In the real world, break ups are a bad thing. They tend to involve extra time in bed, binge watching Friends, and way too much ice cream. In the business world however, break ups have seemingly become the new fad as companies split apart to try and increase their value.
This morning, Hewlett-Packard (HPQ) announced it is splitting up into two companies. One company will be made up of its PC and printer business, while the other will focus on corporate hardware, software and services. The stock is up about 5% today on the news. This announcement comes on the heels of eBay’s (EBAY) announcement last week that it is spinning off its payments system, Paypal, into its own company.
The split is part of a 5 year turnaround plan for HP, which has been struggling recently. Total revenue was $112.3 billion last year, a decrease of 7% of the prior year.
Some parts of the business have been hurting more than others however. In its last earnings report, HP announced its PC and printer business saw a 3.1% growth year to date, but its enterprise hardware and services unit was a whopping 19% below year to date revenues a year prior. But even though the PC and printers business grew slightly this year, it lost its market leader position to Lenovo.
The supposed strategic reasoning behind the split is that streamlining the businesses will allow each one to better maneuver in the marketplace. Rather than focusing on one large behemoth, each company can have more dedicated and focused management to navigate the competitive needs of their marketplaces.
To be honest, I don’t really buy this strategic reasoning. I think the streamlining approach absolutely made sense in the eBay scenario, where eBay and Paypal are operating very different businesses and Paypal is hoping to sell to eBay’s competitors. However, HP’s two businesses are similar enough that they should still be able to generate efficiencies by keeping them together.
I doubt that either business will be significantly more efficient on its own. My doubt is further increased by the fact that Meg Whitman, HP’s CEO, shot down a split proposal three years ago. Now she has apparently changed her mind.
In reality, I think HP’s decision to split comes down to valuations and potential acquisitions, not strategy. Company valuations for the most part depend on “multiples.” A multiple is how much you multiply a company’s revenues or earnings by to get to a valuation for the company. For example, let’s say I wanted to buy Lisa’s pumpkin patch (going for seasonal appropriateness here). If similar pumpkin patches are being sold for 10 times their revenues, and Lisa’s pumpkin patch makes $1,000 in revenues for the year, I would pay Lisa $10,000 for her pumpkin patch.
Multiples are typically how analysts determine if stocks are trading for fair values and how other companies decide how much to pay for their acquisitions. The key about multiples though is that they change based on the industry. So a high growth industry like social media will have a higher multiple than a slower growth industry like retail.
This change in multiples is the key to HP’s split. Right now HP has a price to earnings ratio of 13.88, which means it is trading at almost 14 times its earnings. But if the enterprise business has a multiple of 10 times earnings and the computer business has a multiple of 20 times earnings (the average being 15 now), the sum of the two halves suddenly becomes greater than the original, whole business.
On top of this, splitting the two companies makes them easier to sell to or merge with another company. And if a company is being sold, you want its valuation as high as possible, which the split aids.
I’m not impressed by the HP split and will not be running to buy stock. To me this feels more like a numbers game than a strategic business move.