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HP Split May Trigger Wave of New Deals

The two new companies may be targeted for buyout or other deals.

Shutterstock / Holly Kuchera

Bankers rejoice! By next year, when computing giant Hewlett-Packard is expected to split into two companies, both will be in deal-making mode.

Let’s start with HP Inc., the name for the soon-to-be independent personal computer and printing division after the split. A freshly independent and smaller company will likely draw the attention of past suitors Dell and Lenovo, which may consider coming back to the table after quiet approaches by HP about a possible deal over the last year bore no fruit.

The combined printing and PC assets posted $56 billion in combined sales in 2013 and brought in $4.8 billion in operating profits. It commanded an 18 percent share of the global PC market as of July according to the research firm IDC. If combined with either Dell or Lenovo that share would swell to account for roughly one-third of the market and create the world’s largest PC maker for any winner of the assets.

The cost to buy HP would likely be about half of its annual sales, and maybe less, judging by the take out values of similar deals. When Dell went private last year, it was worth $25 billion or less than half of the $56 billion in sales it reported in its last fiscal year as a publicly traded company. When Lenovo bought IBM’s server unit, it paid $2.3 billion or exactly half of its estimated annual revenue. And we also know that HP in its current form is trading at a valuation of about $66 billion or roughly 0.6 times its estimated annual sales.

Financing a deal at this range would not be difficult for Dell, which is now bankrolled by private equity firm Silver Lake, also a partner in its deal last year to go private. Dell could finance a takeover of the new company with funding from the $10.3 billion Silver Lake IV fund, closed last year, and from Michael Dell’s personal $16 billion fortune, plus the issuance of additional debt, if required.

Lenovo has already been acquisitive this year, having spent a combined $5.2 billion for IBM’s commodity server business as well as smart phone maker Motorola Mobility from Google.

But how much the PC and printer division would really be worth remains up in the air until we learn more this week. The trick would come from estimating the value of the declining assets. PC sales globally declined by nearly two percent year on year in the most recent quarter, according to IDC.

A simpler structure

This brings us to the second part: HP’s enterprise assets, which will be known as Hewlett-Packard Enterprises. That unit is split roughly between the Enterprise hardware group, which posted sales of $28 billion last year, and the troubled Enterprise Services Group, which brought in $23 billion, plus the $3.9 billion from its software operation. So let’s do a little back-of-the-envelope math to conjure a valuation.

The biggest piece of the Enterprise hardware operation is the $12 billion industry-standard server business. When Lenovo bought IBM’s server unit, it paid $2.3 billion, or exactly half of the unit’s estimated sales, suggesting HP’s server business is worth about $6 billion, or maybe more because it’s the market leader.

Then there’s the $3.4 billion storage business and the $2.5 billion networking business, which, judging by the roughly two-times annual sales valuation of rivals NetApp and Juniper Networks, would establish an $11.8 billion valuation for these two parts of Hewlett-Packard Enterprises. That would roughly value all of its enterprise hardware business at $18 billion (2 x 3.4 billion + 2 x $2.5 billion + $6 billion = $17.8 billion). The $1.1 billion Business Critical Service business is well on its way to evaporating to nothing, so let’s assume it’s worthless within five years.

Coming up with a value for the troubled Enterprise Services unit is harder because its business has declined by nearly $3 billion in annual revenue since 2011. Made up primarily of the company formerly known as EDS, which HP acquired for about $14 billion in 2008, it posted an operating profit of only $679 million last year on $23.5 billion in revenue. The turnaround task there is probably the most daunting one within HP. It had already written down the value of the division by $8 billion in 2012. One thing is clear, any premiums that might be assigned to the networking and storage businesses will be offset by a sizable discount for Enterprise Services.

This brings us to the software unit, will be plagued by the optics of the massive write-down HP took on it after the disastrous $10 billion Autonomy acquisition in 2011. There’s also the added albatross of pending litigation related to that deal: HP has said it plans to sue former executives of that company, and regulators in both the U.S. and U.K. are said to be investigating the case as a criminal matter. Both legal processes could take years.

We know that HP contemplated a so-called “merger of equals” with data storage giant EMC earlier this year, but couldn’t agree on terms. One sticking point may have been the premium that HP was willing to pay for EMC, but another was the operations drag that PCs and printing would exert on the combined company. There’s no way EMC CEO Joe Tucci, who’s due for retirement next year, would want to leave that company in potentially worse shape than he found it, so a combination including PCs and printing would have been a non-starter.

In theory, HP might be able to negotiate more favorable terms with EMC after the split, making the possibility of a new round of merger talks a distinct possibility. But another bidder could also emerge and offer shareholders of both companies better terms. Who might it be?

Both Dell and Cisco Systems could make moves, should they choose to do so. Cisco has tended to be more conservative in its M&A strategy of late and has shied away from huge deals. CEO John Chambers is getting ready to retire soon, and he took the rare step of publicly slapping down speculation that he might be interested in acquiring EMC.

That leaves Dell, who, given sufficient financing at its fingertips, could contemplate an offer that would beat any all-stock transactions by offering shareholders cold, hard cash.

HP, Dell and Lenovo declined to comment.

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