The Hewlett-Packard Mess

Hey there everybody. I wanted to hop on real quick here and give you a thumbnail sketch of why I placed the buy order on Hewlett-Packard this morning. Make no mistake, the news that broke before the market opened about their $8.8 billion write-down in regards to last year’s acquisition of Autonomy is big. It means that prior management essentially threw billions of dollars down the drain when they bought this company, but the effect of this going forward bears some discussion. No one wants to see shareholder value abused in this fashion, but it’s important to remember that both the CEO of the acquirer and the acquisition target were replaced quite some time back, and both left under a cloud of suspicion anyway.

My guess is that we’re not just talking about fraud on the part of Autonomy, but some level of incompetence in conducting the due diligence at the Hewlett-Packard board level in regards to what they should have paid for the company. Prior management is gone, of course, so this opens the way for extra finger-pointing and makes for some pretty salacious headlines. The question for us though, as traders, is does it represent an opportunity for someone with a reasonably short term perspective to make a few bucks. I think it does.

You have to remember that Hewlett-Packard has a base book of business that does very well. In fact, it throws off billions in cash flow every year. The money that was wasted on the acquisition was accumulated profit that had been built up by this cash flow generating outfit over time. It does not impair their ability to make money or generate free cash flow in any way going forward. Therefore, I suspect that disappointed investors will move out fairly quickly, leaving behind those of us who will trade short-term for profit and/or those who are focused on the longer-term, future cash generating ability within Hewlett-Packard.

Not only does Hewlett-Packard create plenty of excess working capital on a quarterly basis, they have a dividend of just under 5% on an annual basis that should provide some cushion as the share price falls further. It would be easy for them to defend the stock price by either buying more shares back or increasing the dividend payout.

I have no idea if my purchase at $11.70 will be the only shares that I buy, because I’ll be watching this afternoon to see if I can get some even better price levels. After today, I will probably have all the shares that I’ll pick up, and I want to begin teaching some lessons about how options can accentuate our gains in a stock like this. We will have an opportunity to write short-term covered calls on stock rallies, and cover them when the stock sinks. Between those moves, and the dividend, my guess is that we can generate a relatively safe profit of 20 to 30% per year on Hewlett-Packard.

If all of this sounds like Greek at this point, don’t despair. That’s one of the things I want to accomplish here on the website. I want to use these types of market situations as learning opportunities, so that when they happen in your own portfolio, you have seen the tools in use and can respond appropriately within your own decision framework. Hang in there. I think this will be interesting!