HP and the Value Investor’s Dilemma

Value investors have always taken a cue from Warren Buffett, and one of the mantras through the tech bubble was an aversion to tech stocks. It might not be an overstatement to say that a lot of the outperformance of the mini-Buffetts that were operating at that time did as well as they did because of their aversion to tech stocks. So, it’s been interesting, in this environment, to see a lot of the self-titled value investors pile into tech. With price to earnings ratios in the mid-single digits, one can certainly understand why the old vanguard of tech is appealing to bargain hunters.

I’ve always maintained that technology companies are more binary than most people realize. Few of the competitive moats that exist in other industries exist in the tech space. And the competitive moats that have worked historically are now under fire. Marc Andreeson’s recent WSJ op ed piece illustrates the point well.

The tech landscape is largely winner take all, and the king of the hill has a relatively short time frame to reign before something else disrupts it. Historically, it’s been far better to be a consumer of technology than a purveyor of it in most instances.

Which brings us to HP. It trades cheaply by historical measures. The trouble is that HP has come out and told investors that the businesses they are in are not the businesses they will be in five years from now. They are dumping WebOS (their tablet and cellphone division) and backing away from competing against the iPad. They’re evaluating strategic alternatives for the PC division. So those historical measures are not really meaningful.

Both HP and Dell are pushing hard into higher margin “corporate enterprise solutions”. This is a fancy label for a hardware or software company that does consulting. Most of the growth HP has had in these areas has been acquisition related, not organic growth. And most of the acquisitions have been pricey. So, what you are buying with HP is a new management team, a new strategy, and a smattering of divisions that have eroding competitive moats. Moreover, the Autonomy purchase signals that management is more comfortable executing this strategy by acquiring assets rather than building from the ground up. And judging by the 10x sales price tag, you’re not getting the acquisitions cheap. Hardly a comforting sign for a passive investor. Especially considering that 15% of Autonomy’s revenue comes from IDOL OEM, the embeddable search component. This is the piece that is licensed by some of the very same names HP wants to compete against going forward, so the question remains how the new revenue stream will shake out through the integration phase. Not exactly the kind of situation that lends itself to an investment thesis based on reversion to the mean margin analysis.