2024-01-11 09:15:00 ET
Summary
- Hewlett Packard Enterprise Company has seen stagnation and made smaller acquisitions in recent years, resulting in just flattish sales as retained earnings have been used to strengthen the balance sheet.
- Hewlett Packard announced a near $14 billion deal to acquire Juniper Networks, Inc., which could shift the product mix and increase networking business, although at a big (relative) price.
- The all-cash deal will require significant financing and has led to a decrease in Hewlett's stock value, with debt on the increase, and earnings accretion being likely minimal.
In the summer of 2020, I believed that Hewlett Packard Enterprise Company ( HPE ) looked cheap and likely would remain cheap for some time to come, as cheapness alone is seldom enough of a reason to make a good investment.
In the years that followed, HPE has seen stagnation. After the business became more acquisitive in 2023, it started 2024 with a big deal, as HPE announced a near $14 billion deal to acquire Juniper Networks, Inc. ( JNPR ) , which raises some real questions here.
On HPE
Hewlett Packard Enterprise was spun off from its former parent, with HP Inc. ( HPQ ) in essence being the surviving entity of the former giant. The remaining enterprise business is comprised out of a range of segments which includes intelligence edge, HPC & AI, storage, compute and financial services and was a giant operation already.
Pre-pandemic, for the year 2019, this was a $29.1 billion business, which saw sales fall 6% that year. Adjusted earnings were reported at $1.77 per share, yet GAAP earnings have been coming in much lower (for a longer period of time) due to structural transformation and restructuring costs, among others.
Trading at $15 pre-pandemic, the 8 times adjusted earnings multiple looked non-demanding, yet with negative top line growth and heavy adjustments made to earnings, it is understandable why investors acted reserved to apply a higher multiple to these numbers.
Moreover, the company actually operated with a near $5 billion net cash position pre-pandemic, equal to $3 and change on a per-share basis. That, however, is if we define net cash as all the inclusions of all financing receivables and payables, as HPE has a large financing business as well.
With shares down to $10 in the summer of the pandemic, overall valuations were very non-demanding, certainly not if we factor in net cash, a number which would take a small hit following a near billion dollar deal for Silver Lake, which added about half a percent (albeit quickly growing) revenues to the business.
Shares Are Stuck
Since the summer of 2020, HPE shares quickly recovered, alongside the rest of the market, trading in the mid-teens by year-end. Ever since, shares have been trading in a remarkably tight trading range between $12 and 18 per share for a period of three years which followed, now trading hands at $16 per share. This makes for some returns, but nothing exciting in any case.
The years 2021 and 2022 were relatively uneventful, but some acquisitive moves were made in 2023. The company announced some relatively smaller acquisitions, with few financial details announced, with acquisitions including the likes of Pachyderm, Athonet, Axis Security and OpsRamp, among others. The cash flows statement for 2023 revealed that about three quarters of a billion were spent on such acquisitions.
By November, the company posted its fiscal 2023 results, with full year sales of $29.1 billion, reported up 2% for the year, coming in dead flat compared to 2019. GAAP earnings were reported at $1.54 per share on a diluted basis, more than doubling from the year before, as adjusted earnings were reported at $2.15 per share. While I am happy to adjust for some amortization charges, the same is not the case for a rather substantial stock-based compensation ("SBC") expense, as well as continued transformation costs, which makes that the GAAP earnings look quite fair.
Moreover, the balance sheet has seen continued strength, with growing net cash balances. Net debt is reported at $8.3 billion, but this excludes financing receivables to the tune of about $15 billion here, as well as some equity investments. The company guided for 2024 sales to be up 2-4% in constant currency terms, although adjusted earnings per share are seen down to $1.82-$2.02 per share, being a wary sign.
A 1.31 billion share count still gives shares a $21 billion valuation at $16, and if we factor in net cash holdings of around $7 billion (again including financing receivables and payables), the resulting $14 billion enterprise valuation is equal to just half times sales.
Quite frankly, not much has changed since 2019 as the business has been completely stagnant sales, despite some M&A action, as the share count has been flat in recent years, with earnings used to pay out a quarterly dividend of $0.13 per share, and gradually strengthen the balance sheet.
A Huge Move - Juniper
In the first week of 2024, HPE announced that it has reached a deal to acquire Juniper Networks in an all-cash deal which values the stock at $40 per share, granting Juniper an $13.6 billion equity valuation, roughly at par with the enterprise valuation of HPE here, after paying a 32% premium for the shares of Juniper. Of course, the relative deal is a bit smaller if we strip out the financing assets of HPE in the net cash/debt calculation.
A deal could shift the product mix into higher growth and higher margins areas and be accretive to non-GAAP earnings per share (although not quantified), according to the press release, as the deal will significantly increase the networking business of the combination.
The all-cash component makes that significant financing is required, in fact $14 billion in loans are anticipated to be raised in connection to the deal, with deal closing seen later this year, or perhaps early in 2025. The overall deal should provide substantial room for costs synergies, seen at $450 million per annum, although full realization is not seen until three years post deal closing. Furthermore, synergies are seen equal to about 8% of Juniper's revenues, thereby looking quite ambitious.
While the deal is set to be an all-cash deal, it is noteworthy that the company announced a prospectus for a mixed shelf offering late in December, in hindsight being a clear indication that a major deal might be at hands.
And Now?
The reality is that it feels as if HPE is making a rather expensive deal here, and that two more or less wounded animals are tying up their operations, although Juniper arguably has seen better growth than HPE here. On top of higher growth, Juniper posts operating margins in the high-teens, versus a low teens performance on this front by HPE itself.
The all-cash component means that net debt will jump to $7 billion, reversing from a similar net cash position, but that is only if we treat the financing receivables/liabilities as cash alike, which means that gross debt is quite a bit higher. In the deal presentation , HPE announced an $8.3 billion current net debt load (ahead of financing receivables) but sees pro forma net debt at just $18.1 billion, with the increase being far less than the enterprise valuation applied to Juniper. This might be due to a $3 billion delayed term loan, the workings of which are not exactly known to me here.
Moreover, with Juniper valued at around 2.5 times sales, and HPE trading at just 0.5 times sales (if we treat financing assets and liabilities as cash alike) the deal is quite substantial, as shares of HPE have fallen about 10% in reaction to the deal announcement, shedding some $2 billion in value in response to a substantial roughly $3 billion premium being offered for Juniper.
After all, Juniper is adding a mere $5.6 billion in sales, or about 20% in sales to HPE standalone, while the deal tag is equivalent to the own enterprise valuation here, or just a bit less, depending on the definitions. With additional interest expenses largely eating earnings accretion from Juniper, I wonder how great earnings accretion is at closing.
I am wary given the exchange ratios. Obviously this is a winning deal for investors in Juniper Networks, Inc., but I have some continued reservations on Hewlett Packard Enterprise Company here, as deals have hurt some of the qualities of the acquisition targets in the past.
For further details see:
Hewlett Packard Enterprise: Making A Big Bet On Juniper Networks