Hewlett-Packard (HPQ - Free Hewlett-Packard Stock Report), a Dow 30 component, is the world’s largest provider of information technology products and services, with $126 billion in revenue in fiscal 2010, which ended on October 31st, 2010. Over the years, H-P has diversified its business mix via internal investments and acquisitions (about 35 deals for roughly $31 billion in the past four years). The company established a unique operating style early in its history that has been imitated by many other Silcon Valley firms.

Humble Beginnings

In 1939, Bill Hewlett and Dave Packard, two Sanford University-trained engineers, set up a company in a Palo Alto, California garage to produce audio oscillators, electronic instruments used to test sound equipment. The company’s first product, the HP 200A, was reviewed by The Walt Disney Company (DIS - Free Disney Stock Report), which asked for certain modifications. This resulted in the creation of H-P’s second product, the Model 200B, that was used in specially equipped theaters that showed Disney’s film Fantasia in 1940. As the product line grew, operations moved to new facilities. H-P incorporated in 1947 and became a publicly-traded company in 1957, with an initial public stock offering at $16 a share.

Over the years, H-P’s product line evolved as new technologies emerged, and the company became known for innovation. H-P’s Website highlights some milestones: Signal generators using microwave technology during World War II; Oscilloscopes, which measure fluctuations in electrical quantity, in the 1950s; Electronic medical devices, early scientific computers, and light-emitting diodes in the 1960s; A variety of computing products in the 1970s, including the handheld calculator and the first minicomputer based on 4K dynamic random access memory chips rather than a magnetic core; Computer printers and products based on reduced instruction set computing in the 1980s. In the past two decades, the range of computing products and services has continued to expand, aided by acquisitions, including Compaq Computer in 2002, technology services provider Electronic Data Systems in 2008, and mobile device-maker Palm in July.

Corporate Profile

Hewlett-Packard is more balanced today than in the past with regard to revenues, profits, and geography. It is organized into seven product groups. Services, which accounts for over a quarter of the company’s revenues and is one of H-P’s more profitable, albeit slower growing businesses, provides infrastructure technology outsourcing, applications services, and business processing outsourcing. Enterprise Storage and Servers, an $18.7 billion business that sells a broad array of storage systems and servers to companies, enjoyed nice growth in both revenues and operating margins in fiscal 2010. HP Software, though a relatively small contributor to both revenues and operating earnings, is the company’s most profitable business.

The Personal Systems Group is H-P’s largest business (over 30% of fiscal 2010 revenue) but has the narrowest profit margins. It sells personal computers, workstations, and handheld computing devices, mainly based on Microsoft’s (MSFT) Windows operating system and using processors made by Advanced Micro Devices (AMD) and Intel (INTC). The Imaging and Printing Group, also one of H-P’s larger segments and its second-most-profitable business, supplies printers, printing supplies, and services. Finally, HP Financial Services offers leasing, financing, and other services to facilitate purchases of H-P products, and Corporate Investments includes Hewlett-Packard Laboratories, its research operation, and business incubation projects.

The HP Way

Hewlett-Packard is almost as well known for its open corporate culture as it is for its information technology businesses. Its founders believed in communicating the company’s objectives to employees and then giving them room to work toward those objectives in the manner they considered best. The company established an open door policy, that is, open cubicles and offices without doors, to encourage communication and trust. Employees, including management, are addressed by their first names. H-P introduced flexible working hours. The company became known for its work-life balance, diversity, and community service, and many of its practices were later copied by other technology firms. Dave Packard set down the company’s story and its management practices in 1995, in a book called The HP Way.

The Way Forward

Having nearly tripled its revenues (via internal growth and acquisitions) and substantially improved its operating margin since fiscal 2001, H-P has posted mixed results in recent quarters, and is making some big changes. First, former e-Bay chairman Meg Whitman replaced Leo Apotheker as president and chief executive officer in September. Although Mr. Apotheker is credited with developing a strategic vision for the company, the board felt that new leadership was needed to meet the challenges posed by the currently more difficult operating environment, including weak sales to public-sector entities and in Europe. The halving of the stock price since the start of calendar 2011 and alleged deterioration in employee morale probably also contributed to the change a the top.

Second, the company said it would go forward with much of a transformation program announced in August by Mr. Apotheker. The program includes plans to move H-P into higher-margined growth markets, sharpen its focus on areas like cloud computing and software for companies and government entities, and increase strategic investments to foster innovation, which may have been shortchanged while the company was cutting costs in recent years. H-P is still evaluating whether it will spin off its personal computer business, and intends to reach a decision by the end of calendar 2011. It still expects to go forward with the pending acquisition of Autonomy at over ten times the enterprise software provider’s revenue. H-P also continues to look for ways to deploy the webOS operating system technology (possibly in appliances or automobiles) that it gained when it purchased Palm Inc. in 2010.  In the near term, the company said it needs to moderate share buybacks and investments in order to rebuild the balance sheet. Note, however, that Ms. Whitman and H-P’s board may ultimately decide to make changes in the company’s direction. 

With so much in flux, H-P’s earnings prospects in the next several quarters are very hazy. If the Autonomy acquisition goes forward, related restructuring and hedging costs could sharply reduce results in the final quarter of fiscal 2011 (which ends October 31, 2011). The softness in the government and southern European markets probably also persisted in the October quarter. Moreover, revenue in fiscal 2012 might be significantly constrained should the personal computer business be spun off next year. The move could also hurt H-P’s printer business, since personal computers and printers are often sold at the same time. At best, we look for earnings growth in fiscal 2012 to be modest.

At the recent depressed level, H-P shares have considerable recovery potential over the 3- to 5-year pull. But it often takes a while to turn a big ship, like Hewlett-Packard, around, and the company’s future direction is not yet clearly defined. All but aggressive investors may want to stay on the sidelines for the time being. 

At the time of this article’s writing, the author had a position in Disney.