The Upcoming 2014 Hewlett Packard Technology Innovation Stock Investing Bonanza August 22, 2011

North Carolina Investment Advisor Re-Affirms Confidence in Hewlett Packard (HPQ). End Quote

(1888PressRelease) August 23, 2011 - A Little History Lesson on the Downside of Betting Against HPQ

Back during the Hewlett Packard buyout of Compaq, in 2002, when HPQ first got into the personal computer manufacturing business, many investment commentators thought the move was a really bad idea for investors.

Typical of the negative stories was one by Carol J. Loomis, senior editor-at-large at Fortune Magazine. (February 7, 2005).

Loomis suggested three years after the CPQ acquisition, when she wrote her analysis of the merger, the stock price of HPQ had disappointed investors. "Did the famed merger that Fiorina engineered between HP and Compaq produce value for HP's shareholders?" Loomis asked. "The stock was worrisome, since it went nowhere," she wrote, at the time.

Loomis was a bit premature in her assessment of the stock price because, for most stocks in technology companies, it takes about 3 years to reflect the increase in stock price from this type of acquisition.

The graph below shows this time period from about 2000 to August of 2011.

The stock price of HPQ moved from around $20 per share in 2003, to around $54 in 2010. It started its move up soon after Loomis wrote her analysis. Most readers can do the math and figure out the percentage increase when the stock price nearly triples in seven years and decide for themselves if this is a stock price that went nowhere.

Today, the stock price is back down around $24 per share.

Loomis also suggested that, "This was a big bet that didn't pay off, that didn't even come close to attaining what Fiorina and HP's board said was in store. At bottom, they made a huge error in asserting that the merger of two losing computer operations, HP's and Compaq's, would produce a financially fit computer business."

Au Contraire: $40 Billion A Year From PC Sales Is Not Chump Change

About 8 years after the merger, the research analysts at Credit Suisse wrote on August 19, 2011, that HPQ, "commands the number one position worldwide with about an 18% share of the world market, based on PC unit shipment data for 2010 from market research firm Gartner. It is also number one in the U.S. PC market, with about a 29% share of fourth-quarter 2010 PC unit shipments."

This global top ranking today is for a company that did not have a computer division at the beginning of 2003.

The analysts at Credit Suisse continued, "We expect HP will be able to maintain traditional PC market share (excluding tablets) of approximately 18% going forward. We forecast PSG revenue of $39.15bn/$37.69bn in FY11/12, which represents 31%/30% of total company revenue with operating margins of 6.1% and 4.5%."

Innovation Does Not Depend On Margins, It Depends on Capital Investment

In 2002, when HPQ bought Compaq, it had about $40 billion in current liquid assets on its balance sheets.

In 2005, when Loomis wrote her story about the CPQ merger not working financially, HPQ had about $40 billion in current liquid assets on its balance sheets.

In 2011, after HPQ buys a software company called Autonomy, for about $10 billion, it will have about $40 billion in current liquid assets, not counting the increase in current assets after it sells the PC division, for about $10 billion.

Stock market pundits and analysts who focus on financial margins when they write about technology companies may not have a very good theoretical model to predict the movement of stock prices.

Technology innovation depends on capital investments made today that lead to the emergence of new markets, in about 3 years. In other words, it will take about 3 years for the benefits of the technology innovation related to buying Autonomy to show up in the current $24 per share stock price of HPQ.

Just like the CPQ experience earlier, when it took about 3 years for the stock price of HPQ to reflect the benefits of the buy out of CPQ.

Capital investments in technology innovation depend on having a supply of capital that can be deployed. In the case of HPQ, the supply of capital for buying Compaq was about $40 billion on the balance sheets in 2002.

HPQ would not have a $40 billion pile of legacy capital today to invest in Autonomy unless it had bought CPQ in 2003.

Successful Innovation Is A Market Event, Not An Engineering Feat

Successful technology commercialization is primarily a market event. Clayton Christensen, a professor at Harvard University, provides a useful categorization that divides the universe of innovation into sustaining innovations, which make an existing product more user-friendly, and radical innovation, which are "new-to-the world" innovations.

Sustaining innovations, while interesting fodder for graduate business courses, are not the most exciting part of technology innovation because they do not create new future markets, which concomitantly create wealth.

Radical innovation, such as cloud computing, creates new markets, and new markets create new streams of income and wealth, under non-socialistic policy regimes.

Generally, the radical innovation depends on a very small group of consumers who take a risk in buying a new product that they had never seen before. Some economists call this a niche market, and the consumers in the niche market take a big risk in buying a product that may not fit into their mental image of how the new product may satisfy their needs.

The great technology innovation advantage that HPQ has over its competitors is that they already have an existing ready-to-buy niche market of consumers that will help transition HPQ from the PC market to the new future markets, such as cloud computing.

Most of these niche consumers for cloud computing are existing HPQ PC customers.

The Upcoming Hewlett Packard Technology Innovation Stock Investing Bonanza

There are no guarantees that HPQ can make this market transition from PCs to business intelligence software, and as all of us investment advisors always note when we write about stocks, the past is not a reliable guide to the future. (Note to SEC regulators: I have HPQ in my client's investment accounts).

If HPQ were to do nothing today to change its business model, it would be out of business in 3 years. Companies who do not continually innovate go through a dreadful time called a downward market bifurcation, which is just like a ratchet.

If HPQ had not bought Compaq in 2003, it would be out of business today.

Once they go through a downside market ratchet, companies generally cannot come back, and they die, just like national economies that go through a downward socialist economic ratchet can die.

In fact, the two future events, HPQ making the technology innovation a success, and the health of the United States economy are related.

The biggest risk to the HPQ transition is not market risk or the lack of capital. It is the political risk associated with increased U. S. government spending and more socialist regulation. Socialist income transfers from rich to poor disrupt the market price mechanisms and makes it impossible for investors today to judge the profitability of making investments because they never know if the socialists are going to mal-appropriate their future profits.

If the United States can recover from its current flirtation with the downside ratchet of socialism, the upcoming HPQ stock investing bonanza today could be the biggest stock market story of 2014.

I admire the tenacity and courage of HPQ's leadership to continue to make the gutsy calls on technology innovation in an era of political instability, and I re-affirm my confidence in the company as a good investment today.

Investment Disclosure: The past performance of an investment is no guarantee of future performance. All investments bear risk of loss of principal invested. There are no guarantees related to investing. Please visit the TSA website and read our ADV Part II disclosure document for information about our investment management fees. HPQ is currently one of the stocks being followed in the TSA Universe of Stocks.

About Thomas E. Vass: Vass is fee-based portfolio manager located in Raleigh, N. C., and the author of Predicting Technology: Identifying Future Market Opportunities and Disruptive Technologies, (2007) which explains his theory of technology evolution and its effect on the economy. His research articles about technology were recently cited by The Social Science Research Network (SSRN) a global publishing platform for social scientists, as being in the top 3% of the most widely read in the world. Contact 919 975 4856.

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