PREVIEW-HP hopes to reassure Street, Dell's margins key

Tue Nov 16, 2010 8:35pm EST

* HP, Apotheker need to regain investor confidence

* Opportunity arises with quarterly results in coming week

* Dell faces questions on government spending

* StarMine sees HP, Dell shares undervalued

By Gabriel Madway

SAN FRANCISCO, Nov 16 (Reuters) - Hewlett Packard Co (HPQ.N) hopes to shift investors' attention from its internal upheaval to financial performance, with an imminent quarterly report expected to again showcase its reputation for solid -- if unspectacular -- growth.

HP shares have suffered after months of grappling with the messy exit of Mark Hurd as chief executive, followed by a nasty public fight with Oracle Corp ORCL.O and its CEO Larry Ellison over the hiring of Silicon Valley outsider Leo Apotheker as its new chief.

HP's financial report comes next Monday, following that of longtime rival Dell Inc DELL.O, which will be closely watched for signs of the same cooling in government spending that plagued Cisco Systems Inc (CSCO.O). [ID:nN10245398]

Amid the dismal headlines, HP investors have two burning questions: Did performance slip with Hurd's exit? And what exactly is this Apotheker fellow all about?

Morningstar analyst Michael Holt said there was no evidence HP's execution was hurt by Hurd's departure -- or the jockeying by executives to succeed him.

"They did execute, and I think they will come in and give that signal of stability," Holt said. "They're really trying to calm the waters with investors."

Gleacher & Co analyst Brian Marshall said Wall Street is eager to hear from Apotheker, who started work on Nov. 1 but remains a mystery to many investors. [ID:nN01194360]

"Leo has to make a good appearance," Marshall said. "The numbers are important, but it's more about how he comes across."

Apotheker's ride has not been smooth thus far. Oracle claims he is ducking a subpoena to testify in its high-profile copyright case against SAP AG (SAPG.DE), where Apotheker was once CEO. HP says Oracle is simply trying to harass him. [ID:nN12175678]

A PR NIGHTMARE

Public relations aside, HP will provide a snapshot of global IT demand when it reports results next Monday. The world's largest tech company by revenue has hinted at a solid upcoming year and has stressed its investments after years of cost-cutting under Hurd. [ID:nN28273797]

For the fiscal fourth quarter ended Oct. 31, Wall Street expects HP to report earnings of $1.27 a share on revenue of $32.8 billion. HP has beaten or matched analysts' earnings estimates every quarter over the past two years.

Its shares are still down about 10 percent since Hurd was forced out on Aug. 6 and -- according to Thomson Reuters StarMine -- may be undervalued. Employing a StarMine quantitative model, HP shares have an intrinsic value of $75.33 -- above their closing price of $41.80 on Tuesday.

IT services and printing are HP's bread and butter, providing nearly half of revenue and two-thirds of operating profit. But strength in the quarter could come from servers and storage, as well as in networking, where there is evidence that the company is beginning to take market share from Cisco.

Although HP lost two percentage points of personal computer market share in the July-September period according to IDC, its operating margin should benefit from improved component costs.

Dell is much more of a question mark, analysts say. Investors in the No. 2 PC maker, which reports earnings on Thursday, got jittery last week after Cisco's weak revenue outlook sent its shares plunging. [ID:nN11206640]

Although it is unclear whether the drop in government spending highlighted by Cisco is a broader issue, analysts warned of Dell's potential exposure. The company's public business provides around a quarter of its revenue.

"Cisco's commentary raises a red flag on Dell's above-peer government exposure," JP Morgan analyst Mark Moskowitz said in a research note.

Dell, which has been in turnaround mode for some time, has been a major beneficiary of the corporate refresh cycle, where companies spend billions to upgrade aging IT hardware.

But the company has struggled to show progress on profitability. Despite efforts to diversify, more than half its revenue still comes from its low-margin PC business.

Investors will therefore once again focus on Dell's gross margin, which Wall Street has targeted at 17.5 percent.

"The question really is, can they turn the growth they've seen into profitability?" said Morningstar's Holt. "That's where they've really struggled, in the operating leverage, or lack thereof."

Still, Dell should benefit from an effort to improve margins in its consumer business, which has been a drag on profitability, and better component costs. Analysts are expecting Dell to report earnings of 32 cents a share on revenue of $15.7 billion.

According to StarMine, Dell's shares are also undervalued, with an intrinsic value of $18.25 versus Tuesday's close of $13.40. (Reporting by Gabriel Madway; Editing by Edwin Chan and Richard Chang))

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