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Krause Fund Research
Fall 2008
Technology Hewlett Packard (NYSE: HPQ)
Recommendation: Buy November 18, 2008
Krause Fund Analysts:
Current Price $30.46
Ben Friedman Matt Halverson
ben-friedman@uiowa.edu matthew-halverson@uiowa.edu
Target Price $45 – 49
Kiran Moorthy Yoav Stramer
kiran-moorthy@uiowa.edu ystramer@gmail.com Hewlett Packs the Heat
Company Overview • HP’s diversified product line minimizes exposure to
Hewlett Packard is a leading global provider of specific product groups combating downside through
information technology products and services to upcoming periods of low or negative GDP growth.
individual consumers, small businesses and large • New breakthrough products in networking will create
enterprises. The company operates seven business a dominant position for HP in servers and storage.
segments including Enterprise Storage and Servers,
HP Services, HP Software, the Personal Systems • HP’s acquisition of EDS shows exploitation of
Group, the Imaging and Printing Group, HP Financial opportunities in their services division, which can work to
Services, and Corporate Investments. HP’s products stabilize the company during a macroeconomic downturn.
include personal computing devices, image and We estimate 2008 growth in that area to be 15.26% based
printing-related software, enterprise information on releases from the first three quarters and fourth quarter
technology infrastructure, and technology services. estimates.
• Market wide shortage of capital creates high barriers
Stock Performance Highlights to entry. HP will maintain market share through a trough
52 week High $52.90 in the economic cycle. HP’s low levels of debt will make it
52 week Low $28.23 easier to find financing for future project. Competitors
Beta Value 1.05 with higher debt like IBM—who’s red-line is being
Average Daily Volume 24.7 m watched with debt levels of $34 billion—may struggle to
Share Highlights find cheap cash.
Market Capitalization $57.70 b One Year Stock Price Performance
Shares Outstanding 2.45 b
Book Value per share $15.73 HPQ S&P 500
10.00%
EPS (2007) $2.76
EPS (2008 estimated) $2.94 0.00%
P/E Ratio 11.2 -10.00%
Dividend Yield 1.10%
-20.00%
Dividend Payout Ratio 11.65%
-30.00%
Company Performance Highlights
-40.00%
ROA 8.19%
ROE 18.85% -50.00%
150
Sales (2007) 104.29 b
Volume (Millions)
Sales (2008 estimated) 114.95 b 100
Financial Ratios 50
Current Ratio 1.21 0
Debt to Equity 1.30
Important disclosures appear on the last page of this report.
P a g e |1
Investment Summary economic recession is imminent and will decrease
growth across all sectors.
We base our “BUY” recommendation on discounted
Figure 1: Global equity losses indicative of imminent or
cash flow and economic profit valuations. Our
existing recession
sensitivity analysis reflects reasonable fluctuations in
key value drivers: WACC, ROIC, and Continuing value YTD Global Equity Performance
of growth, which led us to our target range of $45 – 49. 10.00%
0.00%
Uncertainty in equities in general has reduced current ‐10.00%
‐20.00%
stock prices down to core valuation based on cash flows
‐30.00%
to shareholders (dividends). Because HP has a low ‐40.00%
dividend yield—historically constant at $0.32 per share, ‐50.00%
projected to remain at that level—we feel that the market ‐60.00%
has severely undervalued the company’s stock. ‐70.00%
‐80.00%
Moreover, we feel this undervaluation is industry-wide
USA EURO China India
as both comparables analysis and dividend discount
models price HP at or near current levels of trading. Real GDP
Economic recession will hinder IT spending
However, we feel that current prices are more a Real GDP shrank by an annualized rate of 0.3% in the
reflection of a flight to payout through dividends rather third quarter of 2008 with expectations of continued
than a true lack of confidence in HP’s business model. negative growth. A Wall Street Journal Online survey
Compared to DCF estimates from Barclays, BMO, and conducted October 3 – 7 2008 , predicts fourth quarter
Baird, our target price are still slightly conservative. GDP to shrink by 1.2% (annualized) and first quarter
2008 GDP to shrink an additional 0.1% (annualized).
As real GDP begins to grow sometime during the middle Refer to Figure 2 for visual. i We feel these estimates are
of 2009, we believe the market will start to value HP too conservative, and that real GDP will shrink by over
based on its core business model rather than cash flow to 2% in the fourth quarter after adjusting for seasonality
shareholders. When this happens, expect a surge in the with a continued decline in excess of 1.5% for the first
equity value as low debt levels and cost reduction efforts quarter 2009.
put HP in a unique position to gain market share.
Computers and peripheral equipment contributed -0.08%
Economic Review of the percentage change in real GDP for the third
Factors affecting Information Technology quarter of 2008, showing the first period of negative
growth since early 2005. ii We expect this trend to
Economic Overview continue. Historically, IT spending is usually around
Economy shows recessionary trends double the pace of GDP growth (S&P). If our low GDP
The U.S. economy is widely expected to enter a estimates prevail, IT spending should contract in the
recession, if not already in one. The economy is projected period. Specifically, we expect computers and
currently facing substantial changes, many of which peripheral equipment to contribute a factor of 1/3 of the
relate to subprime mortgages and deregulation in the total GDP shrinkage in each of the upcoming two
banking industry. The easy access to credit in the early quarters. This would imply a contribution between 0.4%
part of the decade lead to artificially inflated housing and 0.5% in the fourth quarter and between 0.0% and
prices. The increases in interest rates and home 0.3% in the first part of 2009.
foreclosures have had a significant negative impact on
the major global equity indices. Forecasts also show the economy beginning its recovery
in Q2 2009. We agree with this prediction to the extent
Leading economic indicators such as Gross Domestic that we do not think Real GDP growth will be negative.
Product (GDP), consumer confidence, and With this in mind, we expect computers and peripheral
unemployment rates are in close proximity to historic equipment to show a full recovery within 24 months.
recessionary periods. The Federal Reserve and the
Treasury department have taken aggressive measures to
ensure a shortened economic downturn. However, as
long as fear remains in the marketplace, we feel an
Page | 2
Figure 2 between 2001 and 2007. Meanwhile, 18.5% of software
revenue derives from exports. A weakened US dollar
GDP: Annualized Change over Period will increase global demand, but it will also increase the
6.0% cost to import; the inverse is also true.
5.0%
4.0% HP’s 2007 annual report indicates non-U.S. sales
3.0% represented 70% of total revenues. iv According to the
2.0% same report, HP has currency risk exposure to over 40
1.0% currencies worldwide, but this risk is concentrated
0.0% within the Euro, Yen, and Pound Sterling. However, for
-1.0% most currencies, HP is a net receiver and so the firm
-2.0% benefits from a weaker US dollar. The company utilizes
forwards to hedge currency risk and they may use swaps
to exchange foreign currency when debt is non-dollar
denominated.
Consumer Credit
Decelerating credit will brings down PC sales Based on the trend in historical implied volatility in the
Consumer credit increased by $6.9 billion in September, options on 6-month USD/EUR forward contracts, the
representing a 3.2% annualized increase over the market has been predicting an increase in USD/EUR
previous month. This represents increases in both since July 2006. Currently, 6-month forward contracts
revolving and non-revolving lines of credit. However, are predicted to be approximately 60% more volatile
benefits to non-revolving lines of credit, such as new than the lows in July 2006. We feel this indicates a
vehicle sales, will drop off in coming months, so this strengthening US dollar on a global level over the next 6
increase may be temporary. to 24 months, which will drive down manufacturing
costs. Refer to Figure 3 for a comparison of foreign
Meanwhile, revolving lines of credit show modest currency changes to the U.S. dollar.
growth, but this is not necessarily a good sign of
economic strength. Poor employment and personal Figure 3
income numbers suggests that consumers are may be Foreign Currency Changes vs.
relying on extended credit card balances to contest the
weak economy. As the yearend approaches, we expect US Dollar
slow or possibly negative growth in consumer credit as YEN Pound Sterling Euro
consumers begin to maximize their credit balance and/or
20.00%
curtail spending on nonessential goods. 15.00%
10.00%
This raises concerns for future consumer spending over 5.00%
both short and long term. We expect this decelerating 0.00%
-5.00%
demand to have an adverse effect on electronics retail -10.00%
sales. Negative electronics retail sales growth of -1.8% -15.00%
in September and -2.3% in October add more credence -20.00%
-25.00%
to our expectation. As the strain on credit lines
continues, computer hardware and peripheral sales will
continue to suffer. We feel this trend will remain
constant into the first quarter of 2009, notably after
seasonality adjustments. iii Unemployment
Expect more jobs lost throughout the next 6 months
Currencies October’s unemployment rate reached 6.5%, a 40 basis
Strengthening dollar will keep manufacturing costs point increase over the September numbers and a rate
under control, but may hurt HP’s position as a net that exceeds the peak unemployment levels during the
receiver last economic downturn. Refer to Figure 4 for visual.
Many US based technology companies have established While the unemployment rate has been increasing all
or out-sourced manufacturing to low-wage countries year, the recent upswing in unemployment levels is
such as India and China in an effort to reduce costs. For indicative of a fairly long and deep recession into next
example, peripheral imports from China rose 38.7% year. We expect unemployment to continue to rise
Page | 3
through the fourth quarter 2008 before showing signs of other industries through a trickledown effect, which has
stability near the end of the first quarter 2009. increased the risk of lower product demand and slowing
revenue growth.
Figure 4
Unemployment Business Cycle
7.00% The Business Cycle has peaked –cyclical business
negatively affected
6.00%
We believe that the business cycle has peaked, and has
been decelerating for some time. We have not yet hit a
Unemployment Rate
5.00%
4.00%
recession in the most literal sense although many growth
indicators like Real GDP have fallen into negative
3.00%
growth1. This will have a negative impact on cyclical
2.00% products and industries.
1.00%
While much of HP’s focus is on innovations such as
0.00% cloud computing where we expect high growth, the cash
Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08
generated to invest in such innovations comes from
Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 cyclical cash-cows like low and mid range servers,
Unemployment 5.10% 5.00% 5.50% 5.50% 5.70% 6.10% 6.10% 6.40% imaging and printing technology (IPG), and PC sales.
While HP’s growth sectors will continue to perform well
in most economic environments, the revenues used to
Unemployment’s impact on technology is two-fold: first, invest in such innovations may dry up in coming months
it adversely affects business purchases, as there is with decreased revenue streams in IPG and PC sales.
approximately a 1:1 ratio between employees and We expect any decline in revenue to be a short-term
computers at a business. Second, unemployment serves effect that Hewlett Packard can afford to weather due to
as a proxy for other cost-cutting measures such as its diversified product line and widespread global
declining investment in research and development. By market.
spending less money on research and development,
technology companies sacrifice long-run returns through
innovation. Firms such as Dell and IBM have already Computer Peripherals Overview
taken such measures. HP’s research in development as a Industry Outlook
percentage of sales was .5% lower in the third quarter of
2008 compared to the first quarter. v Coupled with IT Spending Slowing
rising inflation, business cost-cutting measures may also Baird’s third quarter 2008 survey shows IT spending
include delays in hardware upgrades, which will again slowing; this most specifically reflects at slowing rate at
have a negative effect on sales. which corporations are updating their servers and PCs.
As budgets reset as companies begin their new fiscal
Economic Trends years, this slowed spending could have a significant
negative impact on first quarter 2009 sales. vi
Credit Crunch
Bank failures are creating a flight to quality Manufacturers Reducing Component Inventories
Recent bank failures have created a large amount of In slashing its 2008 fourth quarter guidance, Intel, one of
uncertainty in the equities market; this has shifted HP’s most powerful suppliers, cited the PC supply chain
demand to treasuries and related securities with low “aggressively” reducing component inventories on
default risk. As a result, market volume has decreased expectations for a slowdown. The company also cited
holistically making it is harder for firms to raise capital. weak demand in all segments and regions. vii
The recent failure of Lehman Brothers and subsequent Weak Retail Sales in Consumer Electronics
buyout of Merrill Lynch did not significantly affect U.S. retail electronics sales were down 5.6% in October
Hewlett Packard’s stock, and it has historically held low compared to last year’s numbers. Best Buy reported soft
correlation to the financial sector (which represents only sales in October, which reinforced sell-side analyst
2% of HP’s revenues). However, though not affected concerns about the consumer electronics industry
directly, HP along with almost every sector of the umbrella under which peripherals sits. Short-term retail
economy has felt the impact of tightened credit. The sales will be weak heading into the holiday season,
negative side effects of bank failures have spread to raising concerns of excess inventory levels. viii
Page | 4
markets, HP is the clear leader holding 43.0% and 33.5%
Conclusion: Rising Inventories Diminish Margins of the market respectively. Other major players include
We expect exceptionally weak sales heading into the Dell (mid-range only), IBM, and Sun Microsystems. All
holiday season (1Q FY 2009 for HP). This affects the together, these firms make up around 90% of total
peripheral industry’s profit margins in two ways. First, revenues in both these segments. Adding to the
slow sales clearly lower revenue expectations. Second, obstacles for new market entrants is the acquisitive
slow sales will cause inventory buildup to the point appetite of the industries major players. HP alone spent
where some party must slash prices to avoid more than $6 billion in fiscal 2007 to acquire 10
obsolescence. software, technology, and service companies, not
including their recent acquisition of EDS. iv
If the industry does not slow production in anticipation
of this slow-down, inventories exceed sales, clogging all An inability to compete with large firms on price and
distribution channels from the manufacturer to the brand recognition, combined with a high cost of capital
retailer. The Intel report indicates that manufacturers and dismal sales forecasts makes the potential for new
have slashed component inventories significantly which entrants low in the near term.
is indicative of an anticipation, but the risk of excess
inventory is still high on the retail side. Suppliers
Low product differentiation diminishes supplier power
Given the rate of innovation within peripherals, Hardware manufacturers tend to purchase from the
inventory turnover needs to be high in order to maintain lowest cost parts supplier due to low product
profit margins. Peripherals inventory becomes obsolete differentiation. The commoditization of the computer
quickly, and if the distribution pipeline becomes clogged hardware components industry has led to a large amount
with excess, component makers, peripheral of importing from low cost manufacturing centers like
manufactures, and retailers all risk an expensive India and China. In turn, this has created an
inventory write-off. environment in which suppliers have little bargaining
power. While suppliers are slightly dependent on raw
We feel that production will slow down to a level materials such as steel and aluminum, hedges are in
appropriate for diminished sales expectations. This still place to minimize this impact.
reduces income for those within the peripheral industry
by a significant amount. This generalization does not hold true for all parts
suppliers. Intel stands out as the chief exception. With
Industry Review high brand power, superior product quality, and high
customer loyalty, Intel has significant power especially
Potential Entrants when compared to other suppliers. Because Intel’s
High barriers to entry will keep dominant players on top supplier power extends universally across the computer
The credit crunch creates a lack of available capital, hardware industry—Intel supplies between 85-95% of
creating difficulties for new entrants into the market who microprocessors used in PCs ix —its company specific
rely on large amounts of capital for growth. impact is negligible.
Consistent pricing pressure within the industry will also Customers and Price Pressures
ensure that only the most efficient firms survive. As new Price pressure indicates moderate buyer power while a
entrants face increased marketing costs to compete with global reach and diverse customer base strengthens
high brand awareness in the industry as well as research income stability
and development costs, they will have difficulties in a Approximately 65% of Hewlett Packard’s sales come
market with constant price competition. On the other from international markets (2007 10-K p. 147). This is
hand, firms like HP, Dell and IBM—those with diverse consistent with industry trends as the U.S. holds 29.9%
product portfolios—can adjust prices to react to or even of the global market share viii. In 2007, US sales grew by
create price competition that could drive any new entrant 6.5%, just under half the global rate. Last year, Asia
out of business. Pacific market to gain global share, but in the late 90s, it
struggled by comparison. Due to volatility in growth
In terms of market share, IBM accounts for 57.2% of the and revenue in regional markets, it is critical for
high-end servers business with HP having the second hardware manufacturers diversify geographically to
largest share with 18.1% as of 2006, the most recently maintain semi-stable revenue streams.
available data. In the mid-range and volume server
Page | 5
Customer loyalty is relatively low, but brand awareness
is high as minimal differentiation has created a price Performance by Product Group
competitive environment that stresses the manufacturers’ Figure 6
ability to control capital outlay and fixed costs. Revenues By Product Segment
Financial
Services and
Substitutes Other, 2%
Threat of substitution growing from gaming sphere and
other smart appliances HP Services,
Historically, PCs and other computer hardware provided Imaging and 16%
Printing Group, HP Software,
unique services. However, advances in gaming console 27% 2%
technology, along with the innovations in handheld
devices such as Blackberries and the iPhone have
Enterprise
duplicated many of the PC’s basic communication tasks. Storage and
Servers, 18%
A moderated but growing threat of substitution may
erode hardware and peripheral sales in the future.
Personal Systems
Group, 35%
Analysis of Hewlett Packard
Overview
Corporate Strategy
Hewlett Packard’s corporate strategy focuses on cost Figure 7
Fiscal 2007 Financial Metrics (Dollar amounts in Millions)
reduction, restructuring, and targeted growth. Technology Solutions Personal Systems Imaging and Printing
Group* Group Group HP Financial Services
Net Revenue $37,740 $36,409 $28,465 $2,336
Restructuring and cost reduction: Year over Year Net revenue %
HP will continue to focus on cost reduction while taking increase 10.3% 24.8% 6.3% 12.4%
Earnings from operations $4,156 $1,939 $4,315 $155
advantage of its global position. With the restructuring
Earnings from operations as a %
of HP’s recent acquisition, Electronic Data Systems of net revenue 11.0% 5.3% 15.2% 6.6%
(EDS), the company plans to reduce its combined
Technology Solutions Group Breakdown
workforce by 7.5% (24,600 employees) – a plan Enterprise Storage and
resulting in an estimated $1.8 billion in annual cost Servers HP Services HP Software
Net Revenue $18,769 $16,646 $2,325
savings. Just recently, the company has announced a Year over Year Net revenue %
shutdown holiday - a plan to reduce operating costs. iv increase 8.4% 6.6% 78.7%
Earnings from operations $1,980 $1,829 $347
HP is also in the process of consolidating 85 data centers
Earnings from operations as a %
worldwide into six state-of-the-art centers in three U.S. of net revenue 10.5% 11.0% 14.9%
cities and plans to reduce 25% of its global real estate
within the next two years. HP Consolidated
Net Revenue $104,286
Year over Year Net revenue %
Targeted Growth: increase 13.8%
HP estimates fourth quarter FY08 revenue between Earnings from operations $8,719
$30.2 and $30.3 billion (slightly above our fourth quarter Earnings from operations as a %
of net revenue 8.4%
estimate of 30.0 billion) and expected diluted EPS to be Net Earnings $7,264
between $0.95 and $0.97. This number is similar to
November estimates from Barclays Capital and BMO HP Imaging and Printing Group (IPG)
who estimate 4Q EPS at $1.02 and $0.99 respectively. x IPG performance held together by solid supplies growth
Positive forecasted growth is a result continued strong performance countering significant declines in printer
performance across product portfolio - growth in hardware revenue due to aggressive pricing.
enterprise storage and servers, notebooks, and the IPG, HP’s largest sector contributing 27% of the
software and services industry. Forecasted growth is also company’s total revenues and 40% of operating profits,
a result of higher growth in emerging markets especially posted 3Q08 revenues of $7B (+3% growth y/y) and
in Brazil, Russia, India, and China. iv operating margins of 15%, on target with HP’s predicted
14.5% to 15% estimate. Though margins were on par,
performance in the sector was two-sided. Printer
hardware underperformed posting -11% revenue
declines stemming from flat consumer hardware growth,
Page | 6
not a surprise with recent declines in consumer competition from companies such as Dell –who have
spending, and a 9% decline in commercial hardware unit recently entered the retail channel –will continue to
sales. Printer Supplies, however, performed better than exhibit pricing pressures stunting HP’s operating
expected with growth of 11% offsetting the declines in revenue. Average selling price declined for 3Q08 was
hardware sales. xi 5%., not terrible, but likely to decrease further.
We expect growth for the remainder of 2008 to be +13%
We feel that continued pricing pressures and declining y/y and operating margins to decline slightly in the
hardware growth – associated with the poor economic fourth quarter to 5.3%. We believe the segment will
outlook –will continue to adversely affect the segment; continue to surpass the overall company and HP’s long-
however HP’s steady growth in market share and term segment growth target of 5 to 7% for the next few
substitution of revenues to the higher profit yielding years. We expect growth to be weak around 6% in
supplies section should keep IPG’s long-term future 2009, based on continued price per unit declines and
outlook positive. Intel’s recent announcement of weaker than expected
demand across all its segments. We expect growth to
We expect growth to hover around 1.5% for 4Q08, 0% pick back up over 12% in 2010 with operating margins
throughout FY09 and around 3.34% long-term growth– staying steady around 5.0%. xii
on the underside of HP’s long-term growth estimates of
4-6%. We feel that continued pricing pressures and Top Competitors in PSG: iv
declining hardware growth will continue to negatively 1.) HP
affect the segment, however HP’s steady market share
growth and revenue growth in supplies section should 2.) Dell
Top Competitors in IPG: iv 3.) Acer
1.) HP
4.) Lenovo
2.) Canon
HP Enterprise Storage and Servers
3.) Epson Unfavorable pricing eating away at ISS sales revenue
and margins; Storage revenues strong
4.) Lexmark The ESS, consisting of Industry Standard Servers(ISS) -
bulk of ESS revenue-, Business Critical Systems(BCS),
HP Personal Systems Group (PSG) and Storage, posted 3Q08 revenue of $4.7B (+4% y/y)
Emerging markets and strong notebook sales, lead PSG and operating margins of 11.5%, above last years’
growth to outpace company as whole; Volatile numbers but below forecast due to unfavorable pricing.
component prices and increasing competition from ISS sales by unit went up 13%, but revenues in the group
companies such as Dell and Apple may affect future experienced only a fractional 2% due to aggressive
operating margins pricing from competitors eating away average selling
PSG, the largest segment of the HP business and heir to price and increased input costs eroding gross margins.
the number one worldwide PC market share, posted
3Q08 revenue of $10.3B (+15% y/y, +1.8% q/q) and Blade growth remains strong (66% growth in Q308) as
operating margin of 5.7%, slightly above analysts’ well as Itanium-based Integrity System revenue growth
expectations. xi (+18% y/y) now making up 78% of BCS revenue. These
will be HP’s top performers in the segment for years to
PSG’s top line looked great in the third quarter, with come. iv Storage revenue increases have also offset
sales that outpaced the entire company - suggesting a pricing pressures in ISS. Storage revenues increased
healthy industry demand. Growth was primarily driven 16.5% due to mid and low range servers.
by strong notebook sales growth in emerging markets
caused by a global shift in demand from desktops to We expect price competition to negatively impact HP
notebooks. PC unit sales growth was 20% y/y, notebook margins. HP may be able to shift its mix and reduce
and desktop revenue were up 26% and 6% y/y in the costs through further commoditization of components-
third quarter. resembling Dell’s operations- but we expect stagnated
Operating margins for the segment were 5.7%, above growth in the next few quarters on the lower side of
some expectations, but also down relative to last year - HP’s long term target growth for the sector of 4 to 6%
the first time in over two years the company failed to closer to 3- 5%.
increase year-over-year operating margins.iv Increased
Page | 7
Top Competitors: iv
Servers Storage
1.) IBM 1.) EMC
2.) HP 2.) HP
3.) Dell 3.) IBM Future Prospects
4.) Sun 4.) Dell Hewlett Packard has positioned itself to be the dominant
player in the computer peripherals industry in the long
HP IT Services and Software run. Their global reach and diversified product line
Services and Software high margins and growth create economies of scale that allow them to be a cost
potential but only small portion of HP total revenues; leader. In a time of economic uncertainty, they also
EDS acquisition will increase this percentage have low levels of debt relative to equity, which can
create earnings that are more predictable for HP as well
HP Software and Services segments posted 3Q08 as make it easier for the company to secure financing for
revenues of $4.75B (+14% y/y) and $781M (+41% y/y) continued inorganic growth even as the credit markets
and operating margins of 15.6% and 12.1%, the highest tighten. IBM for instance has a business model that
margins of HP segments. Though the sector does not includes high levels of debt- $34 billion to be exact.
make up a huge amount of the company’s revenues, it is Comparing the two top market leaders in a credit crisis,
a target for future growth and adds value through its high HP seems to be the safer investment.
operating margins and its use to expand diversify HP’s
product portfolio. iv However, given present economic uncertainty many of
HP’s short-term prospects are unclear. A volatile stock
In fiscal year 2007, HP allocated $6B to acquire 10 market coupled with a weak global economy heightens
software, technology, and services companies. These the risks of equity ownership while diminishing the
acquisitions coupled with the recent acquisition of EDS, returns. With this uncertainty, cash is king. Investors
service revenue will move from 16% of the company’s will pay a premium for stocks with a high payout ratio,
total revenue to 30% in an attempt to capitalize on the but HP’s constant $.32 dividend undervalues the
higher operating margins the segment offers. Because of company when discounted in the DDM. While a
the counter cyclical trend in the services segment globalized and diversified product line creates many
(decrease in IT budgets for new products and updates benefits, HP’s position as a net receiver in currency
can mean more spending on services), expansion in the transactions will erode earnings if the dollar keeps
segment also works to further stabilize the company the making gains against foreign currencies. However, we
company during macroeconomic fluctuations. predict the economic uncertainty and the volatility in the
global economy to stabilize by the end of 2009.
We expect this segment to experience huge growth in the
coming years. Investment Positives
Top Competitors: iv Strong Positioning Relative to Peers:
Services: Software: The EDS acquisition provides HP with a coherent cost-
1.) IBM 1.) IBM reduction plan in printing and services. Moreover, HP
shows less exposure to PCs and more exposure in
2.) Accenture 2.) CA enterprise storage and solutions than Dell. Because we
expect PCs to show severely diminished growth in 2009
3.) EDS 3.) HP while servers should still perform well, these exposures
play to HP's advantage over Dell. vi
4.) HP 4.) BMC Software.
Yahoo! Finance Consensus forecasts show HP
Figure 8 outperforming competitors DELL and IBM by
Page | 8
significant margins. Krause fund estimates take a more The volatile market is a result of a weak economy and
conservative outlook on HP’s revenue growth, but it still tightened credit standards that make financing difficult
shows growth through 2009 with consistent to come by. While HP has a low level of debt, many of
outperformance of its peers (see Figure 5). its products are discretionary spending items which may
be more susceptive to a recession than more stable DDM
Our Dividend Discount Model (DDM) forecasts a target
price of $28.51. This is near HP’s current trading levels
(it is at a slight discount), but we do not feel that it
accurately represents the intrinsic value of the stock.
Due to economic uncertainty, investors are wary of firms
Figure 5 like HP with low dividend payouts ($0.32 per share),
and they are only willing to pay a slight premium over
HP Forecasted to Outperform Peers
the value of the underlying payout to equity holders.
25.00%
However, HP’s forecasted growth and dominant market
20.00% position create value not captured in a DDM,
15.00% questioning the validity of using this model as a long-
term projector of stock value for HP.
10.00%
consumer goods like food or clothing.
5.00%
0.00% Strong Dollar:
-5.00%
Current Qtr Next Qtr Current Yr Next Yr Because nearly 70% of HP’s sales come from abroad, a
strong dollar dilutes revenues brought to the US from
DELL IBM HPQ (Yahoo!) HPQ (Our estimates)
international sales. Moreover, a volatile dollar (as
graphed in the economic overview) makes it difficult
Diversified Product Line: and expensive to hedge against fluctuations
HP does not have high exposure to one specific product
group. Technology Solutions, Imaging and Printing, and Low Payout Ratio:
Personal Systems all account for roughly one third of Investors pay a premium for cash dividends and the
HP’s revenues in 2007 exclusive of small (nearly securities markets exhibit a flight to quality in general as
negligible) revenues from financial services. demand is rising for government treasuries and other
Technology Solutions splits almost evenly between HP low-risk and risk-free goods. HP’s low dividend payout
services and enterprise storage and solutions with HP is bringing down its value right now as shown by what
software making up the remaining small amount. This we feel is an unfairly low dividend discount valuation.
high level of product diversity reduces risks specific to
certain product and services groups and we see it acting Uncertainty of Acquisitions:
as a stabilizing factor in forecasting earnings. It will take years to integrate EDS’ operations into HP’s
core company. The uncertainty of this and other
Global Reach: acquisitions creates additional fears for investors that
Nearly seventy percent of HP’s revenues come from may cause the stock to continue trading at a discount to
abroad. This reduces exposures to specific markets and its DCF and EP valuations.
economic trends within one region, creating more
recession proof company. Valuation
Overview of Methods Used
Investment Negatives
Volatile Market: Our Discounted Cash Flow (DCF) and Economic Profit
As shown on the employee stock options page of our models created a target price of $46.99, representing a
model, projected volatility is extremely high in the 54% premium on the current market price ($30.46).
equities market. This represents uncertainty and fear Dividend Discount Models (DDM) found a target share
among investors. While we firmly believe the HP has price of $28.51. The Relative Price/Earnings (P/E)
strong fundamentals, it is difficult to predict when the Multiple model forecasted an intrinsic share price of
markets will stabilize so that HP’s price can reflect $32.32. These models show large variation in price. As
fundamentals rather than its low dividend payout. discussed earlier, we feel that our DCF and EP models
are most accurate, and therefore we are confident in our
Weak Economy: “BUY” recommendation.
Page | 9
market value of debt and equity to arrive at the weights
DCF/EP Models of the capital structure. Using WACC, we calculated our
Our DCF and EP models found a target price of $46.99, discount rate to be 9.30%.
which is 54% higher than the current market price. Both
models incorporate a continuing value growth level of Revenue, Expenses, and Other Forecasts
3.88% based on expectations of GDP growth, inflation, Based on management’s expectations and our
and maturity in peripherals. Our continuing value ROIC macroeconomic outlook for the current fiscal year, we
of 25.6% comes from expected NOPLAT and invested forecast total revenues for FY 2009 of $ 128.797 billion.
capital. This ROIC is high because research and This represents revenue growth of 3.14%, which is lower
development—a major investment for Hewlett than many analyst estimates, but we feel is appropriate
Packard—is expensed rather than capitalized due to given the current macroeconomic projections through
accounting standards. If we capitalized R&D expense, the middle of next year—both of which were discussed
this number would be significantly lower. Therefore, we earlier.
believe that a high ROIC is justified. While we hold our costs somewhat constant as a percent
of sales, these estimates err to conservatism, as HP’s
P/E Model recent acquisitions should reduce costs if they are
Our relative Price/Earnings and PEG valuation models properly integrated. The risk of a failed merger or
created target prices between $27.24 and $34.93. Like acquisition prevents full-integration of these cost savings
the DDM, these models forecasted prices near HP’s into our model.
current trading levels. Because tech stocks pay
notoriously low dividends, we feel that the entire
industry is undervalued, and this shows with relative
pricing. While it is not surprising that comparables Sensitivity Analysis
analysis yielded prices near current trading levels, we do
not feel that this technique currently represents the In computing our valuation for HP we made a number of
intrinsic value of Hewlett Packard. critical assumptions and forecasts. We firmly believe in
the assumptions, but it is imperative to highlight and
Weighted Average Cost of Capital (WACC) discuss the effect deviations in the variables have on the
We calculated HP’s Weighted Average Cost of Capital intrinsic value. The terminal value makes up 80% and
(WACC) to be 9.12%. We made numerous assumptions 78% of the DCF/EP and DDM, respectively. The
in regards to our cost of equity. importance of the terminal value led us to choose three
variables that most affect the terminal value. In order to
The Capital Asset Pricing Model (CAPM) was utilized test the accuracy of the terminal value variables, we
to calculate the required rate of return on equity. We tested ROIC, CV growth rate, and WACC.
used the 30 year Treasury Bond rate from Bloomberg of
4.19% to calculate our risk –free rate. The S&P 500 CV Growth Rate
market risk premium of 4.82% was derived from the The CV growth rate is important when determining the
historical geometric average annual spread between the target price because it represents constant growth for HP
return of the S&P 500 index and the yield on treasury from the terminal year of the model through infinite. We
bonds from 1928 – 2007. The raw beta of 1.17 was estimated a CV growth rate of 3.88% based on
calculated by running a weekly regression against the macroeconomic conditions, inflation expectations,
S&P 500 over the past five years. Incorporating these industry forecast, and HP’s size and market position
values resulted in a cost of equity equal to 9.83% relative to its peers. Any future changes in these
characteristics can greatly alter the CV growth rate. If
We used a cost of debt of 6.30% based on estimates Microsoft were to grow at a slightly different rate in the
found on Bloomberg, and we do not we foresee any terminal period it would cause our intrinsic value to
necessary changes in capital structure to be necessary. change significantly. As seen in the table below, a 2-
Therefore, we used its current capital structure in point increase or decrease creates stock price changes of
calculating the WACC. We calculated the market value 27.2% and -15.1%, respectively.
of equity by multiplying the company’s outstanding
shares times their current stock price, finding the MV to CV Growth
be $87.1 billion. We calculated debt using the book 2.38% 2.88% 3.38% 3.88% 4.38% 4.88% 5.38%
value of debt and the present value of operating leases. $ 39.89 $ 41.88 $ 44.21 $ 46.99 $ 50.35 $ 54.51 $ 59.78
We divided the individual market value by the total
Page | 10
Continuing Value: ROIC Compared to DCF estimates from Barclays, BMO, and
Return on invested capital is used in the continuing Baird, our target price are still slightly conservative.
value calculations of both discounted cash flow and
economic profit, but it does not have as large of effect on As real GDP begins to grow sometime during the middle
stock price as other variables. Across a 6% interval, the of 2009, we believe the market will start to value HP
stock price only changed by about $2.50 when holding based on its core business model rather than cash flow to
growth constant at 5%, and became more sensitive as shareholders. When this happens, expect a surge in the
growth increased. ROIC also becomes more sensitive equity value as low debt levels and cost reduction efforts
when WACC decreases, but in both cases changes in put HP in a unique position to gain market share.
ROIC have a lower effect than other variables analyzed.
ROIC
22.60% 23.60% 24.60% 25.60% 26.60% 27.60% 28.60%
$ 45.99 $ 46.35 $ 46.68 $ 46.99 $ 47.27 $ 47.53 $ 47.78
Weighted Average Cost of Capital (WACC)
The sensitive nature of WACC is the result of the
various assumptions: risk free rate, beta, market risk
premium, and the tax rate. Since WACC is an essential
part of our fundamental model, a minor deviation in our
assumptions has the potential to have a large affect the
stock price. A 3-point decrease or increase changes the
intrinsic stock price by -12.98% and 15.23%,
respectively. As revealed in the following table, WACC
and the stock price show an inverse correlation. CV
WACC depends largely on economic conditions, but the
relatively low beta leads us to believe the discount rate
should not vary too much from our current rate.
WACC
6.12% 7.12% 8.12% 9.12% 10.12% 11.12% 12.12%
$ 54.15 $ 51.63 $ 49.25 $ 46.99 $ 44.85 $ 42.82 $ 40.89
Investment Summary
We base our “BUY” recommendation on discounted
cash flow and economic profit valuations. Our
sensitivity analysis reflects reasonable fluctuations in
key value drivers: WACC, ROIC, and Continuing value
of growth, which led us to our target range of $45 – 49.
Uncertainty in equities in general has reduced current
stock prices down to core valuation based on cash flows
to shareholders (dividends). Because HP has a low
dividend yield—historically constant at $0.32 per share,
projected to remain at that level—we feel that the market
has severely undervalued the company’s stock.
Moreover, we feel this undervaluation is industry-wide
as both comparables analysis and dividend discount
models price HP at or near current levels of trading.
However, we feel that current prices are more a
reflection of a flight to payout through dividends rather
than a true lack of confidence in HP’s business model.
Page | 11
Important Disclaimer Works Cited:
This report was created by students enrolled in the
i
Security Analysis (6F:112) class at the University of Mataloni, Lisa. "GROSS DOMESTIC PRODUCT: THIRD
Iowa. The report was originally created to offer an QUARTER 2008 (ADVANCE)." Wall Street Journal Online.
internal investment recommendation for the University 30 OCT 2008. BEA. 14 Nov 2008
<http://online.wsj.com/public/resources/documents/bbgdp.pdf
of Iowa Krause Fund and its advisory board. The report
>.
also provides potential employers and other interested ii
"Economic Forecast and Calendar ." Market Watch.
parties an example of the students’ skills, knowledge and OCT 2008. Market Watch. 14 Nov 2008
abilities. Members of the Krause Fund are not registered <http://www.marketwatch.com/news/economy/economic_cale
investment advisors, brokers or officially licensed ndar.asp?dist=skey>.
financial professionals. The investment advice contained
iii
in this report does not represent an offer or solicitation to "United States: Consumer Credit (G19) ." Dismal Scientist.
buy or sell any of the securities mentioned. Unless 07 NOV 2008. Moody's. 10 Nov 2008
otherwise noted, facts and figures included in this report <http://www.economy.com/dismal/pro/release.asp?sid=63B1
are from publicly available sources. This report is not a B2C7-B599-49E5-9C40-322B5CE4D16C&r=usa_credit>.
complete compilation of data, and its accuracy is not
iv
guaranteed. From time to time, the University of Iowa, "Hewlett-Packard Co 2007 Annual Report." HP Investor
its faculty, staff, students, or the Krause Fund may hold Relations. Hewlet-Packard Co. 10 Nov 2008
a financial interest in the companies mentioned in this
v
"United States: Employment Situation ." Dismal Scientist. 07
report.
NOV 2008. Moody's. 9 Nov 2008
<http://www.economy.com/dismal/pro/release.asp?sid=63B1
Figure Citations: B2C7-B599-49E5-9C40-322B5CE4D16C&r=usa_employ>.
One-Year Price Performance: Yahoo! Finance
http://finance.yahoo.com/q/bc?t=1y&s=HPQ&l=on&z=m&q= vi
l&c=spx Noland , Jayson. "Computer Hardware & Storage, Reducing
Estimates on HPQ and Dell." Technology Research, Baird 04
Figure 1: Analyst created chart. Source Data: Yahoo! Finance Nov 2008 05 Nov 2008
vii
http://finance.yahoo.com/q/hp?s=%5ESTOXX50&a=00&b=1 Baird, "Industrial Conference Highlights." Morning
&c=2008&d=10&e=14&f=2008&g=d Meeting Report, Baird 13 Nov 2008 18 Nov 2008
viii
Figure 2: Analyst created chart. Source Data: Moody’s Fassler, Matthew. "Near-term expectations now more
Economy.com: United States GDP realistic, but issues linger." Company Update Best Buy
http://www.economy.com/dismal/pro/release.asp?r=usa_gdp Company, Inc. Goldman Sachs 13 Nov 2008 18 Nov 2008
ix
Figure 3: Analyst created chart. Source Data: Yahoo! Finance Smith, Thomas. "Computers: Hardware." Standard & Poors
http://finance.yahoo.com/q?s=FXB Industry Surveys 17 April 2008 1 Nov 2008
http://finance.yahoo.com/q?s=FXE
x
http://finance.yahoo.com/q?s=FXY Reitzes, Ben. "Lower Ests, Better Positioned than Dell."
Hewlett-Packard, Barclays Capital 11 Nov 2008 15 Nov 2008
Figure 4 : Analyst created chart. Source Data:
xi
Figure 5: Analyst created chart. Source Data: Yahoo! Datamonitor, "Computer Hardware in the United States."
Finance Industry Porfile Feb 2008 20 Sept 2008
http://finance.yahoo.com/q?s=HPQ
xii
http://finance.yahoo.com/q?s=DELL Reitzes, Ben. "Hewlett-Packard." Lehman Brothers Equity
http://finance.yahoo.com/q?s=IBM Research 27 Aug 2008 20 Sep 2008
Figure 6: Analyst created chart. Source Data: HPQ 2007
Annual Report
Figure 7: Analyst created chart. Source Data: HPQ 2007 10-K
Figure 8: Friar, Sarah. "IT Spending Survey: Download bias
continues." Independent Insight, US Technology Strategy,
Goldman Sachs 8 Sept 2008 10 Nov 2008
Page | 12
Hewlett-Packard Co
Key Assumptions of Valuation Model
Ticker Symbol HPQ
Current Share Price $30.46 (as of 14 Nov. 2008)
Shares Outstanding 2,450,000,000 (as of 14 Nov. 2008)
WACC 9.12% (computation attached)
CV Growth 3.88% (computation in revenue growth assumption)
CV ROIC 25.60%
CVGrowth EPS 4.00%
Beta 1.17 (Bloomberg; raw beta, weekly interval, 5 yr. time period)
Market Risk Premium 4.82% (Geometric avg. premium stocks to T-bonds 1928-2007)
Risk Free Rate 4.19% (Bloomberg; 30 yr. U.S. Treasury bond rate)
Cost of Equity (CAPM) 9.83%
Cost of Debt 6.30% (Bloomberg)
Marginal Tax Rate 21.90%
Avg. Time to Maturity of Employee Stock Options (years) 4.43
Current Dividend Yield 1.10%
Annualized St. Deviation of Stock Returns 38.80%
Asset Life for Operating Leases (years) 4
2008 EPS $2.92
Income statement and balance sheet assumptions below
Revenue decomposition and growth assumptions attached
2005 A 2006 A 2007 A 2008 E 2009 E 2010 E 2011 E 2012 E 2013 E
Income Statement Accounts
Sales 86696 91658 104286 114954 118567 128797 137349 144210 150413
Revenue Growth 8.5% 5.7% 13.8% 10.2% 3.1% 8.6% 6.6% 5.0% 4.3%
Cost of products/Sales -60.6% -60.3% -60.8% -60.4% -60.4% -60.5% -60.5% -60.4% -60.4%
Cost of services/Sales -15.8% -15.2% -14.5% -14.5% -14.4% -14.5% -14.9% -14.9% -14.9%
Financing interest/Sales -0.2% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3%
COGS/Sales -76.6% -75.7% -75.6% -75.1% -75.1% -75.3% -75.8% -75.5% -75.5%
Gross Margin 20256 22230 25398 28612 29571 31864 33266 35288 36821
Gross Margin/Sales 23.4% 24.3% 24.4% 24.9% 24.9% 24.7% 24.2% 24.5% 24.5%
Research & development expense/Sales -4.0% -3.9% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5%
Depreciation Expense/BV PPE -12.4% -11.6% -11.7% -11.8% -11.4% -11.6% -11.6% -11.5% -11.6%
Other SGA -10.9% -10.4% -9.9% -9.5% -9.4% -9.3% -9.1% -9.0% -9.0%
Amortization of purchased intangibles/Purchased intangibles -17.3% -34.5% -31.8% -20.0% -20.0% -20.0% -20.0% -20.0% -20.0%
Marginal tax rate -21.9% -21.9% -21.9% -21.9% -21.9% -21.9% -21.9% -21.9% -21.9%
Yearly acquisition-related charges and restructuring charges are computed on a individual basis
Pension curtailments and dispute settlements are assumed to be zero
All else use a moving average or are noted otherwise
Hewlett-Packard Co
Key Assumptions of Valuation Model
2005 A 2006 A 2007 A 2008 E 2009 E 2010 E 2011 E 2012 E 2013 E
Balance Sheet Accounts
Current Assets:
Normal cash (.5% of sales) 433.48 458.29 521.43 574.77 592.83 643.99 686.75 721.05 752.06
AR/Sales 11.4% 11.9% 12.9% 12.1% 12.3% 12.4% 12.2% 12.3% 12.3%
Inventory/Sales 7.9% 8.5% 7.7% 8.0% 9.0% 8.0% 8.0% 8.0% 8.0%
Current financing receivables/Sales 4.0% 3.3% 2.8% 3.4% 3.2% 3.1% 3.2% 3.2% 3.2%
Other liabilities/Sales 4.8% 5.2% 5.9% 5.3% 5.5% 5.5% 5.4% 5.5% 5.5%
Current deferred tax assets/tax provision 315.5% 417.3% 240.9% 220.0% 154.0% 107.8% 75.5% 52.8% 37.0%
Tax, supplier, and other receivables/Sales 5.7% 5.7% 5.4% 5.6% 5.6% 5.5% 5.6% 5.6% 5.6%
Property, Plant, and Equipment
Gross PPE/Sales 16.0% 16.4% 15.7% 20.0% 23.0% 20.0% 22.4% 23.4% 25.4%
Accumulated depreciation/Gross PPE 53.5% 54.3% 52.5% 53.4% 53.4% 53.1% 53.3% 53.3% 53.2%
Other Assets:
LT financing receivables/Sales 2.6% 2.6% 2.7% 2.6% 2.6% 2.6% 2.6% 2.6% 2.6%
LT deferred tax assets/Tax provision 197.6% 148.5% 50.2% 40.0% 28.0% 19.6% 13.7% 9.6% 6.7%
Current Liabilities:
Accounts payable/Inventory 148.7% 156.2% 146.7% 150.5% 151.1% 149.5% 150.4% 150.3% 150.1%
Deferred revenues/Sales 4.4% 4.7% 4.8% 4.6% 4.7% 4.7% 4.7% 4.7% 4.7%
Employee compensation & benefits/sales 2.7% 3.4% 3.3% 3.2% 3.3% 3.3% 3.2% 3.3% 3.3%
Warranty/Sales 1.8% 1.7% 1.7% 1.7% 1.7% 1.7% 1.7% 1.7% 1.7%
Sales and marketing programs/Sales 2.3% 2.6% 2.8% 2.6% 2.7% 2.7% 2.7% 2.7% 2.7%
Other current assets/Sales 4.8% 5.2% 5.9% 5.3% 5.5% 5.5% 5.4% 5.5% 5.5%
Other accrued taxes/Total income taxes for the year 176.2% 238.3% 155.0% 160.0% 160.0% 160.0% 160.0% 160.0% 160.0%
Taxes on earnings/Income tax expense 206.7% 191.8% 98.8% 98.6% 97.9% 86.8% 89.7% 88.8% 86.8%
Other Liabilities:
Long-term deferred revenue/Sales 1.5% 1.9% 2.4% 1.9% 2.1% 2.1% 2.0% 2.1% 2.1%
Other long term liabilities/Sales 1.7% 1.8% 1.9% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8%
Notes payable/Current Assets 4.2% 5.6% 6.7% 7.2% 6.7% 6.1% 5.8% 5.4% 5.2%
LT debt/Total assets (keep constant when forecasting) 8.5% 8.7% 6.1% 8.8% 8.8% 8.8% 8.8% 8.8% 8.8%
10 yr T-Note 3.9% 3.9% 3.9% 3.9% 3.9% 3.9% 3.9% 3.9% 3.9%
Other LT liabilities/Sales 1.7% 1.8% 1.9% 1.8% 1.8% 1.8% 1.8% 1.8% 1.8%
Other assets and accrued restructuring are assumed to remain constant
Goodwill remains constant after accounting for recent acquisitions
Pension liabilities assumed to diminish 1% per year
Other comprehensive income assumed to be zero
Most other balance sheet items projected based on moving average, but are flexible to
ensure that assets, liabilities, and equity balance
Hewlett-Packard Co
Revenue Breakdown
Net revenue (values in millions $) 2005 2006 2007 5 yr. avg. 2 yr. avg. 2008E 2009E 2010E 2011E 2012E 2013E 2014E
Industry standard servers 9,389 9,982 11,380 12,258 13,055 14,230 15,368 16,290 16,942 17,569
15.7% 6.3% 14.0% 12.0% 10.2% 8.0% 6.5% 9.0% 8.0% 6.0% 4.0% 3.7%
Business critical systems 3,812 3,656 3,564 3,504 3,469 3,434 3,400 3,366 3,400 3,434
1.4% -4.1% -2.5% -1.8% -3.3% -1.0% -1.0% -1.0% -1.0% -1.0% 1.0% 1.0%
Storage 3,517 3,670 3,825 3,965 4,124 4,289 4,469 4,656 4,847 5,046
10.0% 4.4% 4.2% 2.8% 4.3% 4.0% 4.0% 4.0% 4.2% 4.2% 4.1% 4.1%
Enterprise Storage and Servers 16,717 17,308 18,769 19,727 20,647 21,953 23,237 24,312 25,189 26,048
Enterprise Storage and Servers Growth 10.90% 3.54% 8.44% 6.64% 5.99% 5.11% 4.66% 6.32% 5.85% 4.63% 3.60% 3.41%
Technology services 8,599 8,348 8,678 9,199 9,567 9,854 10,149 10,454 10,767 11,090
-3.2% -2.9% 4.0% 1.7% 0.5% 6.0% 4.0% 3.0% 3.0% 3.0% 3.0% 3.0%
Managed services 4,097 4,382 4,821 6,219 6,779 7,233 7,667 8,050 8,405 8,774
67.5% 7.0% 10.0% 30.4% 8.5% 29.0% 9.0% 6.7% 6.0% 5.0% 4.4% 4.4%
Consulting and integration 2,840 2,887 3,147 3,688 3,910 4,172 4,380 4,599 4,783 4,974
12.9% 1.7% 9.0% 6.4% 5.3% 17.2% 6.0% 6.7% 5.0% 5.0% 4.0% 4.0%
All other Services - - - 151 1,070 1,134 1,202 1,274 1,351 1,418
6.0% 6.0% 6.0% 6.0% 6.0% 5.0%
HP Services 15,536 15,617 16,646 19,187 20,255 22,392 23,399 24,378 25,306 26,257
Services Growth 12.19% 0.52% 6.59% 7.74% 3.56% 15.26% 5.57% 10.55% 4.49% 4.18% 3.81% 3.76%
OpenView 691 899 1,988 2,629 2,918 3,180 3,340 3,506 3,647 3,793
18.1% 30.1% 121.1% 47.4% 75.6% 19.0% 11.0% 9.0% 5.0% 5.0% 4.0% 4.0%
OpenCall & other 370 402 337 368 379 390 406 422 439 457
6.3% 8.6% -16.2% 4.2% -3.8% 4.4% 3.0% 3.0% 4.0% 4.0% 4.0% 4.0%
Software 1,061 1,301 2,325 2,997 3,297 3,571 3,745 3,929 4,086 4,249
Software Growth 13.72% 22.62% 78.71% 33.63% 50.66% 28.91% 10.00% 8.31% 4.89% 4.89% 4.00% 4.00%
Technology Solutions Group 33,314 34,226 37,740 41,911 44,199 47,916 50,381 52,619 54,580 56,555
Technology Solutions Group Growth 11.59% 2.74% 10.27% 8.07% 6.50% 11.05% 5.46% 8.41% 5.14% 4.44% 3.73% 3.62%
Desktops 14,406 14,613 17,642 18,895 19,461 21,797 23,541 24,011 24,492 25,079
0.7% 1.4% 20.7% 9.5% 11.1% 7.1% 3.0% 12.0% 8.0% 2.0% 2.0% 2.4%
Notebooks 9,763 12,000 15,850 19,020 20,732 23,427 26,238 28,862 31,286 33,101
15.9% 22.9% 32.1% 23.1% 27.5% 20.0% 9.0% 13.0% 12.0% 10.0% 8.4% 5.8%
Workstations 1,195 1,368 1,721 1,988 2,187 2,427 2,670 2,883 3,056 3,209
17.4% 14.5% 25.8% 17.0% 20.1% 15.5% 10.0% 11.0% 10.0% 8.0% 6.0% 5.0%
Handhelds 836 620 490 443 421 409 400 396 392 387
-5.6% -25.8% -21.0% -8.2% -23.4% -9.5% -5.0% -3.0% -2.0% -1.0% -1.2% -1.2%
Other 541 565 706 755 778 809 842 875 910 947
104.9% 4.4% 25.0% 39.0% 14.7% 7.0% 3.0% 4.0% 4.0% 4.0% 4.0% 4.0%
Personal Systems Group 26,741 29,166 36,409 41,101 43,579 48,869 53,690 57,028 60,136 62,723
Personal Systems Group Growth 8.61% 9.07% 24.83% 14.65% 16.95% 12.89% 6.03% 12.14% 9.87% 6.22% 5.45% 4.30%
Commercial hardware 6,558 6,899 7,181 6,736 6,332 6,522 6,717 6,919 7,057 7,198
2.6% 5.2% 4.1% 4.5% 4.6% -6.2% -6.0% 3.0% 3.0% 3.0% 2.0% 2.0%
Consumer hardware 4,497 4,427 4,442 4,069 3,703 3,740 3,814 3,891 3,969 4,048
3.7% -1.6% 0.3% 0.5% -0.6% -8.4% -9.0% 1.0% 2.0% 2.0% 2.0% 2.0%
Supplies 14,045 15,402 16,788 17,793 18,683 19,692 20,479 21,299 22,044 22,926
6.4% 9.7% 9.0% 8.8% 9.3% 6.0% 5.0% 5.4% 4.0% 4.0% 3.5% 4.0%
Other 55 58 54 51 49 48 48 47 47 46
-80.1% 5.5% -6.9% -7.8% -0.7% -6.0% -4.0% -1.0% -1.0% -1.0% -1.0% -1.0%
Imaging and Printing Group 25,155 26,786 28,465 28,817 28,766 30,001 31,059 32,155 33,117 34,218
Imaging and Printing Group Growth 3.95% 6.48% 6.27% 5.98% 6.38% 1.24% -0.18% 4.29% 3.53% 3.53% 2.99% 3.33%
HP Financial Services 2,102 2,078 2,336 2,724 2,819 2,960 3,108 3,232 3,361 3,496
Financial Services Growth 10.92% -1.14% 12.42% 5.21% 5.64% 6.00% 3.50% 5.00% 5.00% 4.00% 4.00% 4.00%
Corporate Investments 523 566 762 991 1,090 1,220 1,367 1,476 1,565 1,652
Corporate Investments Growth 16.48% 8.22% 34.63% 22.37% 21.43% 30.00% 10.00% 12.00% 12.00% 8.00% 6.00% 5.60%
Total segments 87,835 92,822 105,712 116,594 120,453 130,966 139,605 146,511 152,759 158,645
Eliminations of intersegment net revenue and other (1,139) (1,164) (1,426) (1,640) (1,886) (2,169) (2,256) (2,301) (2,347) (2,394)
2.2% 2.2% 22.5% 21.1% 12.4% 15.0% 15.0% 15.0% 4.0% 2.0% 2.0% 2.0%
Total net revenue 86,696 91,658 104,286 114,954 118,567 128,797 137,349 144,210 150,413 156,251
Total Net Revenue Growth 8.50% 5.72% 13.78% 9.34% 9.75% 10.23% 3.14% 8.63% 6.64% 5.00% 4.30% 3.88%
Adj. % of
HP Quarterly Sales Revenue (values in millions $) Q1Y08 Q2Y08 Q3Y08 Q3 Rev. EQ4Y08 EFY08
Enterprise Storage and Servers 4,820 4,780 4,741 18.0% 5,386 19,727
Enterprise Storage and Servers Growth 9.00% 4.00% 5.00% 5.00% 5.11%
Services 4,378 4,627 4,753 18.1% 5,429 19,187
Services Growth 11.00% 12.00% 14.00% 24.00% 15.26%
Software 666 727 781 2.7% 823 2,997
Software Growth 11.00% 28.00% 29.00% 18.00% 28.91%
Technology Solutions Group 9,864 10,134 10,275 36.1% 10,828 41,101
Technology Solutions Group Growth 10.00% 9.00% 11.00% 14.00% 8.91%
Personal Systems Group 10,791 10,041 10,254 34.7% 10,416 41,502
Personal Systems Group Growth 24.00% 16.00% 15.00% 3.00% 13.99%
Imaging and Printing Group 7,312 7,591 6,979 23.1% 6,935 28,817
Imaging and Printing Group Growth 4.00% 6.00% 3.00% -8.00% 1.24%
Financial Services 642 685 680 2.4% 717 2,724
Financial Services Growth 17.00% 25.00% 17.00% 9.00% 16.59%
Corporate Investments - - - - - -
Corporate Investments Growth 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
(Corp. investments not on 10QY08 statements)
Total net revenue 28,467 28,262 28,032 100% 30,000 114,954
Total Net Revenue Growth 13.00% 11.00% 10.00% 6.00% 10.23%
Hewlett-Packard Co
Income Statement
Fiscal Years Ending 2007
(values in millions, except per share amounts) 2005 2006 2007 2008E 2009E 2010E 2011E 2012E 2013E 2014E
Net revenue:
Segment Total 87,835 92,822 105,712 116,594 120,453 130,966 139,605 146,511 152,759 158,645
Elimination of intersegment net revenue and other (1,139) (1,164) (1,426) (1,640) (1,886) (2,169) (2,256) (2,301) (2,347) (2,394)
Total consolidated net revenue 86,696 91,658 104,286 114,954 118,567 128,797 137,349 144,210 150,413 156,251
Costs and Expenses:
Cost of products (52,550) (55,248) (63,435) (69,432) (71,614) (77,922) (83,151) (87,089) (90,819) (94,282)
Cost of services (13,674) (13,930) (15,163) (16,611) (17,074) (18,676) (20,465) (21,458) (22,381) (23,188)
Financing interest (216) (249) (289) (299) (308) (335) (467) (375) (391) (406)
Research & development expense (3,490) (3,591) (3,611) (3,985) (4,150) (4,508) (4,807) (5,047) (5,264) (5,469)
Depreciation Expense (1,722) (1,749) (1,922) (2,713) (3,109) (2,998) (3,573) (3,898) (4,432) (5,251)
Other SGA (9,462) (9,517) (10,304) (10,921) (11,145) (11,985) (12,526) (12,974) (13,537) (14,063)
Selling, general & administrative expense (11,184) (11,266) (12,226) (13,634) (14,254) (14,983) (16,099) (16,872) (17,969) (19,313)
Amortization of purchased intangible assets (622) (604) (783) (811) (885) (886) (878) (876) (881) (898)
Restructuring charges (1,684) (158) (387) (340) (900) (300) (121) (61) (30) (15)
In-process research & development charges (2) (52) (190) (40) (54) (62) (67) (77) (82) (64)
Pension curtailments & pension settlements, net 199 - 517 - - - - - - -
Acquisition-related charges - - - (75) (400) (50) - - -
Total costs & operating expenses (83,223) (85,098) (95,567) (105,227) (109,639) (117,722) (126,055) (131,856) (137,818) (143,635)
Earnings (loss) from operations 3,473 6,560 8,719 9,727 8,928 11,075 11,294 12,355 12,595 12,617
Interest & other income (expense), net 189 606 444 350 300 250 250 250 250 250
Gains (losses) on investments (13) 25 14 (10) (2) 3 3 6 2 -
Dispute settlement (106) - - - - - - - - -
Earnings (loss) from continuing operations before taxes 3,543 7,191 9,177 10,067 9,227 11,328 11,547 12,610 12,847 12,867
Provision for (benefit from) taxes (1,145) (993) (1,913) (2,205) (2,021) (2,481) (2,529) (2,762) (2,814) (2,818)
Net earnings (loss) $ 2,398 $ 6,198 $ 7,264 7,862 7,206 8,847 9,018 9,849 10,034 10,049
Net earnings (loss) per share - basic $ 0.83 $ 2.23 $ 2.76 $ 2.94 $ 2.74 $ 3.28 $ 3.38 $ 3.61 $ 3.69 $ 3.40
Weighted average shares used to compute net earnings per share
Weighted average shares outstanding - basic 2,879 2,782 2,630 2,676 2,630 2,700 2,670 2,729 2,720 2,954
Dividends Paid 926 894 846 856 842 864 854 873 870 945
Dividends per share $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32
Hewlett-Packard Co
Balance Sheet
Fiscal Years Ending 2007
(values in millions) 2005 2006 2007 2008E 2009E 2010E 2011E 2012E 2013E 2014E
Assets
Current Assets:
Cash & cash equivalents 13,911 16,400 11,293 7,793 10,953 25,394 28,432 36,696 43,068 47,407
Short-term investments 18 22 152 158 164 171 177 184 192 199
Accounts receivable, net 9,903 10,873 13,420 13,853 14,537 15,962 16,805 17,733 18,513 18,750
Financing receivables, net 2,551 2,440 2,507 3,873 3,753 4,018 4,420 4,568 4,765 4,976
Inventory 6,877 7,750 8,033 9,196 10,671 10,304 10,988 11,537 12,033 12,500
Deferred tax assets - short term 3,612 4,144 4,609 4,850 3,112 2,674 1,908 1,459 1,040 729
Tax, supplier, and other receivables 4,910 5,242 5,655 6,439 6,617 7,129 7,654 8,022 8,358 8,594
Prepaid and other current assets 1,552 1,393 1,733 1,728 1,717 1,705 1,689 1,672 1,653 1,653
Total current assets 43,334 48,264 47,402 47,892 51,525 67,357 72,073 81,870 89,623 94,808
Property, plant & equipment, gross 13,880 15,024 16,411 22,991 27,270 25,759 30,766 33,745 38,205 45,313
Accumulated depreciation 7,429 8,161 8,613 9,508 10,534 11,523 12,702 13,989 15,451 17,184
Property, plant & equipment, net 6,451 6,863 7,798 13,483 16,736 14,236 18,064 19,757 22,754 28,129
Financing receivables 2,246 2,340 2,778 2,992 3,090 3,380 3,586 3,770 3,935 4,084
Deferred tax assets - long term 2,263 1,475 961 882 566 486 347 265 189 133
Other 2,993 2,834 3,908 3,908 3,908 3,908 3,908 3,908 3,908 3,908
Goodwill 16,441 16,853 21,773 30,773 29,850 29,551 29,551 29,551 29,551 29,551
Purchased intangible assets 3,589 3,352 4,079 4,057 4,423 4,429 4,390 4,382 4,405 4,489
Total assets 77,317 81,981 88,699 103,986 110,098 123,347 131,920 143,502 154,366 165,103
Liabilities and Stockholders' Equity
Current Liabilities:
Notes payable & short-term borrowings 1,831 2,705 3,186 3,413 3,209 3,143 3,907 3,892 4,257 4,033
Accounts payable 10,223 12,102 11,787 13,842 16,128 15,400 16,522 17,342 18,056 18,781
Employee compensation & benefits 2,343 3,148 3,465 3,625 3,917 4,198 4,448 4,712 4,896 5,084
Taxes on earnings 2,367 1,905 1,891 2,175 1,979 2,154 2,270 2,453 2,441 2,478
Deferred revenues 3,815 4,309 5,025 5,334 5,596 6,087 6,449 6,798 7,087 7,355
Accrued restructuring 1,119 547 123 123 123 123 123 123 123 123
Other accrued taxes 2,018 2,366 2,965 3,527 3,233 3,969 4,046 4,419 4,502 4,508
Warranty 1,563 1,585 1,762 1,561 1,563 1,588 1,604 1,610 1,615 1,590
Sales and marketing programs 2,036 2,394 2,930 2,977 3,166 3,465 3,640 3,851 4,016 4,162
Other 4,145 4,789 6,126 6,085 6,479 7,140 7,463 7,904 8,252 8,542
Total current liabilities 31,460 35,850 39,260 42,661 45,392 47,268 50,472 53,103 55,245 56,656
Long-term debt 3,392 2,490 4,997 7,775 9,116 9,651 10,813 11,564 12,580 13,532
Pension, post-retirement, and post-employment liabilities 2,515 2,099 1,495 1,480 1,465 1,451 1,436 1,422 1,408 1,393
Long-term deferred revenue 1,331 1,750 2,459 2,223 2,451 2,730 2,802 2,993 3,126 3,750
Other long term liabilities 1,443 1,648 1,962 2,048 2,158 2,354 2,486 2,623 2,736 2,837
Total Liabilities 40,141 43,837 50,173 56,188 60,582 63,453 68,009 71,706 75,094 78,169
Stockholders' Equity:
Common stock 20,518 17,993 16,407 21,064 20,459 21,743 21,305 21,094 21,311 21,855
Treasury Stock (1,127) (5,434) (5,919) (10,458) (11,522) (16,010) (7,946)
Retained earnings 16,679 20,133 21,560 27,910 35,916 44,070 53,064 62,224 73,971 73,025
Accumulated other comprehensive income (loss) (21) 18 559 (49) (1,426) - - - - -
Total stockholders' equity 37,176 38,144 38,526 47,798 49,515 59,894 63,910 71,796 79,271 86,934
Total Liabilities and Stockholders' Equity 77,317 81,981 88,699 103,986 110,098 123,347 131,920 143,502 154,366 165,103
Hewlett-Packard Co
Cash Flow Statement
Fiscal Years Ending 2007
(values in millions) 2005 2006 2007 2008 E 2009 E 2010 E 2011 E 2012 E 2013 E 2014 E
Cash flow from operating activities:
Net earnings (loss) 2,398 6,198 7,264 7,862 7,206 8,847 9,018 9,849 10,034 10,049
Add: depreciation and amortization 1,964 2,481 2,374 3,608 4,135 3,987 4,752 5,184 5,894 6,983
Changes in working capital accounts:
Accounts receivable 323 (970) (2,547) (433) (684) (1,425) (842) (928) (781) (237)
Financing receivables 394 111 (67) (1,366) 121 (265) (402) (148) (198) (210)
Inventory 194 (873) (283) (1,163) (1,475) 367 (684) (549) (496) (467)
Tax, supplier, and other receivables (71) (332) (413) (784) (178) (512) (525) (368) (336) (235)
Prepaid and other current assets (450) 159 (340) 5 11 12 16 17 19 -
Accounts payable 846 1,879 (315) 2,055 2,286 (728) 1,122 820 713 725
Deferred revenues 857 494 716 309 262 491 362 349 289 268
Taxes on earnings 658 (462) (14) 284 (196) 175 116 184 (12) 37
Employee compensation & benefits 135 805 317 160 292 282 250 263 185 188
Other 168 644 1,337 (41) 394 662 323 440 348 290
Changes in other operating accounts
Long term financing receivables 78 94 438 214 99 290 206 183 166 149
Long term deferred revenues (59) 419 709 (236) 228 279 72 191 133 624
Other non-current liabilities 90 205 314 86 111 196 132 138 112 102
Net cash provided by (used for) operating activities 7,525 10,852 9,490 10,558 12,611 12,657 13,916 15,624 16,071 18,264
Cash flow from investing activities:
Increase in short term investments 293 (4) (130) (6) (6) (6) (7) (7) (7) (8)
Capital expenditures 2,572 2,372 (3,906) (7,834) (2,576) 1,441 (4,193) (1,688) (3,489) (4,673)
Changes in intangible assets 514 237 (727) 22 (366) (6) 39 9 (24) (84)
Property, plant & equipment, net 198 (412) (935) (5,685) (3,254) 2,500 (3,828) (1,693) (2,997) (5,375)
Other cash flows from investing activities (1,753) (2,171) (2,593) (3,170) (2,940) (3,035) (3,522) (3,634) (3,909) (4,112)
Net cash provided by (used for) investing activities 1,824 22 (8,291) (16,672) (9,141) 893 (11,510) (7,013) (10,426) (14,251)
Cash flow from financing activities:
Issuance (payment) of short term borrowings (680) 874 481 227 (204) (66) 764 (15) 365 (224)
Issuance (payment) of long term debt (1,231) (902) 2,507 2,778 1,340 536 1,161 751 1,015 952
Dividends paid (926) (894) (846) (856) (842) (864) (854) (873) (870) (945)
Proceeds from issuance of common stock (1,640) (2,525) (1,586) 4,657 (604) 1,284 (438) (211) 217 544
Other cash flows from financing activities (4,643) (4,430) (6,729) (4,324) - - - - - -
Net cash provided by (used for) financing activities (9,120) (7,877) (6,173) 2,482 (310) 890 632 (347) 727 327
Net increase (decrease) in cash 229 2,997 (4,974) (3,632) 3,160 14,440 3,038 8,264 6,372 4,339
Cash, beginning of year 12,663 13,911 16,400 11,426 7,793 10,953 25,394 28,432 36,696 43,068
Cash, end of year 12,892 16,908 11,426 7,793 10,953 25,394 28,432 36,696 43,068 47,407
Hewlett-Packard Co
Common Size Balance Sheet
Fiscal Years Ending 2007
2005 2006 2007 2008 E 2009 E 2010 E 2011 E 2012 E 2013 E 2014 E
Assets
Current Assets:
Cash & cash equivalents 14.4% 15.0% 15.5% 9.7% 6.5% 8.4% 18.2% 19.4% 24.0% 27.1%
Short-term investments 0.4% 0.0% 0.0% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%
Accounts receivable, net 11.6% 10.7% 10.3% 11.5% 11.5% 11.1% 11.4% 11.5% 11.6% 11.7%
Financing receivables, net 3.4% 2.7% 2.3% 2.2% 3.2% 2.9% 2.9% 3.0% 3.0% 3.0%
Inventory 8.1% 7.4% 7.3% 6.9% 7.6% 8.1% 7.4% 7.5% 7.6% 7.6%
Deferred tax assets - short term 4.3% 3.9% 3.9% 4.0% 4.0% 2.4% 1.9% 1.3% 1.0% 0.7%
Tax, supplier, and other receivables 5.5% 5.3% 5.0% 4.9% 5.3% 5.1% 5.1% 5.2% 5.3% 5.3%
Prepaid and other current assets 1.3% 1.7% 1.3% 1.5% 1.4% 1.3% 1.2% 1.2% 1.1% 1.0%
Total current assets 48.8% 46.7% 45.7% 40.7% 39.8% 39.3% 48.2% 49.2% 53.6% 56.5%
Property, plant & equipment, gross 15.8% 15.0% 14.2% 14.1% 19.1% 20.8% 18.5% 21.0% 22.1% 24.1%
Accumulated depreciation 8.2% 8.0% 7.7% 7.4% 7.9% 8.0% 8.3% 8.7% 9.2% 9.7%
Property, plant & equipment, net 7.6% 6.9% 6.5% 6.7% 11.2% 12.8% 10.2% 12.3% 12.9% 14.3%
Financing receivables 2.5% 2.4% 2.2% 2.4% 2.5% 2.4% 2.4% 2.4% 2.5% 2.5%
Deferred tax assets - long term 2.4% 2.4% 1.4% 0.8% 0.7% 0.4% 0.3% 0.2% 0.2% 0.1%
Other 2.7% 3.2% 2.7% 3.4% 3.2% 3.0% 2.8% 2.7% 2.6% 2.5%
Goodwill 18.0% 17.7% 15.9% 18.7% 25.5% 22.8% 21.2% 20.2% 19.3% 18.6%
Purchased intangible assets 4.7% 3.9% 3.2% 3.5% 3.4% 3.4% 3.2% 3.0% 2.9% 2.8%
Total assets 86.7% 83.3% 77.6% 76.1% 86.3% 84.1% 88.4% 90.0% 93.9% 97.3%
Liabilities and Stockholders' Equity
Current Liabilities:
Notes payable & short-term borrowings 2.9% 2.0% 2.6% 2.7% 2.8% 2.5% 2.3% 2.7% 2.5% 2.7%
Accounts payable 10.7% 11.0% 11.4% 10.1% 11.5% 12.3% 11.0% 11.3% 11.4% 11.4%
Employee compensation & benefits 2.5% 2.5% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.1% 3.1%
Taxes on earnings 1.9% 2.6% 1.8% 1.6% 1.8% 1.5% 1.5% 1.5% 1.6% 1.5%
Deferred revenues 3.4% 4.1% 4.1% 4.3% 4.4% 4.3% 4.4% 4.4% 4.4% 4.5%
Accrued restructuring 0.2% 1.2% 0.5% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1% 0.1%
Other accrued taxes 2.5% 2.2% 2.2% 2.5% 2.9% 2.5% 2.8% 2.8% 2.9% 2.8%
Warranty 1.7% 1.7% 1.5% 1.5% 1.3% 1.2% 1.1% 1.1% 1.1% 1.0%
Sales and marketing programs 2.3% 2.2% 2.3% 2.5% 2.5% 2.4% 2.5% 2.5% 2.5% 2.5%
Other 4.5% 4.5% 4.5% 5.3% 5.1% 4.9% 5.1% 5.1% 5.2% 5.2%
Total current liabilities 32.5% 33.9% 33.9% 33.7% 35.4% 34.7% 33.9% 34.4% 34.8% 34.8%
Long-term debt 5.3% 3.7% 2.4% 4.3% 6.5% 7.0% 6.9% 7.4% 7.6% 7.9%
Pension, post-retirement, and post-employment liabilities 3.0% 2.7% 2.0% 1.3% 1.2% 1.1% 1.0% 1.0% 0.9% 0.9%
Long-term deferred revenue 1.6% 1.4% 1.7% 2.1% 1.8% 1.9% 2.0% 1.9% 2.0% 2.0%
Other long term liabilities 1.5% 1.6% 1.6% 1.7% 1.7% 1.6% 1.7% 1.7% 1.7% 1.7%
Total Liabilities 43.9% 43.2% 41.5% 43.0% 46.6% 46.3% 45.5% 46.4% 46.9% 47.3%
Stockholders' Equity:
Common stock 25.2% 22.1% 17.0% 14.1% 17.5% 15.6% 15.6% 14.5% 13.8% 13.4%
Treasury Stock 0.0% 0.0% 0.0% 0.0% -0.9% -4.1% -4.2% -7.1% -7.5% -10.1%
Retained earnings 17.8% 18.0% 19.0% 18.5% 23.2% 27.4% 31.6% 36.2% 40.7% 46.6%
Accumulated other comprehensive income (loss) -0.3% 0.0% 0.0% 0.5% 0.0% -1.1% 0.0% 0.0% 0.0% 0.0%
Total stockholders' equity 42.8% 40.1% 36.1% 33.0% 39.7% 37.8% 42.9% 43.6% 47.0% 50.0%
Total Liabilities and Stockholders' Equity 86.7% 83.3% 77.6% 76.1% 86.3% 84.1% 88.4% 90.0% 93.9% 97.3%
Hewlett-Packard Co
Common Size Income Statement
Fiscal Years Ending 2007
(values in millions, except per share amounts) 2005 2006 2007 2008E 2009E 2010E 2011E 2012E 2013E 2014E
Net revenue:
Segment Total 101.3% 101.3% 101.4% 101.4% 101.6% 101.7% 101.6% 101.6% 101.6% 101.5%
Elimination of intersegment net revenue and other -1.3% -1.3% -1.4% -1.4% -1.6% -1.7% -1.6% -1.6% -1.6% -1.5%
Total consolidated net revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Costs and Expenses:
Cost of products -60.6% -60.3% -60.8% -60.4% -60.4% -60.5% -60.5% -60.4% -60.4% -60.3%
Cost of services -15.8% -15.2% -14.5% -14.5% -14.4% -14.5% -14.9% -14.9% -14.9% -14.8%
Financing interest -0.2% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3% -0.3%
Research & development expense -4.0% -3.9% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5% -3.5%
Depreciation Expense -2.0% -1.9% -1.8% -2.4% -2.6% -2.3% -2.6% -2.7% -2.9% -3.4%
Other SGA -10.9% -10.4% -9.9% -9.5% -9.4% -9.3% -9.1% -9.0% -9.0% -9.0%
Selling, general & administrative expense -12.9% -12.3% -11.7% -11.9% -12.0% -11.6% -11.7% -11.7% -11.9% -12.4%
Amortization of purchased intangible assets -0.7% -0.7% -0.8% -0.7% -0.7% -0.7% -0.6% -0.6% -0.6% -0.6%
Restructuring charges -1.9% -0.2% -0.4% -0.3% -0.8% -0.2% -0.1% 0.0% 0.0% 0.0%
In-process research & development charges 0.0% -0.1% -0.2% 0.0% 0.0% 0.0% 0.0% -0.1% -0.1% 0.0%
Pension curtailments & pension settlements, net 0.2% 0.0% 0.5% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Acquisition-related charges 0.0% 0.0% 0.0% -0.1% -0.3% 0.0% 0.0% 0.0% 0.0% 0.0%
Total costs & operating expenses -96.0% -92.8% -91.6% -91.5% -92.5% -91.4% -91.8% -91.4% -91.6% -91.9%
Earnings (loss) from operations 4.0% 7.2% 8.4% 8.5% 7.5% 8.6% 8.2% 8.6% 8.4% 8.1%
Interest & other income (expense), net 0.2% 0.7% 0.4% 0.3% 0.3% 0.2% 0.2% 0.2% 0.2% 0.2%
Gains (losses) on investments 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Dispute settlement -0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Earnings (loss) from continuing operations before taxes 4.1% 7.8% 8.8% 8.8% 7.8% 8.8% 8.4% 8.7% 8.5% 8.2%
Current U.S. federal tax provision (benefit) 0.8% -0.5% 0.2% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Deferred U.S. federal tax provision (benefit) -0.2% 0.6% 0.6% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Current Non-U.S. tax provision (benefit) 0.7% 0.8% 1.2% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Deferred Non-U.S. tax provision (benefit) 0.0% 0.2% -0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Total state tax provision (benefit) 0.0% 0.0% -0.1% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Provision for (benefit from) taxes -1.3% -1.1% -1.8% -1.9% -1.7% -1.9% -1.8% -1.9% -1.9% -1.8%
Net earnings (loss) 2.8% 6.8% 7.0% 6.8% 6.1% 6.9% 6.6% 6.8% 6.7% 6.4%
Net earnings (loss) per share - basic $ 0.83 $ 2.23 $ 2.76 $ 2.94 $ 2.74 $ 3.28 $ 3.38 $ 3.61 $ 3.69 $ 3.40
Weighted average shares used to compute net earnings per share
Weighted average shares outstanding - basic 2,879 2,782 2,630 - 2,676 2,630 2,700 2,670 2,729 2,720
Dividends Paid 926 894 846 - 856 842 864 854 873 870
Dividends per share $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32 $ 0.32
Hewlett-Packard Co
Value Driver Estimation
Fiscal Years Ending 2007
(values in millions) 2005 2006 2007 2008E 2009E 2010E 2011E 2012E 2013E 2014E
NOPLAT calculation:
Total Operating Revenue 86,696 91,658 104,286 114,954 118,567 128,797 137,349 144,210 150,413 156,251
Operating Expenses
Cost of products (52,550) (55,248) (63,435) (69,432) (71,614) (77,922) (83,151) (87,089) (90,819) (94,282)
Cost of services (13,674) (13,930) (15,163) (16,611) (17,074) (18,676) (20,465) (21,458) (22,381) (23,188)
Research & development expense (3,490) (3,591) (3,611) (3,985) (4,150) (4,508) (4,807) (5,047) (5,264) (5,469)
Selling, general & administrative expense (11,184) (11,266) (12,226) (13,634) (14,254) (14,983) (16,099) (16,872) (17,969) (19,313)
Amortization of purchased intangible assets (622) (604) (783) (811) (885) (886) (878) (876) (881) (898)
In-process research & development charges (2) (52) (190) (40) (54) (62) (67) (77) (82) (64)
Total Operating Expenses (81,522) (84,691) (95,408) (104,513) (108,030) (117,037) (125,467) (131,420) (137,397) (143,213)
EBITA 5,174 6,967 8,878 10,441 10,537 11,760 11,882 12,790 13,016 13,038
Marginal tax rate 21.9% 21.9% 21.9% 21.9% 21.9% 21.9% 21.9% 21.9% 21.9% 21.9%
Provision for (benefit from) taxes (1,145) (993) (1,913) (2,205) (2,021) (2,481) (2,529) (2,762) (2,814) (2,818)
Add: Tax shield on financing expense 47 55 63 65 68 73 102 82 86 89
Add: Tax shield on restructuring charges 369 35 85 74 197 66 26 13 7 3
Add: Tax shield on dispute settlements (44) - (113) - - - - - - -
Less: Tax on interest income 41 133 97 77 66 55 55 55 55 55
investments (3) 5 3 (2) (0) 1 1 1 1 -
Adjusted Taxes (1,479) (944) (1,848) (2,270) (2,220) (2,564) (2,602) (2,801) (2,851) (2,855)
Deferred sax assets - short term 3,612 4,144 4,609 4,850 3,112 2,674 1,908 1,459 1,040 729
Deferred tax assets - long term 2,263 1,475 961 882 566 486 347 265 189 133
Change in Deferred Taxes (20) 256 49 (162) 2,055 517 905 531 495 368
NOPLAT 3,715 5,767 6,981 8,333 6,262 8,678 8,375 9,458 9,671 9,815
Invested Capital Calculation:
Normal cash (.5% of sales) 433 458 521 575 593 644 687 721 752 781
Accounts receivable 9,903 10,873 13,420 13,853 14,537 15,962 16,805 17,733 18,513 18,750
Financing receivables 2,551 2,440 2,507 3,873 3,753 4,018 4,420 4,568 4,765 4,976
Inventory 6,877 7,750 8,033 9,196 10,671 10,304 10,988 11,537 12,033 12,500
Tax, supplier, and other receivables 4,910 5,242 5,655 6,439 6,617 7,129 7,654 8,022 8,358 8,594
Prepaid and other current assets 1,552 1,393 1,733 1,728 1,717 1,705 1,689 1,672 1,653 1,653
Operating Current Assets 26,226 28,156 31,869 35,665 37,888 39,762 42,242 44,253 46,075 47,254
Accounts payable 10,223 12,102 11,787 13,842 16,128 15,400 16,522 17,342 18,056 18,781
Deferred revenues 3,815 4,309 5,025 5,334 5,596 6,087 6,449 6,798 7,087 7,355
Taxes on earnings 2,367 1,905 1,891 2,175 1,979 2,154 2,270 2,453 2,441 2,478
Employee compensation & benefits 2,343 3,148 3,465 3,625 3,917 4,198 4,448 4,712 4,896 5,084
Other 4,145 4,789 6,126 6,085 6,479 7,140 7,463 7,904 8,252 8,542
Operating Current Liabilities 22,893 26,253 28,294 31,060 34,098 34,980 37,153 39,209 40,732 42,240
Net Working Capital 3,333 1,903 3,575 4,605 3,790 4,782 5,089 5,044 5,343 5,014
Book value of property, plant & equipment 13,880 15,024 16,411 22,991 27,270 25,759 30,766 33,745 38,205 45,313
Accumulated depreciation 7,429 8,161 8,613 9,508 10,534 11,523 12,702 13,989 15,451 17,184
Net Property, Plant and Equipment 6,451 6,863 7,798 13,483 16,736 14,236 18,064 19,757 22,754 28,129
Long-term financing receivables 2,246 2,340 2,778 2,992 3,090 3,380 3,586 3,770 3,935 4,084
Other 2,993 2,834 3,908 3,908 3,908 3,908 3,908 3,908 3,908 3,908
Purchased intangibles 3,589 3,352 4,079 4,057 4,423 4,429 4,390 4,382 4,405 4,489
PV of operating leases 2,633 2,204 2,288 3,065 3,076 3,322 3,417 3,611 3,860 3,979
Net Other Operating Assets 11,461 10,730 13,053 14,022 14,498 15,039 15,301 15,671 16,109 16,460
Long-term deferred revenue 1,331 1,750 2,459 2,223 2,451 2,730 2,802 2,993 3,126 3,750
Other long term liabilities 1,443 1,648 1,962 2,048 2,158 2,354 2,486 2,623 2,736 2,837
Net Other Operating Liabilities 2,774 3,398 4,421 4,271 4,609 5,084 5,288 5,617 5,862 6,587
Invested Capital $ 18,471 $ 16,099 $ 20,005 $ 27,839 $ 30,414 $ 28,974 $ 33,167 $ 34,854 $ 38,343 $ 43,016
Return on Invested Capital 17.65% 31.22% 43.37% 41.65% 22.49% 28.53% 28.90% 28.52% 27.75% 25.60%
Free Cash Flows $ 6,286.67 $ 8,139.36 $ 3,075.27 $ 499.11 $ 3,686.48 $ 10,119.32 $ 4,181.65 $ 7,770.00 $ 6,181.97 $ 5,142.46
Economic Profit $ 1,795 $ 4,082 $ 5,513 $ 6,508 $ 3,722 $ 5,903 $ 5,731 $ 6,431 $ 6,491 $ 6,316
Hewlett-Packard Co Hewlett-Packard Co
Weighted Average Cost of Capital(WACC) Estimation
Dividend Discount Model (DDM) or Fundamental P/E Valuation Model
Fiscal Years Ending 2007
Risk free rate (Bloomberg; 30 yr. U.S. Treasury bond rate) 4.19%
Equity risk premium (Geometric avg. premium stocks to T-bonds 1928-2007) 4.82%
2009 E 2010 E 2011 E 2012 E 2013 CV
Beta (Bloomberg; raw beta, weekly interval, 5 yr. time period) 1.17
CAPM Cost of Equity (Re) 9.83%
EPS $2.74 $3.28 $3.38 $3.61 $3.69
Cost of Preferred Equity(Rpfd) 0
Key Assumptions
CV growth of EPS 4.00%
Pre-Tax Cost of Debt (Rd) (Bloomberg) 6.30%
CV ROE 11.56%
Cost of Equity 9.83%
Marginal Tax Rate (t) 21.9%
WACC 9.12%
Derived P/E Multiple 12.76
Price (14 Nov. 2008) $30.46
Number of shares outstanding 2,450,000,000
Market value of equity (E) 74,627,000,000
Future Cash Flows
Weight of Equity 85.65%
P/E Multiple 12.76
Short & long term debt (Sept. 5, 2008 10Q) 10,219,000,000 EPS(next period) $3.40
PV of operating leases (2007 10K Notes 4 yr. asset life) 2,287,539,936 Future Stock Price $43.41
Market value of debt (D) 12,506,539,936 Dividends Per Share $0.32 $0.32 $0.32 $0.32 $0.32
Weight of Debt 14.35% Future Cash Flows $0.32 $0.32 $0.32 $0.32 $43.73
Market value of preferred (PFD) -
Weight of Preferred - Discounted Cash Flows $0.29 $0.27 $0.24 $0.22 $27.37
Market value of firm (V) 87,133,539,936
DDM Target $28.39
Weighted Average Cost of Capital (WACC) 9.12% DDM Target (as of 14 Nov. 2008) $ 28.51
Valuation Results Price Differ. from actual price
DCF Method $46.99 54%
EP Method $46.99 54%
Dividend Discount Method $28.51 -6%
Relative P/E $34.93 15%
Relative PEG $29.61 -3%
Hewlett-Packard Co
Discounted Cash Flow (DCF) and Economic Profit (EP) Model Valuation
Fiscal Years Ending 2007
Assumptions: CV growth 3.88%
CV ROIC 25.60%
WACC 9.12%
Cost of equity 9.83%
2009 E 2010 E 2011 E 2012 E 2013 E CV
DCF Model
FCF 3686 10119 4182 7770 6182 158816
PV (FCF) 3378 8498 3218 5479 3995 102631
PV (FCF) 127199
Add: Non-operating assets
Excess cash $ 7,219
Short-term investments $ 158
Less: Non-equity claims
Debt and PV (Operating leases) $ 12,507
PV (ESOP) $ 5,967
Pension obligations $ 1,480
PV (Equity) $ 114,621
Shares outstanding 2,450
Target price $ 46.78
Target Price (As of 14 Nov. 2008) 46.99
EP Model
ROIC 22.49% 28.53% 28.90% 28.52% 27.75% 25.60%
EP 3722 5903 5731 6431 6491 120472
PV (EP) 3411 4957 4410 4535 4194 77852
PV (EP) 99360
Invested capital 27839
PV (Operations) 127199
Add: Non-operating assets
Excess cash $ 7,219
Short-term investments $ 158
Less: Non-equity claims
Debt and PV (Operating leases) $ 12,507
PV (ESOP) $ 5,967
Pension obligations $ 1,480
PV (Equity) $ 114,621
Shares outstanding 2,450
Target price $ 46.78
Target Price (as of 14 Nov. 2008) 46.99
Hewlett-Packard Co
Present Value of Operating Leases
Cost of Debt 6.30%
Asset Life (yrs)* 4
Operating Leases PV
2003 2004 2005 2006 2007 2008
Minimum future rentals on non-callable operating leases $ 716.00 $ 690.00 $ 824.00 $ 668.00 $ 692.00 $ 882.00
Present Value of Operating Leases $ 2,287.54 $ 2,204.47 $ 2,632.59 $ 2,134.19 $ 2,210.86 $ 2,817.89
* Operating Leases typically have lives of 2 to 5 years according to annual report footnotes
4 year life based on approximate average from 10-K statements, 2002 - 2007; more detailed information does not exist in a direct form
VALUATION OF OPTIONS GRANTED IN ESOP
Ticker Symbol HPQ
Current Stock Price 30.46
Risk Free Rate 4.19% 0.010505581
Current Dividend Yield 1.10%
Annualized St. Dev. of Stock Returns 69.30%
Average Average B-S Value
Range of Number Exercise Remaining Option of Options
Outstanding Options of Shares Price Life (yrs) Price Granted
Range 1 678 5.00 6.00 $ 25.46 $ 17,262
Range 2 40,902 16.00 3.80 $ 19.85 $ 812,027
Range 3 134,093 23.00 4.50 $ 18.31 $ 2,455,617
Range 4 85,074 33.00 5.60 $ 17.38 $ 1,478,439
Range 5 71,619 45.00 4.30 $ 13.55 $ 970,228
Range 6 21,759 57.00 2.70 $ 8.35 $ 181,774
Range 7 13,214 71.00 1.70 $ 3.94 $ 52,128
Total 367,339 $ 32.53 4.43 $ 17.11 $ 5,967,476
Hewlett-Packard Co
Relative P/E Analysis
(as of 11/14/08)
EPS EPS Est.
Ticker Company Price 2008E 2009E P/E 08 P/E 09 5yr Gr. PEG 08 PEG 09
CSCO Cisco $ 17.77 $1.56 $1.64 11.4 10.8 21.1 0.54 0.51
DELL Dell $ 12.20 $1.39 $1.58 8.8 7.7 11.8 0.74 0.65
IBM IBM $ 92.97 $8.73 $9.24 10.6 10.1 13.5 0.79 0.74
INTC Intel $ 16.03 $1.25 $1.31 12.8 12.2 12.8 1.00 0.96
AAPL Apple Inc. $ 90.24 $5.37 $5.35 16.8 16.9 20.8 0.81 0.81
TXN Texas Instruments $ 19.56 $1.68 $1.36 11.6 14.4 14.9 0.78 0.97
UTX United Technologies $ 54.96 $4.94 $5.25 11.1 10.5 11.3 0.98 0.92
Average 11.9 11.8 0.8 0.8
HPQ Hewlett Packard $ 30.46 $ 2.94 $ 2.74 10.4 11.1 12.5 0.83 0.89
Implied Value:
Relative P/E (EPS08) $ 34.93
Relative P/E (EPS09) $ 32.32
PEG Ratio (EPS08) $ 29.61
PEG Ratio (EPS09) $ 27.24
Hewlett-Packard Co
Sensitivity Analysis
CV FCF
$ 46.99 $ 136,165 $ 143,331 $ 150,875 $ 158,816 $ 166,757 $ 175,094 $ 183,849
CV FCF $ 158,816 6.12% $ 47.25 $ 49.43 $ 51.73 $ 54.15 $ 56.56 $ 59.10 $ 61.77
CV EP $ 120,472 7.12% $ 45.05 $ 47.13 $ 49.32 $ 51.63 $ 53.94 $ 56.36 $ 58.90
CV ROIC 25.60% 8.12% $ 42.96 $ 44.95 $ 47.04 $ 49.25 $ 51.45 $ 53.76 $ 56.19
WACC
CV g 3.88% 9.12% $ 40.99 $ 42.89 $ 44.89 $ 46.99 $ 49.09 $ 51.30 $ 53.62
WACC 9.12% 10.12% $ 39.12 $ 40.93 $ 42.84 $ 44.85 $ 46.86 $ 48.97 $ 51.18
11.12% $ 37.34 $ 39.07 $ 40.90 $ 42.82 $ 44.74 $ 46.76 $ 48.87
12.12% $ 35.65 $ 37.31 $ 39.05 $ 40.89 $ 42.73 $ 44.66 $ 46.68
CV EP WACC
$ 46.99 $ 103,290 $ 108,726 $ 114,449 $ 120,472 $ 126,496 $ 132,821 $ 139,462 $ 46.99 7.62% 8.12% 8.62% 9.12% 9.62% 10.12% 10.62%
6.12% $ 47.32 $ 48.98 $ 50.72 $ 52.55 $ 54.39 $ 56.31 $ 58.34 2.382% $ 50.63 $ 46.38 $ 42.85 $ 39.89 $ 37.36 $ 35.18 $ 33.29
7.12% $ 45.60 $ 47.18 $ 48.85 $ 50.60 $ 52.35 $ 54.19 $ 56.11 2.882% $ 54.56 $ 49.46 $ 45.31 $ 41.88 $ 38.99 $ 36.52 $ 34.40
8.12% $ 43.98 $ 45.49 $ 47.07 $ 48.74 $ 50.42 $ 52.17 $ 54.01 3.382% $ 59.43 $ 53.20 $ 48.24 $ 44.21 $ 40.87 $ 38.06 $ 35.67
WACC
CV g
9.12% $ 42.44 $ 43.88 $ 45.39 $ 46.99 $ 48.58 $ 50.26 $ 52.02 3.88% $ 65.59 $ 57.82 $ 51.79 $ 46.99 $ 43.08 $ 39.84 $ 37.12
10.12% $ 40.98 $ 42.35 $ 43.80 $ 45.32 $ 46.85 $ 48.45 $ 50.13 4.382% $ 73.64 $ 63.67 $ 56.17 $ 50.35 $ 45.71 $ 41.94 $ 38.81
11.12% $ 39.59 $ 40.90 $ 42.29 $ 43.75 $ 45.20 $ 46.73 $ 48.34 4.882% $ 84.64 $ 71.32 $ 61.73 $ 54.51 $ 48.90 $ 44.43 $ 40.79
12.12% $ 38.27 $ 39.53 $ 40.85 $ 42.25 $ 43.64 $ 45.10 $ 46.64 5.382% $ 100.54 $ 81.77 $ 68.99 $ 59.78 $ 52.84 $ 47.45 $ 43.15
ROIC ROIC
$ 46.99 22.60% 23.60% 24.60% 25.60% 26.60% 27.60% 28.60% $ 46.99 22.60% 23.60% 24.60% 25.60% 26.60% 27.60% 28.60%
2.38% $ 39.41 $ 39.59 $ 39.74 $ 39.89 $ 40.02 $ 40.15 $ 40.27 7.62% $ 64.09 $ 64.63 $ 65.13 $ 65.59 $ 66.01 $ 66.40 $ 66.77
2.88% $ 41.25 $ 41.48 $ 41.69 $ 41.88 $ 42.05 $ 42.22 $ 42.37 8.12% $ 56.53 $ 56.99 $ 57.42 $ 57.82 $ 58.18 $ 58.52 $ 58.84
3.38% $ 43.42 $ 43.70 $ 43.97 $ 44.21 $ 44.44 $ 44.64 $ 44.84 8.62% $ 50.66 $ 51.07 $ 51.44 $ 51.79 $ 52.11 $ 52.41 $ 52.68
WACC
CV g
3.88% $ 45.99 $ 46.35 $ 46.68 $ 46.99 $ 47.27 $ 47.53 $ 47.78 9.12% $ 45.99 $ 46.35 $ 46.68 $ 46.99 $ 47.27 $ 47.53 $ 47.78
4.38% $ 49.11 $ 49.56 $ 49.97 $ 50.35 $ 50.71 $ 51.03 $ 51.34 9.62% $ 42.19 $ 42.51 $ 42.81 $ 43.08 $ 43.33 $ 43.57 $ 43.79
4.88% $ 52.96 $ 53.52 $ 54.04 $ 54.51 $ 54.95 $ 55.36 $ 55.74 10.12% $ 39.04 $ 39.33 $ 39.60 $ 39.84 $ 40.07 $ 40.28 $ 40.48
5.38% $ 57.84 $ 58.54 $ 59.18 $ 59.78 $ 60.33 $ 60.84 $ 61.31 10.62% $ 36.40 $ 36.66 $ 36.90 $ 37.12 $ 37.33 $ 37.52 $ 37.70
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