In-Depth

What's Going On with HP?

• October 03, 2011

Editor's Note: Our October issue went to the printer before HP fired CEO Leo Apotheker and hired former eBay CEO Meg Whitman to replace him. While the news only made the question, "What's Going On with HP?" more relevant, it did require a significant update of the story. The version of the story here differs from the print version in its references throughout to the Apotheker-Whitman transition.

As Hewlett-Packard Co. moves to re-invent itself, the resulting entity promises to have a significant but still uncertain impact on its relationship with Microsoft and its channel ecosystem. HP is perhaps Microsoft's largest partner and its August announcement that it is considering the spinoff or sale of its $40 billion PC business has left the channel reeling and rivals licking their chops.

Making matters worse, HP's stunning decision to jettison its mobile device business after months of heavily promoting it, the company's deal to acquire enterprise search vendor Autonomy for a staggering $10.3 billion and an announcement that it is lowering its revenue outlook for the third consecutive quarter has left critics wondering if the largest IT vendor in terms of revenues has lost its way.

Compounding the chaos was the HP board's Sept. 23 surprise announcement that Leo Apotheker was being fired after only 11 months as CEO and being replaced by former eBay CEO Meg Whitman. Whether or not Whitman will undo any of Apotheker's moves remains to be seen.

"I will step back and take a hard look at this but from what I know now, I think the strategy is right, the initiatives that we undertook on Aug. 18 are right and I'll dive in and have a more informed point of view for you, probably at our next earnings call," Whitman said, on last month's conference call for analysts, announcing her appointment.

Just prior to the CEO shakeup at HP, Redmond Channel Partner, delved into Apothekeker's moves.

His decision to discontinue the TouchPad just six weeks after its release stunned customers, channel partners and industry observers. Though sales of the device got off to a weak start, HP had indicated it was in it for the long haul. Just a week before pulling the plug, HP gave away free TouchPads to hundreds of channel partners attending the Xchange conference in Denver, in a bid to get them interested in the platform. But sales were abysmal, in part because of the price tag HP put on the TouchPad. At $499, it cost the same as Apple's entry level iPad. Only after HP had a fire sale to clear inventory, offering the remaining TouchPads at $99, did they sell like hot cakes.

"Our TouchPad has not been gaining enough traction in the marketplace," Apotheker said during HP's Aug. 18 earnings call, according to a transcript posted by Seeking Alpha. "Frankly, the software was met by strong reviews, but the sell-through of the product was not what we expected. Our intention was to solidify webOS as the clear number two platform for tablet. But with such a young ecosystem and poorly received hardware, we were unable to achieve our target. Essentially, the TouchPad and our webOS phone have not met our financial targets and other milestones that were set. To make this investment a financial success would require significant investments over the next one to two years, creating risk without clear returns."

Nevertheless, HP's decision to pull the plug on the TouchPad left channel partners shocked. For example, Green Bay, Wis.-based Camera Corner Connecting Point, a VAR that sells HP PCs, servers, printers, storage and networking gear, invested heavily in the TouchPad, running ad campaigns and hiring a specialist dedicated to the device.

"We all just feel very let down," says Camera Corner Connecting Point CEO Rick Chernick. "Very exhausted is the word I use because we put a lot into it and it went south real fast. We feel upset and very disappointed." When HP reduced the price of the TouchPad to $99, Chernick was able to clear his inventory. "I'm glad they price-protected us," he says.

What's on Tap for webOS?
While the TouchPad hardware business and smartphone product lines are now history, HP says it is still considering options for its webOS software business, which could include selling or licensing it to a third party. The company had grand plans for webOS, which included offering it on its PCs and printers, a move that was surely not welcome by Microsoft. Though webOS would not replace Windows, it would be the interface on top of it.

"By buying Palm, HP created a bit of abrasiveness to their relationship with Microsoft," says Directions on Microsoft research VP Wes Miller. "It was sort of a slap across the face at Microsoft and I think by discontinuing webOS as their platform, there's an opportunity to make that strong again."

Market researcher IDC said in a research note issued on the day of HP's announcement that prospects for webOS look bleak. "Despite statements from HP to the contrary, IDC believes the company's actions today have effectively killed the already slim chance webOS had in the mobile OS market."

Amazon.com, which jumped into the tablet business in late September by announcing the Kindle Fire, is said to be interested in webOS, VentureBeat reported Sept. 29.

Divesting the PC Business
HP has created further uncertainty with its signals that it will likely divest its PC business either through a sale or spinoff. HP is the leading provider of PCs according to both Gartner and IDC. It has an 18 percent share of PCs shipped worldwide in the second quarter, IDC reported in July. In the United States it has an even bigger share -- 26 percent.

While PCs are notorious for their razor thin profit margins, HP has positioned itself as a soup-to-nuts provider of IT solutions. Extending upon that, HP and Microsoft have a longstanding program, called the Frontline Partnership, by which they offer integrated solutions based on HP hardware and Microsoft's various software offerings including both the desktop and server versions of Windows, Exchange, SharePoint and SQL Server, among other products.

Frontline Partnership also is sometimes used by both companies to describe the deeper engagement between them that was formed 20 years ago to ensure HP products bundled with Microsoft software work well together and are jointly supported by both companies.

Moreover, the two companies entered into a three-year $250 million pact to offer advanced data center solutions. The company has already released several appliances bundled with SQL Server and Exchange Server.

The lack of a PC business will especially have repercussions for partners who service small and medium businesses (SMBs) who often prefer to acquire IT from a single vendor. "Without PSG, HP's value proposition will be much weaker in SMBs. PSG not only provided an entrée to upsell servers and services, but has been, for all intents and purposes, HP's major marketing arm and voice to these businesses," SMB Group analysts Sanjeev Aggarwal and Laurie McCabe said in a research note.

"Meanwhile, since SMBs lack IT resources, they typically don't want or can't deal with multiple vendors supplying different pieces of the IT puzzle. This means that when HP hands off its PC business, both SMBs and the HP VARs that serve them -- many of whom are small businesses themselves -- will have the opportunity to rethink whether they want to or should stick with HP on the server side."

Customers who buy PCs from Chernick also purchase printers, servers, storage and networking gear. "Customers don't want to buy from 10 different vendors," he says. "They love the fact that they can go to HP and get everything under one roof. They have one throat to choke, it's beautiful. We may not make much on PCs, the world knows that, but at the same time I'd like to sell them the 50 desktops, the five servers and the SAN with one name on it."

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Executive vice president and head of the Personal Systems Group Todd Bradley has indicated that spinning off the PC business is the preferred scenario. If HP goes that route, Chernick said he is okay with that. "If they sell it off to another company like IBM did, that would have an effect," he said.

Terry Hedden, CEO of Infinity Technology Solutions in Tampa, Fla., said he is not making any drastic moves but is considering his options. "We almost unilaterally recommended HP for both PCs and servers, so the decision to spin it off was very disappointing for us," Hedden says. "Our goal really is to find someone who can do PCs and servers and obviously that's getting harder and harder to find. We're just evaluating options right now and we're going to take it one day at a time."

One option he won't consider is Dell. "Dell has a track record of going direct," says Hedden, who was a Dell reseller until five years ago. "In the Tampa market they launched a direct managed services initiative where they were going to provide on site or remote support to Tampa customers, and we kind of view them as the devil in sheep's clothing. Their business model is direct, I think their channel friendly attitude is a front a little bit and just not something we can trust."

Nevertheless, while Lenovo, Acer, Sony and Toshiba will likely get a bump from HP's action, SMB Group predicts Apple and Dell will be the biggest beneficiaries. Apple will gain from its breathtaking sales of iPads as well as increasing market share for the Macintosh, which IDC pegs at 8.5 percent.

For its part, Dell is best positioned to offer complete IT solutions, from PCs, servers, printers, storage, networking gear and managed services. The company, which has significantly expanded its outreach to the channel in recent years, has launched an active campaign to woo HP customers and partners.

CEO Michael Dell went on a tirade on Twitter looking to capitalize on the uncertainty at HP. "Goodbye HP, sorry you don't want to be in PCs anymore...But we do more than ever. How would you say goodbye to HP?" he wrote. Dell also launched a new Web campaign looking to underscore its commitment to the PC business. The Web page includes a link to a new migration program for HP customers.

"Not only will Dell take advantage of market uncertainty, but it is well-positioned in its ability to serve the end-to-end IT needs of SMBs, from PCs to servers to managed services," according to SMB Group's Aggarwal and McCabe. "In the last two years, Dell has made a significant investment in listening to and understanding the needs of SMB customers, and it's paying off."

HP's lack of an appetite for PCs comes as growth for the systems is on the decline, thanks to the growing popularity of tablets. Just last month, Gartner drastically lowered its growth expectations for this year, from a 9.3 percent increase to a mere 3.8 percent jump totaling 364 million units. PC unit growth will be better next year, 404 million units or a 10.9 percent increase, but sill lower than the 12.8 percent growth previously forecast for 2012.

"Media tablets have dramatically changed the dynamic of the PC market and HP's decision to rethink its PC strategy simply highlights the pressure that PC vendors are under to adapt to the new dynamic or abandon the market," said Gartner research director George Shiffler, in a statement.

Nevertheless, critics questioned the manner in which HP announced its intention to explore options for its PSG, effectively rendering it a lame duck business that will be shrouded in uncertainty until a decision is made.

"I think that it's going to cause a lot of people who had previously bought HP hardware on a cyclical basis to reconsider that," says Directions on Microsoft's Miller. "That's obviously going to impact any partners who have based their work around selling in a whole solution both on the PC side and the server side and bringing in HP for the service side. If you are a partner based around the PC business and you had bet the farm with HP and didn't have a strong partnership with Dell, you may realize there may be some potential implications there."

HP says there is no reason for concern. In a letter to customers, Bradley said HP will continue to support and warranty all PCs, regardless of who owns PSG in the future. "We are here for you today and will be here tomorrow," he said. By separating PSG from HP, Bradley added it will lead to a more agile organization, enabling it to be more responsive.

Whitman promised that HP would make a decision on whether to spin off PSG or retain it by the end of the calendar year.

Not all partners are dismayed with HP's interest in focusing on higher margin offerings targeted at the enterprise. Pat O'Connor, director of business development for remarketed services at Solon, Ohio-based Agilysys Technology Solutions Group in Salon, Ohio, says he welcomes a richer portfolio of software and datacenter solutions.

"The customers' perception is they are becoming more focused on the enterprise and the datacenter certainly. [They're moving into] cloud computing, that's kind of perceived as goodness," O'Connor says.

While he said it is nice to be able to offer HP PCs along with back-end infrastructure, there are other options. "Even though we do sell the entire portfolio and the whole solution, we have a variety of ways we can approach a customer's business needs and come up with a viable solution," O'Connor says. "If HP chooses to move off a product set, and the need is a complete datacenter-to-desktop solution, we can certainly still craft and configure that. There are other vendors that are currently part of our line card and portfolio that we can certainly introduce into the equation."

Case in point: when IBM sold its PC business to Lenovo, Agilysys simply introduced the new company to its portfolio. If HP spins off its PC business, the reasoning goes it could add the new company to its lineup as well. It is presumed, though not certain, that HP would enter into a reseller agreement with the divested PSG entity, just as IBM did when it sold its PC business to Lenovo.

Autonomy Deal Questioned
The fact that HP is using the bulk of its $13 billion in cash reserves to acquire Autonomy, which will only account for 1 percent of HP's revenues, has not been well received. HP has signaled that it is transforming itself from a consumer and enterprise company to just an enterprise company, following in the footsteps of IBM. The plan: get out of low margin businesses and focus on more profitable niches like software, services and the cloud.

But will Autonomy get HP there? And is the company squandering its cash reserves at that price tag, which is nearly 11 times revenues? Apotheker said on HP's earnings call that it is worth it. "Autonomy represents an opportunity for HP, for us to accelerate our vision to decisively and profitably lead a large and growing space, which is the enterprise information management space," Apotheker argued during the August earnings call.

Autonomy's flagship Intelligent Data Operating Layer (IDOL) software, provides cross-enterprise search and content management bringing together silos of unstructured data including email, text, Web pages, voice and video. It's used for e-discovery, records management, archiving and Web content management, among other things.

HP noted that Autonomy's revenue growth was running at a compounded annual growth rate of 55 percent. Its 25,000 customers include major corporations, law firms and federal agencies including. It has 400 OEM partners including Symantec, Citrix, HP, Novell, Oracle, Sybase and TIBCO. How those OEM relationships will fare in the future remains to be seen, particularly Oracle. The two companies have a bitter rivalry that flared up publicly when Oracle hired former HP CEO Mark Hurd and decided to stop supporting the Itanium server platform.

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Those looking for a hint of how Oracle might view the Autonomy relationship now that HP is involved may need look no further than a statement Oracle issued in late September saying that the database giant itself passed on buying Autonomy. The Oracle statement seemed designed to disprove Autonomy CEO Mike Lynch's public statements that he hadn't been shopping the company around.

Analysts raised questions about HP's willingness to shell out $10.3 billion for a company that generated $870 million in revenues last year.

 "The IDOL IP is stagnant. There hasn't been a major release of IDOL in over 5 years," wrote Forrester Research analyst Leslie Owens, in a blog post.  "Buyers of its technology though have been less enthusiastic, regularly citing a firm that is arrogant in its dealings with customers, confused roadmap messages, and technology (particularly the core IDOL platform) that is overly complex and expensive to use," wrote Alan Pelz-Sharpe, a principal with The Real Story Group. "On the other side of the equation is HP, a hardware and services firm that has had very little success with software."

Others are more bullish on the deal. "The Autonomy acquisition brings a broad portfolio of information management technology, along with a growing number of search-based applications," IDC said in a research note. "Autonomy is a highly profitable software business, with a solid customer base worldwide and a significant cash reserve -- that is, it should add significantly to HP's margins."

Pointing to Autonomy's most recent earnings call, IDC noted that Autonomy's cloud business represents 62 percent of revenues today and is growing at a clip if 17 percent. "HP's converged infrastructure solutions are another linchpin of its risk management-aware cloud computing strategy," the IDC note said.

Apotheker said one-third of Autonomy's revenues are from its software-as-a-service business. Autonomy also recently acquired Iron Mountain Digital for $380 million.

"Autonomy is successfully selling enterprise software into a market in which enterprise spending on technology is growing, even while IT budgets are flat or in decline," said Constellation Research analyst Michael Dortch, in a blog post.

By acquiring Autonomy, HP will greatly boost its presence in archiving, e-discovery and enterprise search, wrote 451 Group analyst Nick Patience. In fact, it might be one area where HP has an edge over IBM and others, he noted. However, HP might encounter difficulty assimilating Autonomy, given diverse corporate cultures, which could explain why it will be run as an autonomous division.

"Company cultures are not complementary; the HP way is a long way from the hyper-aggressive sales and marketing culture at Autonomy," said Patience. "Maintaining Autonomy as a separate entity run by [its CEO] Mike Lynch proves this and calls into question how much real synergy can be had from such a structure. I cannot see that being sustained."

Autonomy has lacked support and after-sales service, according to Patience, adding that it will benefit from HP's services offerings.

What's Next for HP?
It appears HP is looking to follow in IBM's footsteps, where it is driving to become a company focused on services, high margin hardware and software. But competing with IBM eye-to-eye may prove challenging. IBM has a huge software arsenal including a database, middleware and business intelligence tools. Revenues in 2010 were $22.5 billion. HP's software business by comparison was only $3.6 billion in its fiscal year 2010.

By adding Autonomy, HP gains another $1 billion in revenue to its software coffers but the company doesn't currently have enough cash to do any other big acquisitions. HP will likely rely on acquiring smaller companies as it did when it picked up Vertica, a supplier of real-time analytics software, earlier this year.

HP chairman Ray Lane told investors he sees Autonomy on a rapid growth trajectory with potential to evolve into a multi-billion business.

From a revenue standpoint, catching up with IBM's software business may prove elusive. But some, such as Infinity Technology's Hedden, think HP can pull off its expansion in the software business. "I think it's interesting that they are moving more into the software space, it's a nod to IBM," he says. "I don't expect that to be the end of it either, I expect they will build a strong portfolio. There's just a lot more margin to be made in software than there is in hardware. And HP has the brand cache to really pull it off."

While Wall Street has been urging HP to shift its focus on higher margin businesses, the PC business accounts for nearly one-third of the company's revenues. What HP will look like without a PC and mobile device business remains to be seen.

Likewise there is some uncertainty over how its relationship with Microsoft will fare. For example, HP is dragging its feet on producing the Windows Azure appliance it said it planned to introduce last year, while last month launching the beta of a public cloud service that will support the open-source OpenStack project.

Directions on Microsoft's Miller believes while there may be some more competitive conflicts than they've had in the past, that the two companies will continue to share common ground. "I think this will probably make Microsoft and HP's relationship much stronger and we'll see how the PC side develops over time."

Related:

• HP Says It Will Keep Its PC Business
• Will HP Hold On to Its PC Business? Maybe
• HP Considers Spinning Off PC Business, Gives Up webOS
• HP Ousts CEO Apotheker, Names Meg Whitman Successor
• Will Autonomy Save HP?