The definition of a value trap is a stock that looks cheap by the numbers but turns out to be cheap for good reason. In recent years, few companies have helped define the concept as well as Hewlett-Packard (symbol HPQ). Its stock has humbled many great investors, including Seth Klarman, of Baupost Group, and the managers of the Dodge & Cox funds. From July 2000 through the end of 2012, the stock plunged 79%.
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The debacle raises the question of how an iconic company that Steve Jobs himself once yearned to work for (and did) came to be investment quicksand. What red flags could have kept investors away?
Lousy CEOs. Beginning in 1999, HP, which had always chosen insiders to head the firm, chose a series of four outsiders: Carly Fiorina, Mark Hurd, Léo Apotheker and current CEO Meg Whitman. Along the way, HP’s culture went from enviable to toxic, and many of the firm’s best managers fled.
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Fiorina, it seems, cared more about her own image than running a successful company. Her decision to pay $25 billion for Compaq Computer was a disaster that still dogs the company. Hurd goosed the share price but trashed HP’s future in pursuit of short-term profits. One of his tricks was to gut research and development. After paying $13.9 billion for Electronic Data Systems, Hurd starved the company. As a result, EDS had so much trouble developing new software that HP last August wrote down $8 billion of its investment.
When scandal torpedoed Hurd, HP, incredibly, hired Apotheker, who had just been fired by SAP. At that point, shareholders should have heeded the lines from Monty Python and the Holy Grail: “Run away! Run away!” Apotheker’s tenure was short—but not short enough. He made one of the worst acquisitions ever, paying $10.3 billion for Autonomy. HP recently accused Autonomy of fraud and wrote off $8.8 billion of the purchase price.
Corporate governance. No company does it worse. From poor CEO choices to near-constant dissension among directors, HP keeps hitting new lows. Both Hurd and former chairman Patricia Dunn were deeply involved in a phone-record spying scandal designed to stop leaks by board members.
Competitive position. HP has only one product line at most with a wide moat against challengers—and even that line, printers, is slipping as people print less because of the proliferation of mobile devices. “You really don’t need anything HP does except printers,” says Brian White, an analyst at Topeka Capital Markets, who rates the stock a sell. “You can get the rest from someone else.” Harsh but true. Most of HP’s current products are essentially commodities.
Use of capital. Contrast HP with IBM. Big Blue got out of the PC business. HP doubled down. IBM has made dozens of small acquisitions to fill specific needs. HP squandered billions trying to transform itself. IBM has devoted enormous sums to stock buybacks. HP has not. The upshot: $1,000 invested in IBM at the start of 2000 would now be worth $2,084. The same amount invested in HP would be worth $379.
There are good reasons HP shares sell for just 4 times estimated year-ahead earnings. The rise of mobile computing is eroding HP’s printer franchise. The firm is barely a blip in the fast-growing tablet market. (HP, which withdrew its first tablet just months after unveiling it in 2011, reentered the business in January.) Plus, HP’s balance sheet stinks. Its $11.3 billion cash hoard is dwarfed by $28.4 billion in debt.
So what to do with HP stock? It’s so cheap it could double, or it could plunge another 50%. I haven’t a clue. And when I’m so uncertain, I follow Warren Buffett’s advice and put a stock in the too-hard-to-figure file. Maybe I’ll buy an HP printer instead.
Columnist Andrew Feinberg manages a New York City–based hedge fund called CJA Partners.
