HP Should Have Avoided A Big Bang

25 August, 2011

When a chief executive unveils a new strategy to shareholders after nine months in the job, they hope for warm applause, not for widespread alarm and a 20 per cent drop in the share price.

Léo Apotheker, chief executive of Hewlett-Packard, provoked the latter last week when he married lower earnings guidance with a plan to acquire Autonomy, the UK software company, for an extremely high price, and to spin off HP’s huge personal computer division. After a fractious call with analysts, his irritated shareholders demonstrated their discontent.

As a result, Mr Apotheker is spending the week wooing investors and media outlets in New York and London (including a visit to the Financial Times) in an effort to restore order. But it will take more than a dose of personal attention to establish his credibility.

Even if the new strategy is vindicated, which it may eventually be, he needlessly alienated investors by thrusting so much unpalatable information and future uncertainty on them at once. He should have taken things steadily rather than making a big bang.

That mis-step carries lessons for other chief executives who seek to make a decisive impact within a few months of their arrival. The temptation, often encouraged by action-hungry analysts and journalists, is to break up companies such as HP in pursuit of clarity and focus. Muddling along with what they inherited feels like an arduous and imperfect compromise.

But chief executives need to establish authority and to set a clear path before they can expect insiders or outsiders to follow their new direction. Investors interpreted Mr Apotheker’s burst of dealmaking, allied to the outlook, as evidence not of vision but of panic.

The irony is that HP wants to make itself more like IBM, the business software and services giant revived by Louis Gerstner, who refused to act precipitously after taking over in 1993. Instead of selling mainframe computers and dismembering Big Blue, as he was urged to do, he kept it big.

“Keeping IBM together was the first strategic decision and, I believe, the most important business decision I ever made … we threw out the investment bankers who were arranging IPOs of all the pieces … we threw out the naming consultants who had decided that the printer division should be called ‘Pennant’ and the storage division ‘Adstar’,” he wrote in his memoir Who Says Elephants Can’t Dance?

Mr Gerstner and his successors went on to restructure IBM, and indeed to spin off and sell large parts of it – including the sale of the personal computer business to Lenovo in 2005. But by the time they did so, they had proved that their alternative vision worked in practice as well as on a consultant’s slide.

By contrast, Mr Apotheker is pinning his hopes, and $11bn of his shareholders’ money, on planting Autonomy at the core of a high-margin software business that now contributes less than 3 per cent of sales. The dull, but well-proven and cash-generative, PC business would have departed before that ambition is fulfilled in 2015.

HP knows that acquisitions often do not work; among other things last week, Mr Apotheker announced the closure of the hardware division of Palm, a company that Mark Hurd, his predecessor, bought for $1.2bn last year. Barely had the TouchPad tablet been launched with a fanfare than it was ditched.

He also presented his fait accompli to investors whom he had assured in June that he was aiming for “the fastest evolutionary path possible” rather than a revolution, and who feel misled. Several of the biggest are value investors that acquired HP shares because they wanted stable cash flow, not volatile growth.

Mr Apotheker is not solely responsible – he seems to have the backing of HP’s board, which itself suffers from a lack of credibility after an era of instability at the top. Both Mr Hurd and Carly Fiorina, who was chief executive before him, departed amid discord.

“The board was thoroughly advised on what would happen. We all knew this was going to be very difficult,” says one of those involved. If so, it is hard to grasp why they did it – unless such Silicon Valley figures as Meg Whitman, Marc Andreessen and Ray Lane, the chairman, do not care about Wall Street investors.

Spin-offs are not bad per se and many value investors like them as a way of releasing assets within conglomerates. Indeed, encouraged by the same investment bankers who put these companies together in the first place, they are all the rage among oil enterprises such as ConocoPhillips and consumer companies such as Kraft.

Nor does the fact that a company’s shares fall when an incoming chief executive announces a growth strategy prove that they are wrong. James Murdoch, for example, alienated British Sky Broadcasting investors in 2003 by going for growth rather than handing them its surplus cash, but he was later vindicated (before becoming embroiled in the News of the World phone hacking scandal this year).

Leaders have to establish their operational credibility before their investors will buy their promises – either that, or they face a long and tough period demonstrating that they were right after all. The fact that Mr Gerstner avoided such a struggle by starting out at IBM unshowily paid long-term dividends.

Mr Apotheker’s appointment last year was, typically for HP, mired in controversy and I defended him at the time from detractors such as Larry Ellison of Oracle. Now he must prove himself.

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HP Should Have Avoided A Big Bang

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