HP on a roll, but challenges await in 2009

Weakening economy, uncertainty over EDS acquisition will challenge HP

HP has been remarkably successful in a difficult financial time, but keeping up the pace in 2009 will be tough.

HP last month reported fourth quarter net revenue of US$33.6 billion, a 19 percent year-over-year increase, or 16 percent after adjusting for currency fluctuations. Forrester Research analyst Andrew Bartels credits HP with expanding and deepening its market presence in both services and software.

"In that sense, it's kind of following the path that IBM has blazed of moving out of hardware, which is under more price pressure," Bartels says.

Secondly, Bartels says HP has done well in the consumer market with personal desktops, and this has helped the company ride out some disappointing earnings in its servers and storage business.

Despite 13 percent growth in storage revenue, the overall storage and server division reported total fourth quarter revenue of US$5.1 billion, down 1 percent from the previous year. While faring well in the blade server market, HP has struggled with sales of industry standard and business critical servers, following a trend which recently saw the worldwide server market post its largest decline since 2002. Moves toward cloud computing and virtualization are harming server sales throughout the market, Bartels notes.

HP itself predicts great financial challenges in 2009.  The company says unfavorable currency exchange rates will likely drag down its fiscal 2009 revenue by five percentage points in its first quarter and six to seven percentage points over the year. The U.S. dollar has gained strength as of late against currencies such as the euro and British pound. More than two-thirds of HP's fourth quarter revenue came from outside the United States.

The economy's impact on customer spending also will no doubt take a toll.

"We don't know how the economy will evolve, but at this point we are expecting the market to be challenging in '09, particularly for discretionary IT spending," HP CFO Cathie Lesjak said during a November earnings call. "As a result, we are trimming our revenue outlook relative to typical seasonality."

HP could see trouble if consumer spending slows down for an extended period, Bartels says. He is also disappointed in the results of the HP-EDS acquisition, which HP pulled off for US$13.9 billion this year. HP and EDS consulting revenues are now lower than the combined sum of the two companies before the acquisition, he says.

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Still, HP attributed much of its fourth quarter gains to revenue from EDS. Without EDS, HP's net revenue would have grown only 5 percent year over year and only 2 percent when adjusted for currency effects.

HP is integrating EDS into the vendor's Technology Solutions Group, and says it will be able to cut more than US$1 billion in fiscal '09 by slashing corporate overhead related to redundancies between HP and EDS.

While EDS will lower HP's operating expenses as a percentage of revenue, the acquisition will also have a negative impact on gross margin, Lesjak says. There is also no guarantee that customers will react positively to the integration of the two companies.

"We are concerned about HP's plan to use EDS to 'sell and deliver more integrated (i.e. HP) solutions,'" Pund-IT analyst Charles King writes. "This strategy should work pretty well with HP's existing enterprise clients but is likely to be considerably less welcome among existing EDS clients."

HP's strategy appears to run counter to IBM's services approach, which King says allows customers to use whatever hardware and software they need regardless of vendor.

HP also risks alienating partners if the vendor does not take a neutral approach to third-party products, King writes.

"Using EDS to promote integrated HP solutions whenever and wherever possible will flatly not play well with EDS's other IT vendor partners, who have been used to evenhanded treatment," King writes. "Be certain those partners are closely watching what HP is planning for EDS."

The IDG News Service contributed to this report.