Enterprise software company, Oracle Corp. (ORCL) is rumored to have emerged as a potential suitor for the beleaguered information technology (IT) major Hewlett-Packard Company’s (HPQ), after the latter’s share prices tumbled to new lows recently.
On August 17 2011, H-P announced a number of initiatives, including the spin off or sale of its low-margin PC business, partial shut down of its webOS business and acquisition of the business software maker Autonomy Corp.
However, these new initiatives did not go down well with investors. H-P’s share price dropped 20.0% and closed at $23.60 on August 18, 2011, which wiped out approximately $12.3 billion of shareholder value.
According to Bloomberg, the 20.0% plunge drove down the valuation of H-P to 5 times of its estimated profit, about 70% less than an average technology company. However, the company’s shares rose 4.0% on August 24, 2011 to close at $24.45, resulting in a market capital of about $50.90 billion.
The sharp drop in share prices was primarily attributed to H-P’s decision to buy Autonomy for a huge premium (59.0%). H-P is shelling out more than $10 billion (10 times of revenue) for the British software maker, which the analysts believe is unjustified. Although Autonomy has a strong business model, the analysts believe its technologies are secondary for H-P’s growth and the sell off reflected investors’ mood in this regard.
H-P shares have declined 42.6% year to date compared to an 8.6% decline in the S&P 500. Analysts expect share prices to remain at low levels over the near term, which makes H-P a takeover prospect for Oracle or another IT major International Business Machines Corp. (IBM).
However, Oracle is expected to make a bid only after H-P spins off its PC and printer business, according to recent reports from The New York Post and Bloomberg. It is also rumored that Oracle may launch a hostile bid by this year end, following the divestiture of H-P’s PC business. In that case, if Oracle succeeds in acquiring H-P, analysts expect the company to sell off the profitable printer business, which is not concurrent to its business model.
H-P’s cheap valuation is also expected to attract other software giants such as IBM. Both Oracle and IBM are aggressive acquirers, with strong balance sheets and will benefit from the full or partial acquisition of H-P’s assets due to same line of business.
We believe Oracle in particular will be interested in buying H-P’s assets (such as the server unit), to boost its market share going forward. According to research firm IDC, H-P was the leader in the server market, with 31.5% market share in the first quarter, closely followed by IBM at 29.2%. However, Oracle was far behind with 6.5% market share. Hence, the acquisition of H-P assets will boost its competitive edge against IBM, in our view.
On the other hand, IBM will be interested to acquire H-P assets (both the server unit and cloud computing business) as the acquisition will make the company a formidable player in both the server and cloud computing markets.
Recommendation
We believe the tough macro environment in the U.S. will make it difficult for H-P to survive acquisition bids going forward. In such a scenario, Oracle remains well positioned to launch a bid for H-P, although it may be contested by IBM.
We maintain our Outperform rating on Oracle over the long term (6-12 months). We maintain a Neutral rating on IBM and H-P.
Currently, both Oracle and IBM have a Zacks #3 rank, implying a Hold rating on a short-term basis. However, H-P has a Zacks #5 Rank, which implies a Strong Sell rating over the short term.
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