Though the markets are under some pressure today, in-line with our views that we’re in the midst of a correction, there’s nothing to panic about.
We took some profits and we’ve added protection to the portfolios, but we’re not expecting any more than a 5%-10% move lower from today. The move may not happen tomorrow or next week, but we think the markets will be lower than they are today at some point within the next few months to a year. We think it’s important to continue to reiterate that, while the put option contracts in the portfolios are now in the money, they can still expire worthless if we do not take profits. Options are far more risky than equities, and they are certainly not for everybody.
Much of the news so far this week, besides the surprising GT Advanced (GTAT) debacle, has centered on the break-up of Hewlett-Packard (HPQ) into two separate publicly-traded entities: Hewlett-Packard Enterprise and HP Inc. We’re actually not too fond of the break up as it will add redundant overhead and management teams, increasing the costs of both entities beyond that which it otherwise would have to bear should it stay together. To make up for the increased costs, CEO Meg Whitman will lay off 55,000 jobs, which is higher than the previous range of 45,000-50,000, which itself is up from a target of 34,000. Here are the highlights of the break-up:
Hewlett-Packard Enterprise will build upon HP’s leading position in servers, storage, networking, converged systems, services and software as well as its OpenStack Helion cloud platform
Meg Whitman to be President and Chief Executive Officer of Hewlett-Packard Enterprise; Pat Russo to be Chairman of Hewlett-Packard Enterprise Board
HP Inc. will be the leading personal systems and printing company with a strong roadmap into the most exciting new technologies like 3D printing and new computing experiences
Dion Weisler to be President and Chief Executive Officer of HP Inc.; Meg Whitman to be Chairman of the HP Inc. Board
Company reiterates fiscal 2014 non-GAAP diluted net earnings per share (EPS) outlook of $3.70 to $3.74 and updates GAAP diluted net EPS outlook to $2.60 to $2.64
Company issues fiscal 2015 non-GAAP diluted net EPS outlook of $3.83 to $4.03 and GAAP diluted net EPS outlook of $3.23 to $3.43
The way to think about this deal is relatively simple. CEO Meg Whitman is throwing in the towel. She can’t execute a turnaround of this battleship, and breaking the company into two smaller vessels gives it a better chance of success. The problem, however, is that breaking apart a company does not generate incremental revenue. It only increases costs. Hewlett-Packard is cutting its staff to the bone via restructuring. What companies have 55,000 people that they can just lay off with no impact to revenue? My guess is not many. Cisco (CSCO) is also cutting its workforce to the bone. We view the break-up at Hewlett-Packard as essentially a non-event, and one that will destroy value, absent the incremental cost/job cuts. Our fair value estimate of Hewlett-Packard remains unchanged at this time.
In other news, Yahoo (YHOO), fresh off the Alibaba (BABA) debut, is looking to put the capital monetized from its stake to work. We highlighted how we feared Yahoo would chase low-ROIC endeavors to stay relevant here, and sure enough, CEO Marissa Mayer and the Yahoo team have become all-too anxious to take a stake in Snapchat at an astronomical $10 billion valuation. Though the stake is reported to be an immaterial $20 million, it reveals the team’s lack of focus on return on invested capital. Even minor investments should be met with the same scrutiny.
Still, we’re not overly worried about this particular investment, and some could argue that it could be viewed as savvy if it opens the doors to a positive-ROIC relationship between Yahoo and Snapchat. In any case, we do think it highlights the hazards Yahoo investors are facing in the event the current management team continues to throw money at investments in order to keep Yahoo relevant (and more directly, in order to keep their jobs). Unlike Hewlett-Packard that is willing to break apart, Yahoo may be in an empire-building stage as its legacy business fades away. We don’t think this investment in Snapchat will work out. Every social platform can’t succeed. Consumers only have a limited amount of time during the day – between Facebook, Twitter, LinkedIn, Google+, etc, there’s already too many (and the list keeps growing).
The biggest disappointment of the day was home-soda maker, SodaStream (SODA), which said that its third-quarter results would be disappointing. Coca-Cola’s (KO) investment in Green Mountain (GMCR) and Monster Beverage (MNST) may be putting pressure on the beverage innovator, and consumers could be turning to healthier alternatives. Here’s what SodaStream’s management had to say in the release:
“We are very disappointed in our recent performance…Our U.S. business underperformed due to lower than expected demand for our soda makers and flavors which was the primary driver of the overall shortfall in the third quarter. While we were successful over the last few years in establishing a solid base of repeat users in the U.S., we have not succeeded in attracting new consumers to our home carbonation system at the rate we believe should be achieved. The third quarter results are a clear indication that we must alter our course and improve our execution across the board. We have already begun a strategic shift of the SodaStream brand towards health & wellness, primarily in the U.S., where we believe this message will resonate more strongly with consumers. In addition, we are developing a comprehensive growth plan for the Company that will encompass Marketing, Product and Innovation, Distribution, Operations and Organization. We intend to share more specifics around our growth plan when we report third quarter results later this month.”
Though a turnaround will be difficult, we think the company’s trouble increases the likelihood that it will become a target of a larger beverage company: Dr. Pepper Snapple (DPS), Starbucks (SBUX) and Pepsi (PEP) are paying attention. SodaStream’s stock has fallen aggressively on the news.
Also disappointing was AGCO’s (AGCO) updated outlook for the third quarter and full-year 2014. The maker of agricultural equipment had the following update:
The Company now expects third quarter net income per share to be in a range from $0.60 to $0.65 including a benefit of approximately $0.15 per share for the reversal of previously recorded long-term stock compensation expense. Full year 2014 net income per share is now expected to range from $4.10 to $4.30. The revised estimates exclude restructuring and other infrequent expenses which may be incurred. AGCO’s results are expected to be negatively impacted by lower sales levels across all regions, lower production and foreign currency translation.
The key takeaway from the AGCO update is weakness in sales across all regions. Deere (DE) investors cannot ignore this news, and the agricultural equipment space may need to reset expectations for the remainder of 2014 and into 2015.
We don’t think third-quarter earnings season will be bright for investors. We continue to believe caution is in order. The correction continues.