Sunday, October 28, 2012

Apple, SAP & Hewlett-Packard: Not Just Numbers, Company's Vision, Strategy and Goals Also Matter For Investors (Part II)

Part I of this two-part blog offered empirical evidence suggesting that few consistently outperforming technology companies (such as AAPL and GOOG) get valuation treatments that defy conventional wisdom.  Part I ended by introducing an investment approach that was based on three simple rules and suggested that management's effectiveness in articulating its corporate vision and goals and its trustworthiness also plays a critical role in winning investors' sentiment.  Let's put each company through this test in part II of this blog and discuss the outcome.

First up, AAPL:  For AAPL, I can safely conclude that the first two rules are securely in the bag.  Investors understand the company and its hugely popular products.  It has successfully sailed with the wind for the past decade and I might even argue that it brought fresh wind in the sails of tablets and smart phone segments.  But when it comes to applying the third and final rule, i.e.  investing in AAPL for the mid-to-long term, and thus paying a reasonable multiple, investors are certainly hesitating to act.  From investors’ point of view, the investment decision boils down to following two points:
  •  AAPL gets fresh lease of life every year when it upgrades its iLine (iPads, iPhones, iPods and Macs) of products;
  • But other than this routine, AAPL management is highly secretive about its vision for the future of AAPL.
For AAPL investors, it is challenging to see beyond a one year horizon.  The investors are asking larger questions to AAPL including:  a) what does AAPL want to be in 5 years and where will it be?  b) Will AAPL dominate some market segments as it does today, if so, what is that longer-term strategy?  Until, AAPL addresses these questions and clearly articulates its strategy and the goals tied to its strategy, it will be hard to see why investors would apply SP500 like or higher multiples on AAPL.

Next up, ORCL: For ORCL, I would start by arguing that ORCL is suffering from a credibility problem with the investors.  Investors get ORCL’s enterprise software and hardware business which is attractive and growing at a secular rate.  ORCL has accepted that inorganic growth model (via acquisition) is the way to move its business forward and stay current on the technology innovation front.   Besides all this, its earlier position on cloud technologies (calling it a fad) and then turning into a true cloud believer (with the acquisition of RightNow, Taleo and its own investments) has sent mixed messages to investors. 

ORCL has done a poor job of laying out its long-term vision for investors and investors are unhappy because they are unable to see a clear path forward.  Does ORCL want to be like its big brethren IBM and package hardware, software, services and cloud infrastructure together for its customers?  What does ORCL want to be?  What are some of its growth plays?  ORCL has attempted to articulate its vision to investors and analysts but the reduced trustworthiness and the past delays in strategic investments have kept investors skeptical at best.  ORCL needs to win the credibility back from its investors and shy away from sending mixed messages to investors and its own customers.

Next up, HPQ:  I don’t know where to begin with this company.  Let’s start at the very top, the board. HPQ’s board has had major credibility issues for many years now because of the scandals and terrible decisions that have resulted in billions of dollars of losses for investors.  The epic stumbles such as the launch of Palm based tablets/smart phones (and then the immediate pull out), public display of flip-flopping decisions on spin-off for Personal Computer unit and then having three CEOs at the helm of HPQ in less than three years has not pleased investors. 

In addition, HPQ’s core businesses continue to suffer resulting in heavy losses because it has been slow to respond to the shift in technology spending to cloud and mobile technologies.  HPQ’s market cap has dropped by more than 80% since peaking at approximately $120B in 2010.  Investors have little to no confidence in HPQ and are pricing in rapid erosion of its customer base and sales (which is reflected in a low price/sales ratio of 0.23.)

Next up, GOOG:  GOOG has wide range of interests resulting in a large array of investments including the investment in driver-less cars.  Not all the projects GOOG has undertaken in recent years have been positive NPV projects and as a result GOOG’s stock has same P/E multiples as that of SP500.  GOOG wants to be a technology company and all the investments GOOG makes have this common origin.  This is a fact but why investors are not comfortable with it?  Is GOOG not effective at convincing investors that this approach is right and will bear fruits?

Is GOOG going to be a media company, or a mobile company, or a hardware company, or an Internet bandwidth company, or a search company or an enterprise software company or all of the above (i.e. a tech conglomerate)?  Apparently, GOOG’s vision and  roadmap are not very clear to investors which is why GOOG had lackluster performance for the first six months of 2012 prior to Q2’s earnings announcement.  I believe that investors have adopted a wait and watch approach on GOOG which is a mature company now but surrounds itself with a high number of uncertainties.

Next up, IBM:  IBM is securely in the bag using the rules I laid out in Part-I.  By 2015, IBM will generate $20 in non-GAAP EPS - this is IBM’s corporate goal for 2015.  I believe that investors should love the simplicity of IBM’s singular goal.  IBM has done a nicejob in articulating its corporate goal for 2015 including the key growth plays that will drive IBM forward to its goal.  The key growth plays from IBM are emerging markets, Analytics, Cloud and Smart Planet initiatives.  IBM has also articulated that it will pursue higher-margin opportunities (i.e. software) and use share repurchase programs to boost EPS.  IBM’s EPS in 2011 was $13.4 which would have to rise by 50% in 4 years if IBM were to accomplish its goal of producing $20 EPS by 2015.

Both AAPL and IBM are iconic and trusted brands.  IBM has provided a clear vision and a path forward but AAPL has not, therefore I am not surprised to see that both IBM and AAPL received similar Trailing and Forward P/E multiples despite the fact that AAPL’s earnings growth is nothing less than spectacular.

This brings me to the last company I will discuss here, SAP:   Just like IBM, SAP is also securely in the bag.  SAP is a global brand and plans to reach 1 billion people in an attempt to become a household name.  I have found SAP to be a goals driven company and it is taking all the necessary steps (both organic and inorganic growth opportunities) to track towards these goals.  This is similar to IBM’s approach but more clearly spelled out.  Here are the goals that SAP has laid out for 2015 on its corporate website:

Source: SAP' Corporate Website

Additionally, just like IBM, SAP has also clearly articulated its growth strategy and the five market categories it plans to expand into.  These categories are: applications, analytics, mobile, database & technology, and the cloud.  SAP’s management has not sent mixed messages to the market (unlike ORCL) since sharing its vision and goals for the future and is gearing up to ride both the mobile (with Sybase and Syclo acquisitions) and the cloud trends (with SuccessFactor and Ariba acquisitions).  

SAP is not the only company growing its revenues at a double digit rate for more than 10 quarters, but it is logging that performance on a consistent basis and tracking towards its 2015 corporate goals.  Investors are cheering this steady performance and have bid up the stock by more than 35% YTD in 2012, higher than every other stock in the group except AAPL (see the graphics below):
Source: Google Finance

Majority of the public companies, if not all, develop a vision, lay out a clear strategy and announce goals to realize that vision.  But some do a better job than others in articulating and sharing this on a regular basis with their investors.  Companies that clearly articulate their vision and strategy to all their constituents including customers, employees, partners and investors earn respect almost instantaneously.  And when these companies publicly track progress against their vision, they benefit tremendously by winning the trust and credibility from each and every constituent (including investors) allowing them to attract top talent, new customers, new partners and new markets to help them grow their business. 

This blog has benefited from the discussions with my friends and colleagues Jens DoerpmundRyan Leask and Rajani Aswani on this topic.

Disclaimer:  All numbers are approximate and the underlying analysis is preliminary.  This blog is not intended for offering any investment advice.  SAP is my employer but all the views and opinions expressed here are solely mine.

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