YCG Investments
“If you buy above average businesses at below average prices, on average, we believe you should come out ahead.” — Brian Yacktman

HP: Reinvent


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Consumers often think of Hewlett Packard (HP) as a computer business, but it is much more than that. Like Dell, its competitor, HP has recognized that the tablet and smartphone revolution will slow traditional pc sales, so they have started to focus in other areas.

We are attracted to the breadth and diversity of the company because it’s more than PCs, but IT & BPO (Business Processing Outsourcing) services, printers & ink cartridges, storage & servers, software, other handheld devices, and networking – that’s a powerful mix of businesses! Specifically, as of their last fiscal year end, while PCs and related sales were 32% of revenue, they only made up a mere 13% of profit. Services made up 36% of profit and imaging & printing made up 28%. So clearly, the core business at HP has been evolving towards a service business, similar to IBM’s recent success with a similar transition.

Many investors seem to have drawn a dark cloud over HP due to the quick departure of the previous CEO, Mark Hurd and increasing distrust over new CEO, Leo Apotheker’s strategy to get the company back on track. Yet Apotheker is definitely a good fit with HP considering his background as CEO of SAP, where in his 20 year career he helped the company become the largest business software applications company in the world.

Hurd did a good job cutting costs for HP in his short time as CEO, but Apotheker has realized that there isn’t a way to cost cut your way to a quality service business in the commercial sector. Instead, he’s been focusing his team at HP to create a sort of “best practices” playbook for service teams to work with. Investments such as this are often slow and painful, but also necessary. Fortunately for HP, since the printing and other businesses are doing so well, Apotheker can afford to focus with laser-like attention to upgrading HP’s BPO and IT services.

We recognize HP as a company with a strong brand, solid balance sheet, great earnings, and well positioned to succeed in the future. Currently, however, short-term investor fears are causing HP to trade at a price that is simply too cheap to ignore. In essence, if you exclude the service business and analyze the cash flows for all other business segments individually, those pieces alone justify the current market price. In other words, it’s almost as though you’re getting HP’s service business, the portion that contributes most to earnings, for free! Overall, the market seems to be giving us an opportune moment to scoop up shares at a time when there are some temporary growing pains for this otherwise great company.

Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.

Posted by: Mike Yacktman | August 01, 2011 | Permalink

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