Shades of Blue reflected in HP's dramatic reshuffling

HP faces uphill climb as it tries to muscle in on software world

HP's plans to get out of the PC business, acquire software maker Autonomy and retreat from its webOS device investments will allow the tech giant to sharpen its focus on enterprise IT markets and capitalize on the software-centric strengths of CEO Leo Apotheker.

HP's plans to get out of the PC business, acquire software maker Autonomy and retreat from its webOS device investments will, if all goes as planned, let the tech giant sharpen its focus on enterprise IT markets and capitalize on the software-centric strengths of CEO Leo Apotheker.

"As an executive who has spent most of my career primarily in software, it is a world I know well," Apotheker said during the company's news-filled earnings call on Thursday.

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But it's an uphill climb nonetheless, as software has been responsible for only a small fraction of HP's revenue in years past. In 2010, HP Software generated $3.59 billion in revenue, or 3% of the company's $126 billion total revenue. But it's on the upswing: HP Software logged 20% year-to-year growth and reached $780 million in revenue in the second quarter of 2011, driven by last year's acquisitions of Fortify and ArcSight, notes Jillian Mirandi, an analyst at Technology Business Research (TBR). HP's fastest growing business unit is also its most profitable, with a 19.4% operating profit.

Conversely, HP's Personal Systems Group, which sells PCs, tablets and smartphones, has the company's lowest profit margin, although it accounted for nearly one-third of HP's overall revenues in 2010. HP's decision to let go of its massive and industry-leading (albeit slow growth and low margin) PC business is a sign of just how severely the explosive tablet market has damaged the PC market.

The PC business is the first obvious domino to fall as Apotheker tries to bring greater profitability to the company, says Ezra Gottheil, a senior analyst at TBR. "It's a much more exaggerated consequence of the [direction] the company decided to go with Leo Apotheker. Clearly the board wanted higher margins," he says.

The planned PC spinoff echoes IBM's sale of its PC business to Lenovo in 2005 to focus on higher-margin enterprise software and services. However, "HP will be challenged to drive software to be the kind of generator of profit that it is at IBM," Gottheil says.

Another challenge is finding a new home for the world's largest PC business; HP estimates it will take 12 to 18 months to sell, spin off or otherwise give the PC business the independence it needs to continue.

"We are focusing on what needs to be fixed, what needs to be shut down and what needs to be considered for separation. And equally, if not more importantly, we are focused on what value-added IP needs to be added to HP in order to stay a leader in the IT world and represent a true value proposition for our customers and investors," Apotheker said.

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Software is clearly in the wheelhouse of longtime SAP chief Apotheker, who took the helm at HP in November 2010. He was put in place to redesign HP around his skill set, much like Steve Jobs did at Apple and Sam Palmisano did at IBM, says Rob Enderle, an analyst with the Enderle Group. "The fact is, a company that is more focused around the core skills of its CEO is inherently more successful," Enderle says.

Adding Autonomy to HP's software arsenal will not only provide a revenue bump but also could give HP a boost in data analytics as well as network and systems management.

A leader in enterprise search and data management, Autonomy has grown through several acquisitions of its own in recent years, including its purchases of content management firm Interwoven, for $775 million in 2009; e-discovery firm Zantaz, for $375 million in 2007; and search software maker Verity, for $500 million in 2005.

More recently, Autonomy acquired CA Technologies' information governance business in 2010 for an undisclosed amount, and it picked up digital assets from Iron Mountain in May of this year.

Such a software portfolio would be "a natural complement to HP's efforts and technologies" in the enterprise content space, says Charles King, principal analyst at Pund-IT. It would dovetail particularly well with HP's Vertica database and 3PAR data storage products.

On the IT management front, HP could gain by combining Autonomy's data expertise with its system management technology, says Curt Monash of Monash Research.

"With Autonomy, you see the usage pattern of the data. If you see the usage patterns, you can make your base-level tools smarter," Monash says. "There's a potential to enhance and strengthen the systems management product line based on the experience that comes with the data management and retrieval product lines."

Yet there are challenges HP will have to address with this facet of its overhaul, too.

"For HP to make this financially successful, it's going to have to do a strong job of enhancing the technology going forward," Monash says. "Autonomy is the leader in enterprise search and retrieval of poly-structured data, but it has grown through acquisition and a lot of the technology pieces are still pretty simplistic. It's the future generation of Autonomy technology, over the next few years, that will determine whether this deal succeeds or fails."

What happened to webOS?

While the shift to focus more on software seems preordained, given Apotheker's background, HP's decision to stop making tablets and smartphones based on webOS comes as a surprise, particularly since the news hit just 49 days after the TouchPad tablet launch, and a year after HP paid $1.2 billion to acquire the OS from Palm.

Developers gave the webOS high marks, and users were enthusiastic about the UI. But neither Palm nor HP was able to make products that lots of users were willing to buy.

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"About a year ago, we made a bet on webOS and the opportunity to launch our own ecosystem around devices, applications and new markets. At that time, we set clear metrics and milestones to monitor the success of webOS," said Cathie Lesjak, HP's executive vice president and CFO. "Our intention was to solidify webOS as the clear No. 2 platform for tablets. But with such a young ecosystem and poorly received hardware, we were unable to achieve our target."

"The tablet effect is real," but HP's webOS devices didn't gain enough traction with consumers, "and we see too long a ramp-up in the market share," Apotheker said. HP plans to look for ways to use and "optimize" the webOS platform, including licensing it to hardware makers.

Analysts say HP buckled under the pressure of Apple's momentum and growing support for Android, but that webOS could still live on at licensees and offer a competitive OS to Android and Windows Phone.

Much like Apple's mobile device strategy, HP intended to wrap together hardware, software and services but lost patience and decided to cut its losses, says TBR's Gottheil. "With their OS, building the market would've taken time. It's clearly an offering that required patience," Gottheil says.

With the decision to separate the hardware and software businesses, HP runs counter to the trend in the mobile market to vertically integrate development. With Google's planned acquisition of Motorola Mobility, Windows Phone became the only major OS whose creator doesn't also make hardware. Now, however, HP joins Microsoft as developer of an OS that is licensed to hardware makers.

"Now that Google has acquired its own hardware vendor, webOS could be a good alternative for some of the Android-only vendors," says Chris Hazelton, an analyst with The 451 Group.

HP plans to turn the webOS into its client play and go after the opportunity that Google created when it bought Motorola, Enderle says. "They couldn't do that as long as they had client hardware. In effect, [HP's] response to the consumerization of IT is to partner with consumer companies, not try to be one anymore. This should create some concerns with Microsoft as they are drifting into Microsoft's turf."

Overall, HP's restructuring and acquisition plans will cause an upheaval within HP, but in the long run, HP's commitment to enterprise IT could be beneficial to corporate customers.

"More focused companies are generally more able to meet the promises they make and have higher customer satisfaction," Enderle says. "There will be some pain in the transition but customer satisfaction for HP should improve."

IDG News Service reporters Agam Shah and Nancy Gohring contributed to this story.

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