HPE continues to get smaller, betting on mergers and spin-offs while competitors get ever bigger.
Proving the rumours true, HPE offloaded its software assets to Micro Focus, a merger which followed the similar spinoff of its services business to CSC in May. This trimming of assets by HPE sits in sharp contrast to recent moves made by its competitors – only the day before the Micro Focus merger, Dell completed its $67 billion acquisition of EMC. While HPE is slimming down, its competitors are bulking up; a point which has not escaped Meg Whitman’s attention.
“We are getting smaller, while Dell is getting bigger, and this is important because I believe speed and agility is important in innovation and go-to-market,” the HPE CEO told Wall Street analysts on Wednesday.
“They are levering up and we are de-levering. We have $5.3 billion of net cash on the operating company and we are going to have a lot more by the time we are done with these [spin-off merger] transactions.”
Whitman’s mention of cash was a subtle way of putting the spotlight on Dell’s huge debt incurred by the EMC acquisition – but maybe it also deflected attention away from the huge gamble HPE is taking in its trimming down of business.
Although HPE can boast that gambles have paid out in the past – the company’s market cap has increased by $10 billion since the split from HP Inc. – its latest flutter raises some serious concerns.
Firstly there is the fact that the Micro Focus deal is being made at a loss to the company, with John Abbott, analyst at 451 Research telling CBR:
“The $8.8bn sale realizes less than half as much as the predecessor company spent on cobbling together the portfolio that it is now divesting. By our math, HP paid out more than $18.5bn on a string of software deals going back more than decade: Autonomy ($11.7bn), Mercury Interactive ($4.5bn), ArcSight ($1.65bn), as well as deals valued in the low hundreds of millions of dollars such as Fortify Software, Vertica Software and Voltage Security.”
The ownership of the company is also one which is murky, with HPE shareholders receiving a 50.1% stake in the merged company in return for its extensive software portfolio. HPE will be merging Application Delivery Management, Big Data, Enterprise Security, Information Management & Governance and IT Operations Management businesses with Micro Focus in order to create one of the world’s biggest pure-play software companies.
However, that company will be under the Micro Focus brand name, not HPE, with Kevin Loosemore, Micro Focus chief executive, cited by the FT as saying: “We have total control of what is happening. We are effectively buying their business…HP will have no share of this business once the deal is done.”
However, the most significant part of this deal, and the one to cause the most concern, is that the pay-off for HPE is speculative.
“One way to think about structure of the HPE software transaction is to view it as a significant upfront payment coupled with an even-larger ‘option’ on the future business,” said Abbott.
“The value of the $6.3bn ownership stake, which is more speculative than the cold-hard cash, will depend on how well the combined company performs. That’s a key consideration, given that Micro Focus equity represents more than 70% of the total consideration in the transaction.”
Abbott went on to tell CBR that HPE used a similar cash-and-equity structure when it span its services business to CSC – meaning HPE have made this bet twice.
However, as bets go, HPE has picked a front-runner in Micro Focus. The British company has already replaced ARM on the FTSE 100, claiming the title as the UK’s biggest software house. The company has a history of mergers and consolidating mature software businesses, with recent acquisitions including Attachmate and Serena Software. It is notable that the latter acquisition saw Micro Focus gain ownership of SUSE, the open-source software company which brings in 20% of revenues. Adding to HPE’s extensive portfolio will not only raise its profile publically, but also boost its offerings to customers.
“With the HPE division Micro Focus gets a mixture of more mature product lines (Mercury Software) and faster growing businesses in hot market sectors like data analytics (Vertica, Autonomy) and enterprise security (ArcSight, Fortify), plus some additions to its existing application delivery management tools,” said Abbott.
Although early days, it does seem that the bet has paid off in the short term. Investors have reacted positively to the news, with the share price of Micro Focus up by almost 20% in yesterday’s trading. The deal saw extensive press coverage, raising the company’s profile while also being seen as a show of confidence in the UK tech sector post-Brexit. Talking to the Guardian, ETX Capital analyst Neil Wilson said:
“After Arm Holdings was sold to SoftBank, it’s a sign that the UK tech sector is still capable of making deals in the other direction,” he said.
“[The HPE deal] would be the biggest acquisition by a British company of a foreign tech firm, and comes in the face of a massive drop in the value of the pound that has made UK firms the target of overseas bidders.”
However, this initial surge in share price mirrors what happened after the CSC spin-off was announced, with stocks trading lower since the initial rush.
Although HPE has placed some large wagers on the sale of assets, the biggest bet has to be its renewed focus on core systems infrastructure. Setting out the company’s vision, including its position on software, CEO Whitman said:
“I want to be crystal clear – HPE is not getting out of software. Software is still a key enabler of our go-forward strategy, but we need the right assets to win in our target markets. Moving forward, we will double down on the software capabilities that power and differentiate our infrastructure solutions and are critical in a cloud environment.
“I am confident that we are making the right choices. Once the ES–CSC and Software–Micro Focus transactions are complete, HPE will be a faster-growing, higher-margin and stronger free cash flow company, well positioned for the future.”
For now it remains to be seen if this strategy will work – after all, the industry is in a state of flux. Just this week Dell and HPE have made plays in very different directions, only time will tell who the best pound-for-pound tech major will be.