand why last quarter's better-than-expected sales did not give more of a boost to the bottom line.

In his note last week, Neff also questioned the impact Dell could have on long-term profit margins in the printer market. He also pointed out the challenges of making significant profits from the PC business.

HP has already committed to more sustained profitability from its computing units. Chief Financial Officer Bob Wayman said last month that the company's plans call for both the PC unit and high-end computer business to be profitable each quarter in the current fiscal year. He also said he was comfortable with analysts' outlook for 2004, which pegged company earnings at around $1.42 per share.

Cautious optimism
Merrill Lynch analyst Steven Milunovich noted that HP sees its PC business as strategic and a potential source of profits, but he said he doesn't expect significant profits until next year at the earliest. Milunovich said he came away from a recent meeting with company management slightly more optimistic than he had been about the company's prospects.

The company may have an easier time of winning consumer business by tying its products together than it will have standing out in the enterprise market, Milunovich said. There, he said, HP faces the challenge of trying to position itself as more of an innovator than Dell but lower cost than IBM.

"IBM and Dell have staked out the extremes," Milunovich said. "The fact that HP's differentiation depends as much on comparing to IBM and Dell as to an absolute proposition is telling."

That said, Milunovich noted that a company doesn't have to be No. 1 to make money. "If you can't be Hertz, be Avis," he wrote. "There's money to be made in being a solid No. 2."

On the printing side of the business, HP continues to generate strong sales and profit growth. The company is expected to outline its strategy to maintain double digit increases in revenue by expanding into new areas, such as high-speed copiers.

Pressures on the profitable ink and toner business remain, but analysts say the company is not seeing any large-scale erosion. Cross noted that the amount of retail shelf space being given to remanufactured ink vendors has been growing at several retailers, with mall shops also opening to sell refilled cartridges.

"There is a huge amount of money to be made doing this," Cross said.

At the same time, Milunovich said that the percentage of cartridges that are being refilled has remained roughly steady for the past 18 months. He cites statistics from Lyra Research that show remanufactured toner cartridges make up about a quarter of toner revenue, while refilled inkjet cartridges account for about 17 percent of ink sales. "The printer supplies business appears safe from disruption for now," he said.