Has HP Turned the Corner?

by Mark W. Hibben
5/23/13

Not out of the Woods Yet

On May 22 Hewlett-Packard reported its fiscal 2013 Q2 results, which indicated that the HP's long downward slide in revenue and earnings is nearing an end. Investors were buoyed by the news, and HP shares shot up nearly 14% in after hours trading.

As CEO Meg Whitman admitted, the recovery process is "non-linear" and far from over, but the signs of a bottom are at hand. In the table below I summarize much of the relevant data.

While revenue is still falling, down 10% year over year, the sequential drop was much less, only 2.7%. Given HP's revenue and earnings trajectory for the past couple of years, signs of a bottom could only come as a welcome justification of investors' faith in HP and Whitman's ability to execute a turnaround. That faith has propelled HP's stock to a 49% gain for the year, making it the best performing Dow component, well ahead of concrete signs of a turnaround, until now.

However, HP's recovery is tenuous and at risk from forces out of its control. When asked when HP could expect to resume sustained revenue growth, Whitman's answer was unequivocal: when the Personal Systems computer business starts growing again. Together with Printing, Personal Systems still generates the lion's share of HP's revenue and is really the heart of the company.

The steep declines in Personal Systems revenue and the even worse decline of 29% in Consumer revenue probably indicates that the industry as a whole is in for another decline in shipments when calendar Q2 data becomes available from Gartner and IDC.

Of course, HP is not just a PC company. Every one of the operating segments listed above suffered some year over year revenue decline, although not as great as in the Personal Systems segment. But just as Personal systems may have reached an inflection point in revenue and operating income, the other segments also bounced back for fiscal Q2, with either slight gains or declines over the previous quarter.

The Shadow of Windows

Wanting to be good partners, HP execs were forced into euphemisms of "macro-economic factors" and "dramatic contraction in the PC market", but it's clear that everyone is worried about one thing: the impact of Windows 8. Yes, I know that Microsoft recently announced that it had sold 200 million Win8 licenses, so it's probably true that not all companies are suffering the steep declines in PC sales that HP is. According to both the Gartner and IDC reports for Q1, Lenovo maintained about the same number of shipments year over year, and picked up a couple of percent of market share in the process.

I'm sure that many would take issue with the idea that Windows 8 has caused problems, but I think most will agree that Windows 8 and RT have yet to effectively counter the disruptive growth of ARM based mobile devices, especially devices running Google's Android OS. IDC's Tablet OS market share data, released on May 1 showed that Android had the dominant market share in Q1 of 56.5% of tablets shipped and showed explosive year over year growth of 247.5%. Given that PC shipments declined about about 14% according to IDC, it's clear that tablet device growth is impacting PC sales. At Google IO keynote on May 15, Google predicted that Android device activations would reach 900 million this year.

Many expect this to change when Windows 8.1 is rolled out and Intel delivers large numbers of Haswell Core processors and Bay Trail Atom processors later this year.

I consider the issue for Windows 8 to be more fundamental: it's really only desirable for a touch screen enabled device. As such, companies like HP with large inventories of non-touch screen PCs are suffering, and will continue to suffer until their product lines fully embrace touch screens. I just did a search on HP's site for touch screen devices and found just 13 PCs, (not counting HP's few tablets and convertibles). Even the majority of HP's "Ultra Books" are older non-touch models, despite Intel having mandated that the UltraBook label could only be applied to touch screen devices. The necessity of touch for Windows 8 is something that caught the PC industry off guard when Windows 8 was introduced last fall, and it appears that HP is still working through its product pipeline.

Whitman indicated that Personal Systems would resume growing by the end of the year, so it's very likely that HP's Windows products will have mostly shifted to touch screens by then. In the mean time, HP is back filling PC sales with a couple of Android tablet devices, and its first Chrome OS laptop.

The HP Slate 7 is a very low cost 7 inch diagonal tablet (starts at $170) running Android 4.1 (Jelly Bean). The Slate 7 costs less than 1/4th of HP's main Windows 8 tablet, the ElitePad 900.

I doubt that Microsoft is very happy about this, but it's clear that HP needs the Android tablets. HP plans to introduce an Android convertible, the Slatebook X2, based on the Nvidia Tegra 4 processor with a 10.1 inch screen. Even though HP will offer very compelling Wintel based convertibles as well, the Slatebook X2 will beat them on price.

Adding to Microsoft's consternation, and Google's glee, HP's Pavillion Chromebook will be its first Chrome OS device. Chromebooks have been the best selling notebook computers on Amazon for quite a while, and the key is price. HP's Chromebook will sell for $330, making it the lowest priced laptop that HP offers.

HP's diversification into devices based on operating systems provided by Google is critical to lowering its exposure to the vagaries of Windows 8, and may even become significant sources of revenue in the coming year.

Is the Optimism Justified?

HP continues to restructure to cut costs, but this has yet to yield much cost reduction. Gross margin is still a very lean 23% and SG&A is only just beginning to decline from a year ago. As a percent of revenue, R&D has actually increased year over year and quarterly, and let's hope this trend continues. HP needs to innovate in order to improve gross margin with new products. HP's R&D revenue percentage is comparable to Apple's (2.57%), which I also think is too low, but well behind Samsung (6.25%) or Microsoft (12.9%). Overall, I think the organizational trends are in the right direction.

The advent of new low power Intel processors and Windows 8 updates will help drive growth in the Windows PC industry starting in the second half of the year. If HP can transition their product line to be almost fully touch screen based, then Personal Systems will resume sustained growth and investor optimism will have been justified.

 

Microsoft's Most Important Hardware: Xbox One

by Mark W. Hibben
5/22/13

The Post PC Era PC

The Xbox One, revealed by Microsoft on May21, demonstrated extremely impressive capabilities not only as a game platform, but as a multimedia PC. Xbox One's brilliant combination of hardware and software positions it to become the center of the consumer's living room and a certain hit this Holiday season, when it becomes available. As a demonstration of Microsoft's growing hardware prowess, Xbox One will put the entire consumer electronics industry on notice.

In "Can Game Consoles Save AMD?" I made the observation that the game console could continue to have a place in the lives of mobile device users who otherwise have dispensed with the traditional desktop PC. This expectation was completely confirmed by the debut of the One. The game play footage from games such as Call of Duty: Ghosts was easily the most detailed and realistic I've seen, including anything on top-of-the line PC gaming rigs.

Mobile devices can't begin to approach what can be done on the new Xbox or current generation PCs. Here, the limiting factor is power consumption. Whereas a tablet might be limited to 5 Watts or less in order to preserve battery life, the Xbox One operates on about 100 Watts, and a typical PC consumes even more.

Xbox One, as a PC substitute, is very PC like inside, having an Intel compatible processor courtesy of AMD, a hard drive, and a Blu-ray drive. The AMD processor is in fact very similar to the Sony Playstation 4 version, with an 8-core 64 bit processor and an integrated Radeon graphics processor integrated on a single chip, the so-called Accelerated Processing Unit (APU).

In addition to the PC hardware, Microsoft is endowing the One with a version of Windows 8. The Xbox One OS uses a tile interface very similar to the Windows 8 home screen, and can freely mix and match games, apps and video on the same screen. The inclusion of Windows was a master stroke for purposes of pulling in as much non-gaming functionality as possible into the One. Microsoft is including a large number of apps including Skype, Internet Explorer, Xbox Music and Video, and others are available such as HBO Go and Netflix.

The main difference between Xbox Windows and Windows 8 is the substitution of voice and gesture commands for the touch enabled UI. An updated Kinect sensor is included with the One and recognizes the user's face and gestures. App starting and control are handled through voice commands, and these worked reliably in the demos.

The Competitive Edge

Up until now, I've been wonder what, if any discriminators would exist between the Sony PS4 and the Xbox One, given that they used similar hardware. Although we haven't seen much of the PS4 so far, I believe that Windows in Xbox gives Microsoft the competitive advantage. Windows enhances the One with so much functionality, without detracting from its appliance-like convenience. We'll know more about PS4 when it's finally unveiled at E3 on June 10. Given that the game consoles have sold an average of 10 million units/year each for Sony and Microsoft, I think the market is at least that big, and first year sales could easily be double the yearly average. Sony and Microsoft have sold about the same number (77 million) of their respective consoles, but I suspect that this time, the market split will not be symmetrical.

With all the hardware goodness of Xbox One, including the Kinect sensor, the retail price looks to be about $500 with an ASP for Microsoft of roughly half that. If Microsoft sells 5 million units in Q4, that would add about $1.25 billion in revenue to the Entertainment and Devices division, home of Xbox and Windows Phone, which would be a 33% increase over the EDD revenue of $3.772 billion in Q4 2012.

The stakes are similarly high for Sony. In its last fiscal year, Sony's game division had revenue of $7.522 billion, down 12% from the previous year. If Sony only manages to sell 10 million PS4s in the coming year, that adds about $2 billion in revenue or 27% of the last fiscal year.

Xbox One Market Impacts

In addition to having a direct impact on game console competitors Xbox One will also have an impact on the market for high end "enthusiast" PCs for gaming. Even though PCs will continue to offer higher levels of performance than the new generation of consoles, consoles will cost thousands less. Intel, in a 2012 Intel Developer Forum presentation, estimated that there were 30 M enthusiast PC users, and I expect the next gen consoles to reduce the size of the enthusiast market as gamers elect to buy consoles rather than new PCs.

Intel also estimated in the same presentation that the mainstream segment of the PC market numbered about 220 M, and I expect Xbox One to also attract users in this segment. Intel, in the process of rolling out its 4th gen Core "Haswell" processors may not even notice the effect of Xbox, but I believe that Nvidia will. The problem is that both Intel Haswell processors and the AMD processors in Xbox One and Playstation 4 include very capable on-board graphics that eliminate the need for a separate graphics processor. This trend of creating ever more capable Intel archecture SOCs will continue to make the discrete graphics processor increasingly irrelevant.

The GPU segment of Nvidia has been pretty much carrying the ball in terms of growth, with the latest quarter's revenue up 8.1% y/y to $785.6 million in Q1. Meanwhile the ARM processor segment lost momentum as revenue declined 22% y/y to $103.1 million. With its efforts to expand into the ARM market stalled, Nvidia's dependence on its line of GPUs makes it vulnerable to the overall technology trend: eventually, discrete graphics processors will only be used for specialized scientific and engineering applications that make use of the tremendous parallel processing power of the GPU.

Living to Fight Another Day

AMD is a clear winner in the next gen consoles, since they sell the same number of APUs no matter how Sony and Microsoft divide the market. Sales of 20 million consoles in the coming year would add about $800 million in revenue to AMD's Computing Solutions Division. The console wins will also help boost sales of AMD's APU's for PCs through a halo effect. Since a console-equivalent APU in a PC would have about the same level of performance and be very economically priced, AMD may be able to win back some of the market share (currently about 12%) that I have previously estimated it lost to Intel in Q1. At 20 million consoles, AMD would just be breaking even, but it would have escaped what many assumed was certain death.