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No Kodak Moment for Hewlett-Packard

Investment mistakes usually fall into one of three categories: analysis, behavior or bad luck. In October 2011, after the shares of Hewlett-Packard Co. had been halved from about $48 earlier that year, I made a case for the stock. That was a mistake. There was no bad luck. I made several errors in my analysis. In this column I want to drill down into my mistakes and provide a new analysis of what is still an attractive investment.

In 2011 I got three things wrong about HP: printers, services and culture. To better understand the company, it’s helpful to use an analytical framework based on two companies in different time periods: computer maker IBM Corp. circa 1993 and film giant Eastman Kodak Co. since 2006.

Kodak was responsible for pioneering work in digital photography as early as the 1970s. In the ’90s, when digital photography was introduced commercially, Kodak’s 35mm film sales at first continued to grow, as digital cameras were an expensive novelty. But as digital cameras got better and cheaper, and thus more popular, sales of 35mm film started to decline. If you were a value investor analyzing Kodak, the stock would have appeared cheap on past earnings. And if you assumed that Kodak’s cash flows would gradually decline years into the future, you’d have been dead wrong. Kodak turned into the value trap of all value traps. Once digital cameras went mainstream, Kodak’s sales went off a steep cliff, falling from $13 billion in 2006 to $5 billion today. Cameras are replaced every few years, and the cost savings from not buying expensive film any longer were substantial. Also, the new digital cameras were simpler, and the learning curve was not steep.

I challenge you to find a single roll of 35mm film at your local grocery or drugstore. You might look on the same shelf that has the eight-track tapes and vinyl records. There is absolutely no reason for 35mm film to exist in the digital world.

If the HP of today is Kodak in 2006, then value investors like me who dare to discount its future cash flows (even if they are declining) are fools. But I’ll argue that for the most part, with the exception of a few of its businesses, HP is IBM in 1993, not Kodak in 2006.

Leave a Comment    (2)

  • POST

Great write up Vitaliy. It comes at a time where I have been questioning lately where the point of maximum pessimism actually is. Of course this is impossible to predict but errors in analysis, behaviour or plain bad luck do not help.

Mar 12 2013 at 3:14 PM EST


You say that the 'Services Business will probably recover in a year or two, albeit to lower margins'. This timeline seems aggressive.

As Meg has stated, Services is a P&L mess. Mainly from sheer neglect of workforce mgmt, along with approving the past big, non-performing, resource intensive Mega-Deals, that HP so desperately want out of their portfolio. The problem is how to get the customers to exit out of these big contracts on friendly (affordable) terms, then what to do with tens-of-thousands more employees (well beyond the current, target of 30k) needing layoffs and severance packages. As these big contracts exit, there's really no place in HP for these folks to go.

In addition, Meg has also stated that the future of services is converting existing customers from traditional legacy to cloud-based services. This strategy requires huge up-front costs in seeding new host centers, next-gen network infra, re-writing existing customer-specific or customer-owned applications, personalized security hand-holding, migration and back-off planning to minimize impacts, etc. The gotcha to all these up-front HP costs is that the customer expects a) significant, immediate cost-savings to lure them to the cloud, and b) continued improved savings and SLAs for them to remain there with you.

Still much more work, money and cuts needed for HP Svcs to recover.

Mar 11 2013 at 11:20 PM EST