How Microsoft's Cloud Eroded HP Enterprise's Q2 Revenue
In November 2015, HP officially became two publicly held companies: HP Inc., which largely consists of personal computers and printers, and Hewlett-Packard Enterprise, which sells computer servers, data storage, networking, software and consulting services intended for business use. HPE executives expected that shedding its consumer businesses would enable it to focus better on the enterprise business. However, so far the biggest beneficiary of this transformation seems to be the personal computer division as Hewlett-Packard Enterprise reported a sharp fall in revenue, nearly 13 percent to $6.24 billion in the quarter ending April 30, in its biggest business that sells servers, networking, and data storage equipment. Even though this fall was the sharpest decline in several quarters, the results surprised no one as Wall Street was expecting this kind of a fall off.
"We have just gone through one of the largest transformations maybe in American business history, we have created four industry leading companies that I think are poised to do very well in their given segments,” said HPE CEO Meg Whitman. “We separated from HPI in November of 2015 and last month, we spun our enterprise services business and merged it with CSC to form DXC Technology. Completing this transaction was a major milestone in our strategy and I’m proud that we were able to execute such a significant change within the tight schedule we laid out and on budget.”
Despite Whitman’s upbeat attitude during the company’s earnings call, the figures from the report, unfortunately, tells a sob story about the 70-year-old brand, once one of the most successful computer industry companies. Besides the fact that revenue from the enterprise group fell 13 percent year-on-year to $6.2 billion, software revenue was down 11 percent to $685 million. Geographically, the Americas witnessed an 8 percent adjusted revenue decline while Europe/Middle East/Africa was down 3 percent and Asia/Pacific dropped 2 percent. The company also recorded negative cash flow in the quarter.
Who is to Blame?
Lower license and professional services sales in software played a huge role in Q2 revenue as across its enterprise product lines, the company saw a significant decline. The decline in sales of its consulting and outsourcing services business largely eroded its revenue. In fact, server revenue was down 14 percent, storage sales fell 13 percent and networking revenue dropped 30 percent as well as technology services revenue, which includes HPE's new Pointnext services brand, was down 2 percent.
One of the biggest factors that caused this falloff is reduced server demand from a single tier 1 service provider customer, according to HPE. Moving forward, the company indicated that they will examine their Tier 1 service provider sales strategy tied heavily to one top public cloud provider, Microsoft. "We are really thinking hard about what the future strategy is for Tier 1," said Whitman. "We continue to get new Tier 1 customers, but this is low-calorie business, actually. So we need to think through does it make sense to continue that business on a go-forward basis or are we better off actually putting our selling resources and our R & D resources into more margin rich, sustainable profitability."
Another factor cited by the executives was the cost of acquisitions. Last month, for instance, HPE acquired data storage provider Nimble Storage Inc for $1.09 billion. On top of that, Nimble was in a loss-making situation when bought. Executives also cited high memory costs and lingering divestiture expenses as factors.
Intense competition also hurt the margin. Due to rising prices of commodity components like DRAM chips, the company increased its prices to counteract. However, this wasn’t the action that some competitors took. Therefore, they had to drop their prices in some cases to match the other competitive figures. The decisions in that regard were given based on a deal. As a result, the margin of those products and services shrank.
Since the company drives more than 60 percent of its business from outside the United States, a strong dollar throughout the quarter negatively affected HPE's overseas revenue numbers. On a related note, HPE's core industry standard server business rebounded with sales down 1 percent when adjusted for currency and divestitures. The company also claimed that the HPE revenue, when adjusted for divestitures and without the impact of currency and the Tier 1 server sales decline, would have been up 1 percent compared with the year-ago quarter.
On a Positive Note
From the bright side, financial services revenue were up 11 percent to $872 million, all-flash storage revenue gained 33 percent while Aruba wireless solutions saw 32 percent growth. As another bright spot, the company saw 20 percent organic growth in HPE's high-performance computing business, which includes SGI. Lastly, the fourth consecutive quarter of growth for HPE Pointnext technology services business was up 3 percent.
Aside from the revenue, Hewlett-Packard Enterprise has recently announced “the world’s largest single-memory computer”, called The Machine. The prototype released 160 terabytes of directly addressable main memory. To put this into perspective, HPE explained such a machine is theoretically capable of simultaneously working with the data held in every book in the Library of Congress five times over – or approximately 160 million books. The architecture is designed to easily scale to a nearly limitless pool of 4,096 yottabytes, which is 250,000 times the entire amount of digital information that is estimated to exist today. This innovation is expected to address the memory issue on a massive scale.
What to Work On?
HP executives expected that the split would enable each new entity to better compete in a tough market. With that in mind, HP’s decision to divest all these technologies was simply related to HP’s bigger strategy of bringing more focus to their core business competencies. Therefore, the market opportunity for these solutions was not their concern back then. However, now it is the time for HPE to pick itself up and dust itself off to seize the opportunities.
“Now that we’ve completed the Enterprise Services spin merger, we’re taking a fresh look at the cost structure for the new HPE. As a smaller company, it should be much easier to spot opportunities to optimize the business, streamline processes and reduce costs. We believe we can take out another $200 million to $300 million in cost in just the second half of this year,” said Whitman while CFO Tim Stonesifer added: “The completion of the spin-merger of our Enterprise Services business gives us the opportunity to further optimize the cost structure of the future HPE.” As per what the company claims, the $200 million to $300 million in cost savings will be separate from the $700 million in a restructuring charge in the current fiscal year and another $200 million in the fiscal year 2018.
Additional to the cost take out, Wittman mentioned their plans to leverage the intelligent edge by putting Aruba technology offerings into the center of the strategy. Her plan is to enable their teams including 25,000 specialists with “world-class expertise”, to collaborate with businesses worldwide to speed their adoption of emerging technologies, including cloud computing and hybrid IT, Big Data and analytics, the intelligent edge and Internet of Things.
Speaking of businesses around the world, Wittman shared her excitement about the feedback she has been getting from their clients: “Customers who know us well, I think are super excited about the focus. They know the services capability that we have. They really resonated to the strategy. This strategy of we make hybrid IT simple, we power the intelligent edge and we have the services to make it happen totally resonate and so we’re excited about that.” She added: “But customers who know us well, I think are super excited about the focus. They know the services capability that we have. They really resonated to the strategy. This strategy of we make hybrid IT simple, we power the intelligent edge and we have the services to make it happen totally resonate and so we’re excited about that.”
Backing up Wittman’s statement on the customer feedback. Dan Molina, CTO of San Diego-based Nth Generation Computing, one of HPE's top enterprise partners, claimed his company is witnessing strong double-digit growth in the HPE business as a result of the transformation of HPE into a hybrid IT intelligent edge market leader.
From the investors’ perspective, Barclays analyst Mark Moskowitz said in a note: “This maelstrom presents an opportunity for long-term and value-based investors to take profits in a more meaningful way as the napkin-math financial engineering of the spins gives way to the reality of a legacy asset being hit by the cloud and increasing competition,” he wrote, adding that HPE may be losing market share to Dell Technologies Inc. in servers and NetApp Inc. and Pure Storage Inc. in storage.
HP Inc is not the only one who has been under the restructuring. As we reported in March 2016, UK-based content management and language translation company SDL, announced its plan to divest parts of their CXM business in order to drive efficiency and invest in the platforms they need for future growth. This type of transformation is not easy for any organization, let alone a tech titan like HP. On the other hand, the company promises a bright future as it demonstrated its strong focus on developing innovative products focused on hybrid IT and the intelligent edge. Having said this, the company still needs to strengthen its hand in terms of its software portfolio and service offerings. I am curious about how “Future HPE” will turn out that will be all about hybrid information technology, intelligent edge, and Pointnext services according to Wittman.