Assessed Blog 1: Shareholder Value Destroyer to Creator: Hewlett Packard

Are managers too obsessed with growth? Do companies who focus on increasing short-term earnings truly maximise the wealth of their shareholders?

The case of Hewlett-Packard (HP) shows how shareholder wealth can be destroyed without effective value-based management. Despite having the intentions to increase shareholder wealth, poor strategic decision making actually led to shareholder wealth destruction.

In 2002, in a bid to improve profitability, HP outsourced the manufacturing of their computers. Despite achieving lower unit costs, and investing greater in their supply chain, product development, and customer relationship management, the company suffered from a fragmented supply chain in the long-term (Mourdoukoutas, 2014). From overly-focussing on improving bottom line figures, this allowed for competitors to enter the market easily resulting in a loss of market share and sales revenue for HP (thus destroying shareholder value). This is a clear example of how focussing on profit maximisation does not necessarily improve shareholder wealth (Arnold, 2013. John Kay's views portrayed through his book 'Obliquity' (2011)closely apply to this case. He argued that profits should not be made to be the sole purpose of the business, but rather that profits are a result of applyging passion and investment in to the business' core activity. HP made the strategic decision to increase profits without analysing the wider impacts from the decision.

Rappaport (2006) states that acquisitions can create or destroy shareholder value quicker than any other corporate activity. Over the past 10 years, HP also acquired a number of companies as part of its strategic direction for growth. However, these acquisitions failed to attain growth and increase shareholder wealth. Compaq, Palm and Autonomy were all bought to enhance HP's competitiveness in growing market segments such as the mobile device market, and the emerging Asian markets. However, little innovation was created, and HP failed to make up ground, eventually writing down these companies for huge billion dollar losses (Financial Times, 2014). 

A possible reason for this failure, may be that HP's management failed to appropriately evaluate measures of P/E and EPS to evaluate the attractiveness of the deals. It is likely that managers approved deals that resulted in a greater EPS post-acquisition, rather than evaluating the long-term potential to create value (Rappaport, 2006). This should be done by estimating the present value of the resulting incremental cash flows and then deducting the acquisition fee (Seth, 1990). Dane Anderson (IT Outsourcing Analyst) concluded "HP seem to say, this looks good, lets buy it because we can buy it and we'll figure out what to do with it later" (Financial Times, 2014). This insight clearly shows that there was a lack of financial reasoning and considered value management involved in the process of the acquisitions made by HP. Had the company assessed the potential synergies more clearly then they could have calculated future cash flows of the joint entitites to assess whether the purchases were financially viable.

However, the strategic decisions of HP for various reasons were misinformed. Positive NPVs projects were not achieved and inefficiencies across the business meant that shareholder wealth was thus destroyed.

Following years of declining performance and share price, HP were one of the best performing stocks on the S&P 500 in 2014 (Mourdoukatas, 2014). New CEO, Meg Whitman, has proposed a new
strategy to break the business up in to two areas (Personal computing and printing division, and software and corporate hardware divisions) (Rushe, 2014). This decision will actually decrease HP's revenue at the expense of increasing their profit margins (Mourdoukatas, 2014). These changes will allow each division to strengthen their core business and become more flexible and responsive to the dynamic markets that they compete in. This strategic move has been praised by investors and the announcement of the restructure resulted in an increase in share price of almost 5% (Financial Times, 2014).  Activist investor Ralph Whitworth praised the deal as a "brilliant value-enhancing move" (Rushe, 2014).

Perhaps HP have learnt their lesson and have decided to better use value management tools to guide their strategic decision making and direction. Value based management holds the primary purpose of "long-term shareholder wealth maximisation" (Arnold, 2013). The objective of the firm, its systems, strategy, processes, analytical techniques, performance measurements, and culture, have as their guiding objective shareholder wealth maximisation. I believe that with the new leadership in the company, the strategic decision making has become increasingly focussed on creating sustainable long-term value with less emphasis on short-term revenue growth.

References

Arnold, G. (2013). Corporate Financial Management.(5th ed.). London:Pearson Education

Financial Times (2014). HP counts cost of ill-fated acquisitions. Retrieved 14th February 2015 from
http://www.ft.com/cms/s/0/b5ba407a-e2be-11e1-a463-00144feab49a.html#axzz3RXk8eRDm

Mourdoukoutas, P. HP's split: A sound strategy or a rabbit pulled out of a hat? Retrieved 14th February 2015 from http://www.forbes.com/sites/panosmourdoukoutas/2014/10/07/hps-split-a-sound-strategy-or-a-rabbit-pulled-out-of-a-hat/

Rappaport, A. (2006). Ten Ways to Create Shareholder Value, Harvard Business Review, 84 (9), pp. 66-77. Retrieved 14th February 2015 from http://cmsu2.ucmo.edu/public/classes/young/Guidance%20Research/Ten_ways_to_create_sharholders_value-Alfred_Rappaport.pdf

Rushe, D. (2014). Hewlett-Packard announces plans to split company in two as lay-offs continue. Retrieved from

http://www.theguardian.com/business/2014/oct/06/hewlett-packard-split-two-data-printers

Seth, A. (1990). Value creation in acquisitions: A re-examination of performance issues. Strategic Management Journal, 11 (2), 99-115. Retrieved 14th February 2015 from Wiley Online Library DOI: 10.1002/smj.4250110203