HP software investment may be about to pay off

Hewlett-Packard Co. CEO Mark Hurd, who revived the company by outselling Dell Inc. in personal computers, is close to a payoff in a more lucrative product: software.
Hurd sliced more than $3 billion in costs to undercut Dell on PC prices even as he poured $6.5 billion into software acquisitions. He nabbed his sixth company last month in two years after winning a bidding war for Opsware Inc., the software maker started by Internet pioneer Marc Andreessen.
The spending, and Hurd’s decision in 2005 to stop giving programs away to computer buyers, may help triple profit in software to $253 million this year. Software, a money-losing unit when Hurd took over in April 2005, delivered a higher profit margin than the printing unit for the first time last quarter.
“We’ve just seen the tip of the iceberg here in terms of what the software business can become,” said UBS AG’s Benjamin Reitzes, ranked the second-best computer analyst by Institutional Investor magazine. He rates the shares “buy.” “It’s still a little small, but there’s the potential.”
Software, though only 2.2 percent of revenue, is the Palo Alto, Calif.-based company’s fastest-growing division. RBC Capital Markets analyst Thomas Curlin said Hurd may make a bid for BEA Systems Inc., the maker of programs that connect server computers and the subject of a $6.7 billion hostile offer from software company Oracle Corp.
Hewlett-Packard and San Jose, Calif.-based BEA declined to comment.
Hurd’s takeovers brought Hewlett-Packard, the world’s biggest PC and printer maker, a new title last year: sixth- largest software maker after No. 1 Microsoft Corp. and No. 2 International Business Machines Corp. Hewlett-Packard, which also trails fifth-ranked Symantec Corp., now spends more of its research budget on software than hardware.
Even enthusiastic investors say Hurd faces risks.
“They are late to the game,” says Chuck Jones, who helps oversee $17 billion, including Hewlett-Packard shares, at Atlantic Trust Private Wealth Management in San Francisco. “They’ve paid at the high end of valuations and they have to put together multiple software companies, technology bases and divergent employees, especially on the engineering side.”
Hewlett-Packard’s biggest buy was the $4.5 billion purchase in 2006 of Mercury Interactive Corp., the top seller of software that tests programming code.
More acquisitions are coming, said Tom Hogan, recruited from Vignette Corp. in February 2006 to find deals and run the software group. “My view is go bigger,” he said. “Build it yourself if you can; if you can’t, go get the market leader and don’t mess around.”
After deciding it would take 18 months to copy Opsware’s technology for managing data centers, Hewlett-Packard beat nine suitors by offering $14.25 a share, or $1.6 billion. The bid was 39 percent more than Opsware’s $10.28 stock price on July 20.
Software may help Hurd cushion earnings as PC makers Acer Inc. and Lenovo Group Ltd. cut prices to lure buyers and as Hewlett-Packard trims printer prices to widen its lead over Lexmark International Inc.
Profit from software may jump from $85 million in 2006 and reach $497 million next year, according to Credit Suisse analyst Robert Semple in New York. Sales may rise 65 percent to $2.14 billion in the year ending this month.
Before the purchases, Hewlett-Packard trailed rival IBM in offering software to improve security, test systems and manage servers that run networks and Web sites.
If Hurd, 50, can wrest customers from IBM and digest his takeovers, software can return profit margins of 20 percent or more, analysts say. That tops the 5.8 percent to 16 percent Hurd culled from the PCs, printers and servers that make up most of Hewlett-Packard’s earnings.
“Hurd’s strategy to move aggressively into software appears to me to be on target,” said Stanley Nabi, vice chairman of Silvercrest Asset Management Group, which owns 1.1 million Hewlett-Packard shares. “If IBM had not moved into software and services over the past 15 years or so, it would very likely not be in existence today.”
Software is typically more profitable than hardware, which prompted IBM to build up that product line in the past decade, UBS’s Reitzes said. Software makers do most of their spending on the initial development, updating programs for little cost while charging a premium for their products. Hardware makers’ manufacturing costs usually stay fixed.
Hurd, who ran the database software unit at automated teller machine maker NCR Corp., is focusing on software to manage storage devices, servers and data centers. Customers are spending to simplify operations and protect files from hackers.
By October 2008, Hurd said, Hewlett-Packard’s revenue will rise 4 percent to 6 percent, after topping $100 billion this year. Sales of printers and PCs will gain 4 percent to 6 percent.
For software, Hurd has promised a 10 percent to 15 percent jump in sales and margins of 18 percent to 22 percent, more than four times the margin forecast for the PC division. •