Domicity Ltd.

Is IBM market value bolstered by too much debt?

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.

Early orders for all Domicity’s IT company studies receive a 33% saving. Click here to be in the first group to learn about the next report.

In addition to published reports, Domicity consults on the strategies & operations of IT companies and trends, and advises governments on economic development and investment attraction related to the IT sector.
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Is IBM’s management falling into the same trap as many households? The siren song of low interest rates appears to be luring Armonk to take on too much debt and some competitors are on the same path.

Benjamin Graham-style value investors tend to shy away from companies that have less than 50% of their assets financed by investors through shareholders’ equity. The fear is that when interest rates spike upwards, or if a company hits choppy waters, investments in critical areas will have to be cut to cover increased debt charges.

As the graph below shows, IBM sits well below Ben Graham’s 50% margin of safety line. Just 17% of IBM’s assets were financed by shareholders’ equity (at Dec. 31, 2011). This compares to 21% for Dell, 25% for Accenture and 30% for Hewlett-Packard. In better shape, according to Graham, are Microsoft at 57% and Oracle at 58%.

IBM has good cash flow, so why is it carrying so much debt and why are Dell, HP and others climbing into the same boat?

The answer … to pump up earnings per share. This, in turn, puts upwards pressure on IBM market value and share price (and also boosts the value of options and share packages for management).

In 2011, IBM generated about $20-billion in cash from operations and spent 121% on:

• repurchase of shares plus dividends – 92%
• capital expenditures – 20%
• acquisitions (net of divestitures) – 9%

IBM made various financial moves including increasing its debt load to cover its cash flow deficit.

The company’s biggest 2011 outlay, totaling $18.5-billion, was spent on currying favor with investors through dividend payments and share repurchases. This compares to the $5.9-billion that IBM invested in expanding the business through capital expenditures and acquisitions.

Share repurchases have become very popular with IBM, HP and some others. They reduce the “per share” denominator of earnings per share (EPS) which puts upward pressure on EPS and share price.

In the decade between 2001 and 2011, IBM repurchased 557-million shares. As a result, the company’s 2011 EPS was 46% higher than would otherwise have been the case without these share repurchases.

Many investors are undoubtedly happier with an increase in IBM market value. However, more cautious investors would prefer to see the company increase its margin of safety by significantly decreasing the proportion of assets financed by debt.

The HP cloud — chasing the Internet of Things

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.

Early orders for all Domicity’s IT company studies receive a 33% saving. Click here to be in the first group to learn about the next report.

In addition to published reports, Domicity consults on the strategies & operations of IT companies and trends, and advises governments on economic development and investment attraction related to the IT sector.
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The Internet of Things (IoT) — wireless networks of sensors that gather data and feed it to the cloud for analysis — is a gold rush in the making for the IT industry. Potential applications are legion and vendors anticipate the IoT will drive much demand for new hardware, software, and services.

Here are just a few of the myriad possible applications that vendors mention:

• advance detection of harmful pathogens in food
• early warning of heart attack or stroke
• bomb sniffing at strategically sensitive locations (but will sensor networks be as cost-effective and diligent as Bart Weetjens’ rats?)
• pollution detection and control
• traffic congestion reduction
• energy conservation in buildings and equipment

For those with a less utopian view, governments will be able to track the activities of the citizenry more closely and hackers may be able to spoof sensor data to cause chaos.

Hewlett-Packard, IBM, Cisco, and others are targeting delivery of end-to-end IoT systems. Other vendors dream of leading in specific IoT areas. For example, Verizon is promoting the wireless networking of sensors; Arrayent produces middleware for companies wanting to connect their products to the Internet; and Pachube has a software platform for developing IoT applications.

Making CeNSE — the HP cloud

HP is an example of an end-to-end systems and services supplier whose strategy includes developing a profitable position in IoT systems. Today’s Internet carries relatively little sensory data — taste, smell, sight, hearing and touch. HP Labs’ researchers believe that sensors with these capabilities will drive the next great stage of the Internet’s evolution.

As part of a broader HP cloud strategy, the company is promoting a Central Nervous System for the Earth (CeNSE). CeNSE would be a worldwide cloud-based network of a trillion or more sensors, able to do such things as monitor the integrity of infrastructure including bridges, appraise the health of wildlife populations, or find oil through enhanced seismic detection, a collaborative project between HP and Shell. IBM’s Smarter Planet is a similar initiative to HP’s CeNSE.

The HP cloud strategy includes developing or acquiring the necessary technological building blocks to be an IoT systems leader, including:

• Nanosensors — HP already uses sensors in its server-side equipment and data center offerings to minimize energy consumption and in its printer products to detect paper type and to optimize ink usage. HP Labs is developing nanosensors that will never need a battery change. And next-generation sensors, under development, will supplement existing high-level movement detection with feel, taste, and smell capabilities.
• Exascale computers — a network of a trillion or more nanosensors, as HP ultimately envisions for CeNSE, will generate the traffic of 1,000 of today’s Internets. Current server-side systems will be overpowered by the deluge of data, requiring radically new “exascale” computer architectures. To eliminate the data bottleneck that plagues today’s systems, HP is developing an exascale design that tightly integrates logic and memory, using new semiconductor technology. Hard drives will be demoted to archival storage.
• Column-oriented datamart software — As part of the HP cloud strategy, the acquisition of database specialist Vertica, appears custom-made for analyzing the Big Data expected from sensor networks — massive data tables with many rows, but few columns.

A global future centred on the Internet of Things could be promising, alarming or both. More certain is that Bart Weetjen’s rats can be expected to have work for some time to come.

IT job cuts — does the cloud have a silver lining?

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.
Early orders for all Domicity’s IT company studies receive a 33% saving. Click here to learn about the next report.

In addition to published reports and consulting on the strategies & operations of IT companies and trends, Domicity advises governments on IT sector economic development and investment attraction.
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In our previous post, we talked about the likelihood that cloud-driven automation will cause major IT job cuts among internal IT shops and services suppliers.

Fans of long-departed Austrian economist Joseph Schumpeter will proclaim that there is nothing to worry about because the cloud will merely unleash a healthy spate of creative destruction. IT job cuts to those activities that prop up legacy architectures could be more than offset by new jobs from out of the cloud.

To a significant degree, Schumpeter was right. Many new cloud-based jobs are being created at IT companies which are:

• undergoing rapid expansion using cloud-based business models (Google, Amazon, Twitter, Facebook etc.)
• developing apps for mobile cloud access devices, in particular smartphones and tablets
• implementing RFID and sensor-based applications for the “Internet of Things”
• developing Big Data systems to analyze and manage the tsunami of structured and unstructured cloud-based data.

The problem with this rosy scenario is that the people losing employment from IT job cuts are often not the same as those taking the new jobs. Different skills may be required and the new jobs may be inconveniently far from the vanishing legacy jobs. The article in the Atlantic referred to in our previous post discusses how these problems have played out in the broader manufacturing sector throughout the US.

The loss of many good-paying manufacturing jobs has almost certainly been a significant contributor to the income crisis among a growing number of households. Growth in US median family income is falling well behind the growth of the overall economy. Lane Kenworthy at the University of Arizona developed the graph below which demonstrates this point.

Domicity expects a major cloud-driven round of IT job cuts to put further downward pressure on median income.

The lack of effective transition programs to ease the plight of those laid off during the restructuring of the US manufacturing sector has been one of the contributors to the social and political unrest leading to the Tea Party and the Occupy movements. More social and political instability could be fueled if the impacts of cloud-induced IT job cuts are ignored and transition programs are not put in place, such as:

• retraining and education courses in cloud-optimized programming languages; Ruby and Python are examples
• courses in cloud-centric business models
• loans to business, particularly SMBs, to develop new opportunities that leverage the cloud
• subsidies to offer older IT workers an early retirement.

Have enough lessons been learned from the restructuring of the manufacturing sector to ease the cloud’s potential for social disruption?

IT job cuts — A hard rain’s a-gonna fall

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an in-depth Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.  Early orders for all Domicity’s IT company studies receive a 33% saving. Click here to learn about the next report.

In addition to published reports and consulting on the strategies & operations of IT companies and trends, Domicity advises governments on IT sector economic development and investment attraction.

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I saw a highway of diamonds with nobody on it …
It’s a hard rain’s a-gonna fall
Bob Dylan

The Jan/Feb 2012 issue of the Atlantic magazine, has a fascinating article on the destruction of US manufacturing jobs.

The article makes the argument that, contrary to popular perception, the US remains a major manufacturer. Over the last 10 years, manufacturing has expanded by about one-third. However, the number of manufacturing jobs has declined by one-third.

Whipsawed between the twin forces of offshoring and automation, US manufacturing job losses between 1999 and 2009 totaled about 6-million. As the article’s author Adam Davidson points out, “About as many people work in manufacturing now as did at the end of the Depression, even though the American population is more than twice as large today”.

I fear there are strong parallels with the developing situation among IT workers — both in internal IT shops and among services suppliers. They too are being torn between the twin forces of offshoring and cloud-driven automation. Further major IT job cuts are on the horizon.

We’ve posted about why India and some other developing countries have become such popular offshoring locales for IT jobs. In a recent chat with a senior IT manager at a major bank, he bemoaned the fact that his operation is planning major IT job cuts in North America and will offshore the work to India.

Further down the line, the same senior IT manager saw cloud-based automation forcing further job cuts and was thankful his career was almost over and that he wasn’t “one of these kids coming into IT today.”

A real world example of IT job cuts

Here’s a real world example of the scale of IT job cuts that cloud computing has the potential to visit upon major IT shops.

Between 2005 and 2008, Hewlett-Packard undertook a thoroughgoing centralization and modernization of its internal IT platform. The goal was to put in place a leading-edge shared services/private cloud architecture for the entire company.

Much has been written about the positive outcomes of this modernization effort, led by former CIO Randy Mott: a halving of the total IT budget in 2005 terms; consolidation of some 85 significant data centres and 370 smaller sites into just three large new mirrored data centres; a 60% reduction in energy costs; a 40% reduction in total number of servers from 25,000 down to roughly 15,000 blades, yet a 250% increase in processing power; a 50% cut in networking costs, despite a tripling of total bandwidth; and a reduction in company-wide applications from approximately 5,800 down to 1,400.

What is not often mentioned about HP’s private cloud is that the modernization effort also targeted a reduction of IT jobs within the company from 19,000 to 8,000.

As well, before HP’s private cloud project, about 50% of the company’s IT work was done by outside contractors. Now, 90% of the work is carried out internally. Cloud computing threatens IT job cuts among system integrators and outsourcers, not just internal IT staff.

In mid-2010, HP began a second major renovation effort, modernizing the additional IT infrastructure that came along with its 2008 acquisition of EDS. This targeted further IT job cuts of 9,000 positions, in addition to the 11,000 eliminated in the first round of cloudification.

A hard rain indeed.

Our next post looks for a silver lining in the darkening cloud of IT job cuts.

Best places to work — long-term competitive advantage

Posted by Susan Sparrow, President, Domicity Ltd.

This post is based on research for an in-depth Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.

Early orders for all Domicity’s IT company studies receive a 33% saving. Click here for your advance notice of the next report.

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In our previous post, we promised to look at the relevance for long-term competitive success of being one of the best places to work.

The Great Place to Work Institute, which produces Fortune’s annual ranking of the top 100 best places to work in the US, also turns out regular rankings of the top multinationals and the best places to work in a number of countries. The Institute argues that there is a relationship between competitive performance, as tracked by stock market returns, that favours the best places to work versus the others.

The graph below, compiled by the Russell Investment Group shows that the publicly-traded companies on Fortune’s 100 Best Companies to Work For list “consistently outperform major stock indices by a factor of 3″.

One IT company that stands out in the Institute’s extended set of rankings around the world is Google. On the 2012 list, Google was Fortune’s #1 best place to work in the US and it has been in the top 5 since it was first chosen in 2007.

A distinctive part of Google’s approach is to shower employees with perks designed to make it a fun place to work: bocce courts, a bowling alley, free food etc.  Fortune quotes a Google staffer: “Employees are never more than 150 feet away from a well-stocked pantry.”

Google is particularly significant because it caught the cloud computing wave early with an all-cloud-all-the-time model. It is augmenting this position by leveraging its status as one of the best places to work, gaining additional momentum as it attracts the best talent from companies with less enlightened human resources regimes.

Google demonstrates that a company can expand offshore operations in a way that does not damage its brand or lower the morale of workers in the domestic market. Both issues are discussed in our previous post. Google ranked #4 on the Institute’s top 25 multinationals. To qualify for the multinational list, Google had to win a place on at least five of the Institute’s national best workplaces lists.

Google is not the only company that is using a progressive HR environment as a way to foster better competitive performance. Other IT companies that made it onto both the US and the multinational lists include: SAS, NetApp, Microsoft, Intel and Cisco.

It is possible to compete successfully in the short-to-medium term with unenlightend HR policies. However, a much safer way to build a strong brand and attract the talent needed to succeed over the long term is to be one of the best places to work.

Best places to work — not Apple, Dell, HP, or IBM

Posted by Susan Sparrow, President, Domicity Ltd.

This post is based on research for an in-depth Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.

Early orders for all Domicity’s IT company studies receive a 33% saving. Click here for your advance notice of the next report.

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A scene from the 2007 documentary Manufactured Landscapes

Fortune Magazine has just released the results of its annual employee satisfaction survey “100 Best Companies to Work For“ . As someone who believes Humans Matter, I looked over the list of US companies in search of insights into why Google, NetApp, SAS, and Intuit are judged best places to work while Apple, Dell, HP, and IBM are not.

Just this month, three media items I came across seem to point in one direction …  the impact of offshoring domestic jobs to countries where labour standards are still underdeveloped.

Last week, I heard Mike Daisey’s monlogue on This American Life, emanating from Chicago’s WBEZ / Public Ratio International. In Mr. Daisey and the Apple Factory, Mike “a self-described worshipper in the cult of Mac” describes his visit to China where he witnessed Dickensian working conditions, including child labour in Hon Hai’s massive Foxconn factory in Shenzhen, with its 430,000 workers. This is the main production centre for Apple’s iPhone. The piece was not flattering … at all.

Then, on Jan. 21, the New York Times published an in-depth article  linking the offshoring of Apple’s production to the plight of the US middle class. It relays a tale of social dumping, told by a former Apple executive, which should make the hair stand up on the back of the neck of any Apple publicist, marketer or recruiter:

“Apple had redesigned the iPhone’s screen at the last minute, forcing an assembly line overhaul. New screens began arriving at the plant near midnight. A foreman immediately roused 8,000 workers inside the company’s dormitories, according to the executive. Each employee was given a biscuit and a cup of tea, guided to a workstation and within half an hour started a 12-hour shift fitting glass screens into beveled frames. Within 96 hours, the plant was producing over 10,000 iPhones a day.”

Finally, I came across this interchange between two commenters on the web version of Fortune’s best places to work list:

Proud IBMer: Good Day. After reading this list of the Top 100 Companies from Fortune; I’m really curious how … one of the leading Technology Companies in the World, IBM that just celebrated 100 yrs in business, has a very strong financial position and Worldwide Industry leadership in Business Consulting, Systems, Software and Services Solutions, how did that get left off the list???

IBM detractor:They are not on the list because IBM doesn’t treat their employees very well. I know many exIBMers in the IT industry here in the states that have bitter feelings. Some were laid off, but many recently are fleeing the company as the economy picks up. In 2008-2010 many long time SWG US software lab employees were laid off, while similar SW labs were started overseas. The sad part is these exIBMers are in the IT industry opposing IBM products and services because of how they were treated, and many are vocal IT Directors in potential IBM customer IT departments …

Apple, because of its recent incredible success, and the faint whiff of idealism that its products give off, has been the focal point of recent publicity regarding production offshoring.

The New York Times and This American Life both use Apple as their centerpiece, but a large number of other product manufacturers are side-swiped along the way, including: Amazon, Dell, Hewlett-Packard, Lenovo, Nintendo, Nokia, Panasonic, Samsung and Sony. In addition, IBM has offshored aggressively to India.

Our next post looks at the implications for the future of the IT industry’s competitive landscape as human resources policies, including offshoring, continue to be front and centre.

HP cloud — Can Bill Veghte vault Apple’s iCloud?

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an in-depth Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.

Early orders for all Domicity’s IT company studies receive a 33% saving. Click here for your advance notice of the next report.

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As discussed in our previous post, Hewlett-Packard took the prize for “Best PC” at the 2012 Consumer Electronics Show (CES). Its Envy 14 Spectre ultrabook was clearly designed to best Apple’s MacBook Air and it does so in several important ways. However, there needs to be an HP cloud solution for SMBs and consumers as part of a strategy to win back from Apple the overall lead in cloud access devices for consumers and SMBs.

It is clear that one well-designed machine is just the start for HP. Compare HP’s FY2011 results to Apple’s performance. Because HP and Apple both compete in the graphics vertical, HP’s Imaging and Printing Group’s (IPG) results should arguably be added to those of its Personal Systems Group (PSG) for an apples to Apple comparison.

HP’s FY2011 combined revenue from PSG and IPG was $65.3-billion; operating income was $6.3-billion for an operating margin of 9.7%. By contrast, Apple generated revenue of $108.2-billion (1.7 times that of HP), operating income of $33.8-billion (5.3 times HP) and an enviable operating margin of 31.2% (3.2 times HP).

The revenue graphs below compare Apple’s FY2006 and FY2011 revenue to HP’s combined PSG and IPG revenue. They show that HP is falling behind fast, particularly because of Apple’s success in non-PC products such as smartphones, tablets, and cloud services (iTunes, Mac Apps, iCloud).

HP’s proprietary operating system, WebOS, failed to vault the company into contention in the smartphone and tablet markets. The HP cloud solution for the consumer and SMB markets now primarily consists of using its PCs as cloud access devices, some of its printers as cloud output devices, and a scattering of largely unrelated cloud services offerings such as the Imaging and Printing Group’s Snapfish media sharing service.

If the HP cloud offering is to best Apple or even blunt its rival’s momentum among consumers and SMBs, HP will have to define a much more coherent and consistent cloud strategy for these two key market segments.

This mission falls to Bill Veghte who assumed the role of HP’s Chief Strategy Officer on Jan. 17, 2012. Veghte is well-qualified to lead the HP cloud strategy. The former head of the Windows business at Microsoft, he spearheaded the roll-out of Windows 7 and the development of a series of other Windows products during his 20 years with the software leader.

When Veghte joined HP in May 2010, he seemed underemployed as the head of its smallish ($3.2-billion) business in enterprise IT management software. No more. In addition to remaining the head of the enterprise software unit and helping HP win in the enterprise cloud, Veghte returns to the trenches to fight his old rival Apple. He must help design an HP cloud solution for consumers and SMBs that is competitive with Apple’s cloud services success formula of using PCs, smartphones, and tablets as springboards to sell cloud services.

Having dropped WebOS as its operating system of choice on cloud access devices, HP is now fully back in the Windows fold and the choice of Veghte makes perfect sense.

HP’s Envy 14 shows move to new business model is underway

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.

Early orders for Domicity reports receive a 33% saving. Click here for advance notification of our next report.

The company which confirmed to the world less than two months ago that it would be a personal computer market player has won ’Best PC’ at the 2012 Consumer Electronics Show. Hewlett-Packard’s premium-priced HP Envy 14 Spectre ultrabook is slated to begin shipping on Feb. 8, 2012.

Before dropping a mid-August bombshell, which now looks more like a trial balloon, that it would exit the PC business, HP had been a market leader. Now, just five months later, it is recommitting to PCs with a vengeance.

The PC off-switch was hit by former CEO Léo Apotheker and the on-switch by his replacement Meg Whitman (and influential sponsor, Executive Chair Ray Lane).

HP’s  business model is transitioning from previous CEO Mark Hurd’s strategy of wringing maximum operating margin from minimal gross margins. The new emphasis is on using engineering expertise to generate fatter gross margins which will fund higher operating margins, more generous wages, and more investment in R&D, sales, and marketing. Link here for more on HP’s business model.

If HP is going to wring more profit from its PC business, it must take a bite out of Apple. The Envy 14 has been self-consciously engineered to best Apple’s comparable 13-inch MacBook Air on key features:

• Display — HP, reportedly with help from LG’s Shuriken technology, crams a 14-inch 1600 X 900 display into a 13.3-inch frame … a clear win over the 13.3-inch 1440 X 900 display on the MacBook Air 13
• Sound — the Envy 14 features Beats audio system with 2 speakers and subwoofer and streams audio wirelessly to up to 4 KleerNet-compatible speakers … the MacBook Air 13 has 2 stereo speakers
• Keyboard — HP and the Mac Air both feature a separate LED to light up each key …  but HP goes one further by equipping its keyboard with a proximity sensor that turns the lighting on as the user approaches and dims it as the user leaves
• Networking — HP offers a gigabit wired LAN port in addition to WiFi and Bluetooth … Mac Air only offers WiFi and Bluetooth
• Cooling — HP, due to its competition in the heat-obsessed server and data centre markets, has sophisticated sensor-based equipment cooling technology and has endowed the Envy 14 with something it is branding CoolSense; a motion sensor detects when the PC is being used and automatically adjusts the fan for greater cooling … whether it runs cooler than the MacBook Air 13 still needs to be proven
• Battery Life — HP claims up to 9-hours battery life (the Shuriken display is said to confer an extra hour), something that still needs to be tested independently … Apple lists up to 7-hours on battery for the MacBook Air 13
• Styling — HP’s Envy 14 uses Corning’s scratch-resistant Gorilla Glass on the lid, display, palmrest and trackpad … depending on the eye of the beholder, it could be more eye-catching than the MacBook Air’s still classy unibody aluminum chassis.

Weight is one area where the Apple outperforms HP. The Envy 14 weighs in at 3.79-pounds versus 2.96-pounds for the Macbook Air 13. A gorilla is heavy and so is its namesake glass. The glass is also difficult to keep smudge free, although the eye-candy wowed the media.

The high-speed port used by Apple, featuring Intel’s Thunderbolt technology, is twice as fast as HP’s USB 3.0 on the Envy 14, but fewer devices support Thunderbolt.

And the price? In a bit of braggadocio, HP has set the price for the base model Envy 14 at $100 above the base price for the MacBook Air 13.

HP undoubtedly enjoyed the buzz generated by its Envy 14 at CES 2012. But the award should not mask the tough tasks ahead … regaining PC market leadership and doing so profitably. More on this in Domicity’s next blog.

HP’s next wave of acquisitions

Posted by Susan Sparrow, President, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.

Early orders for Domicity reports receive a 33% saving. Click here to sign up.

Be careful what you swallow

HP Invent, a corporate branding slogan introduced over a decade ago, early in Carly Fiorina’s stint as Hewlett-Packard CEO, was an attempt to put the company’s history of creativity and innovation front-of-mind.

HP Acquire could be a more accurate catchphrase to describe the company’s recent growth formula.

Since 2000, HP has laid out approximately $72-billion in stock and cash for acquisitions which generated estimated revenue of $50-billion at the time they were acquired. With an average of just 1.5 times revenue, these acquisitions have turned out to be quite affordable. All of HP’s major line-of-business groups were involved in the program. The spending spree has included a couple of former pillars of the industry — Compaq and EDS — and more than 60 additional small and mid-sized operations.

It is not surprising that fans of the old HP Way are concerned that acquisitions on a massive scale have eroded its employee-centred corporate culture. HP now defines a modern multinational, with a value chain that has been thoroughly outsourced, offshored, and commoditized.

If HP had focused on organic growth like Apple and the ”old” HP,  more profit could have been squeezed from each dollar of revenue. It is also likely true that without the acquisitions, HP would not be the number two player in client-side and server-side computing, behind Apple and IBM respectively.

Although HP is not the same as it was, it still has the potential to do great things. The acquisitions program has given the company new areas of strength that can make it a major cloud-era player. These include:

• a leading server-side infrastructure platform for most cloud applications;
• strong security technology and products;
• a pioneering position in what may be enterprise software’s ”next big thing” — real-time analytics and management of structured and unstructured data as it enters the enterprise;
• cloud printing;
• a leading-edge supply chain; and
• a global sales operation that can effectively reach consumers, SMBs, and enterprises.

Even HP’s lagging PC business could turn into a significant cloud asset if, as Microsoft plans, Windows 8 becomes the leading end-to-end client device platform for PCs, tablets, and smartphones.

Consumer and enterprise cloud services

To grow profitably, HP must go where the money is and develop consumer and enterprise cloud services. These markets are moving fast and it is likely that the bulk of HP’s cloud services efforts will remain acquisitions-driven. The purchase of cloud-centric enterprise search leader Autonomy points the way.

Acquisitions in new markets offer high reward potential but are frequently high risk. HP paid $11-billion for Autonomy’s estimated $1-billion in 2011 sales — 11 times revenue, not the 1.5 times revenue of the company’s average acquisition. Autonomy boasts a strong growth record and a Google-like 36% operating margin (operating income ÷ revenue).

However, HP cannot afford to have acquisitions this expensive fail. Otherwise it could be back to HP Invent.

A Fistful of Cloud Dollars continued

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.  CLICK HERE  for advance notice and 33% savings on early orders.

This post provides more detail on our premise that old-line IT suppliers are being pushed to cloud wash their business models because Apple and Google’s development of cloud-centred businesses is yielding a tremendous fistful of dollars.

Domicity’s table below grafts together the income and cash flow statements of Hewlett-Packard, IBM, Apple, and Google. It helps identify how each company spends revenue as it comes in the door and how much money each company has left over to add to cash and investments. We examine the last four fiscal quarters for each company ending closest to the third quarter of calendar 2011.

CLICK on the image to download a larger version as a pdf file.

The overall picture shows that the more cloudy Apple and Google are generating significantly greater Cash from Operations, as a proportion of revenue, than are HP and IBM.

In terms of investment to grow its business in the future, HP invested $14-billion in Capital Expenditures and Acquisitions combined, including more than $10-billion to acquire software innovator Autonomy. This is roughly twice what the other three spent on capital expenditures and acquisitions.

HP’s Autonomy acquisition was funded by drawing down cash and by raising debt capital. HP hopes to inject more profit into its business by rapidly growing Autonomy’s already large private hosted cloud business and by leveraging Autonomy’s cloud-centric Aurasma augmented reality technology.

Having looked after funding future growth, old-timers HP and IBM spend very large sums wooing investors through Dividends and through Repurchase of Common Stock. Stock buybacks shrink the “per share” denominator of earnings per share and the resulting boost to EPS puts upwards pressure on share price. Apple and Google do none of this. They keep their surplus cash in the business.

Given today’s low interest rates, why do Apple and Google keep so much money on hand — more than $81-billion and $43-billion respectively as we discussed in the last post — far more than can be productively used for growth? Part of the reason may be that large portions of their cash and investments are “stranded” offshore.

Apple had 67% of its cash and securities held by foreign subsidiaries at the end of its FY2011 and Google had 48% at the end of its FY2010. For both companies, bringing their offshore  funds back to the US for dispersal could mean a big tax hit.

A Fistful of Cloud Dollars

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.  CLICK HERE  for advance notice and 33% savings on early orders.

In the early 1980s when I began analyzing IT companies, Xerox had introduced a bunch of great computer technology — the mouse, the graphical user interface, and Ethernet — while Exxon, who had a little extra cash from oil, was debuting a new line of fax machines.

The fun of this business is that technology and technology companies are constantly in flux, seemingly unlike other North American markets and styles which, according to a recent Vanity Fair article, used to change radically every decade but in the last two decades “look disturbingly alike”.

Even with the current slowdown, some companies are proving adroit enough to line their pockets from the newest IT fashion —  the cloud.

Some of Domicity’s recent analysis examines the hoard of cash and investments being built up by cloud high fliers including Apple and Google.

Google, with a pure cloud business model, and Apple, with one that it has skilfully retrofitted for the cloud, are building mountains of cash.

Pushed on by their customers and pulled by the riches that Apple, Google and other companies are extracting from the cloud, old-line players including IBM and Hewlett-Packard are frantically cloud washing their business models. The following graph compares the cash and investment holdings for these four competitors.

At Sept. 24, 2011 Apple had a mind boggling $81.6-billion sitting on its balance sheet in cash and investments. Google (at Sept. 30) had $43.5-billion, despite significantly smaller revenue than the others. By contrast, IBM (Sept. 30) and HP (Oct. 31) only clocked in at $26.6-billion and $18.8-billion respectively.

Why are Google and Apple keeping so much money on hand?

A great topic for our next post.

2012: What the Doctor Orders

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.CLICK HERE for advance notice and 33% savings on early orders.

In the face of the accelerating acceptance of cloud computing, the doctor is ordering many IT market competitors to make a Zelig-like transformation in 2012.

For the largest information technology multinationals, making a smooth business transition from one technology generation to another can be difficult and painful, particularly when profits from the old technology tend to erode faster than they grow from the new one.

Companies selling IT hardware, software and services regularly face transitions to new technological paradigms and must become particularly adroit at stick handling the shift. Fujitsu, Hewlett-Packard and IBM which were in business before the 1943 invention of Tommy Flowers’ Colossus, the first programmable electronic computer, have had to negotiate many generational shifts in order to remain profitable and relevant.

Others that were once market leaders became high tech fossils because they were unable to make a generational leap … DEC, Burroughs, Data General, Apollo, Sperry, Wang, Compaq, Sun, [add your favourite entry here].

To preserve market share and value, many of today’s successful companies are struggling to transition to new cloud computing identitities. In this, Fujitsu, HP, and IBM are joined by giants SAP, Oracle, Microsoft, Acer, Lenovo, Hitachi, Intel, Tata, Infosys, Wipro, HCL, Accenture, Cap Gemini, CSC, and many more.

Some market leaders will use the new technology to expand their market position and inject greater profitability. Several start-ups will become full-fledged market leaders on the strength of their concentration in the new technology alone.

Google is an example of a start-up that has ridden a pure cloud computing business model to market leadership. To illustrate the problem facing the IT establishment, the graph below compares Google’s market value to HP. Formed in 1998, Google is a mere teenager whereas HP turns 73 this year. Yet at the end of calendar 2011, Google’s market value was quadruple HP’s.

To become more profitable and to boost its market value, HP is attempting to transition its current operations and products to embrace the cloud. A myriad of cloud-based initiatives are underway, including:

• development of a converged server-side hardware platform;
• hosted private and public XaaS (Everything-as-a-Service) offerings;
• print anything-from-anywhere-to-anywhere initiatives;
• and more.

In 2011, HP was willing to plunk down more than $10-billion to acquire Autonomy and Vertica to leverage the cloud to help build out its underdeveloped software business.

Now comes the hard part for HP. Can its cloud profits grow faster than the decline in profits from its legacy businesses?

A red flag for labour-intensive IT

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.  CLICK HERE  for advance notice and 33% savings on early orders.

Cloud computing’s Everything-as-a-Service (XaaS) paradigm has the potential to radically alter the face of the IT outsourcing industry, conferring market power on those companies who can deliver customer applications from global networks of technologically advanced data centres, at the expense of those whose business models are primarily driven by inexpensive labour.

The traditional “mess-for-less” IT outsourcing model is based on a supplier taking over a client’s increasingly dysfunctional muddle of incompatible multi-generational systems that span several acquisitions and mergers. The outsourcer promises to run the customer’s mess for less. How is it that leading IT outsourcers can deliver a customer’s applications for 20% less than the in-house IT group, while also generating handsome profits? The answer lies in economies of scale, technology, and particularly, in offshoring work to locales where labour costs are substantially lower.

In a previous post, Domicity highlighted the luxurious operating margins being generated by leading Indian outsourcers.  The seemingly bottomless well of low-cost, well-educated workers has also drawn many western IT outsourcers to build a significant presence in India.

Roughly one in every three IBM employees is now located in India.  IBM’s total employment in India by the end of 2011 is estimated at nearly 155,000, up from just 5,000 in 2002. Accenture has about one-third of its headcount in India and HP has a sizeable services contingent on the subcontinent along with several other “BestShore” service delivery centres in developing countries. Meanwhile a group of Indian companies  — Tata Consultancy Services, Infosys, Wipro, and HCL — have leveraged their country’s labour advantage to become a potent force in IT outsourcing.

Enterprise-class XaaS cloud-hosted IT outsourcing promises to eventually send mess-for-less outsourcing into decline, as internal IT shops find they can:

• Outsource one application at a time, rather than having to commission a wholesale outsourcing of the entire IT group (software suppliers are turning their flagship products into applications that can be offered by a range of SaaS hosters)
• Convert the fixed cost of running applications into variable costs, based on business volumes
• Improve price/performance as cloud hosters with experience delivering a specific service — for instance SAP ERP or Microsoft SharePoint — compete for business
• More easily switch from one IaaS or SaaS supplier to another than they could between traditional IT outsourcers
• Simplify the design and integration of solutions carried out by internal IT staff; each application can run on standardized virtual machines, rather than on specifically tuned in-house hardware
• Speed up service delivery through automation and reductions to the operational labour needed to deliver cloud-hosted services.

XaaS should constitute a red warning flag for all IT outsourcers whose business model continues to be based on using cheap labour to deliver mess-for-less outsourcing, integration and management services.

In-house IT staff should also beware. XaaS holds great potential to automate these jobs out of existence as well.

Is Alcatel-Lucent looking tasty to HP?

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.  CLICK HERE  for advance notice and 33% savings on early orders.

Pommes Frites anyone?

Another month and another joint product announcement from Hewlett-Packard’s sprawling alliance with French networking equipment supplier Alcatel-Lucent. Their latest solution uses carrier-grade optical networks to link data centres.

HP and Alcatel-Lucent are cooperating on selling a broad range of products and services to communications services providers (CSPs) and enterprises. Taken as a whole, the alliance addresses a large market opportunity.

The steady beat of joint announcements traces back to mid-2009, when the two companies formed a 10-year global partnership following the dissolution of HP’s tight bond with Cisco. Under the agreement, HP and Alcatel-Lucent are jointly developing and marketing communications-based solutions aimed at “next-generation converged infrastructure”.  HP also took over the management of 60% of Alcatel-Lucent’s information technology operations along with 1,000 IT staff.

The part of the alliance aimed at telcos and other CSPs focuses on enabling new, revenue-generating services, notably cloud-hosted offerings.

Solutions for the enterprise target contact centers, IP telephony, unified communications, mobility, and security.

Over the two-and-a half years since the alliance was formed, joint solutions have been rolled out for most of these areas.

All this cooperation could presage something larger. At the point where HP restores its balance sheet from the $10-billion splurge on Autonomy, will it move to acquire Alcatel-Lucent?

What would an acquisition of Alcatel-Lucent do for HP’s finances? Alcatel-Lucent’s revenue of US$21.3-billion in fiscal 2010 (at 1 Euro = 1.33 USD), would have grown HP’s 2010 top line by 17%.

But what about the bottom line? Would an acquisition of Alcatel-Lucent help HP fulfill its pressing need to develop a more profitable business model?

The table below analyzes the 2010 income statements of HP and Alcatel-Lucent and a combined 2010 income statement for the two.

Click on image below to download a larger PDF version

On the surface, an acquisition would not help solve HP’s profitability problem. Alcatel-Lucent posted an operating loss and a merged entity would have generated slightly less operating income in 2010 than HP did on its own. Seen strictly as an effort to boost HP’s profitability, buying Alcatel-Lucent would make less sense than the recent purchase of Autonomy or an acquisition of Accenture, which we discuss in earlier posts.

However, on closer look, expense reductions developed under the watchful eye of an implacable cost cutter could sweeten the numbers and alter the outcome.

HP’s supply chain strength could reduce Alcatel-Lucent’s Cost of Revenue leading to higher Gross Margin. Merging HP Labs with Bell Labs and combining the engineering corps would undoubtedly create significant opportunities to lower Alcatel-Lucent’s R&D spending from 16% of revenue. As well, HP’s outlay on SG&A was only 10% of revenue compared to 18.2% for Alcatel-Lucent, offering additional significant potential savings.

Flowing all of the extra 1.6% in gross margin (gross profit/revenue) of the merged company down to the operating income line, would have yielded an operating margin (operating income/revenue) of 10.7%, a significant improvement over the 9.1% that HP achieved on its own.

However, delivering a 10.7% operating margin might be unrealistic. It would require shaving $4.5-billion off the joint company’s cost structure, mostly from Alcatel-Lucent’s operations in worker-friendly Europe. Even getting the combined company’s operating margin to the 9.1% that HP achieved in 2010 would require reducing expenditures by $2.3-billion.

Solely based on an income statement analysis, HP’s acquisition of Alcatel-Lucent may not appear to make sense.

Other than the sheer pleasure of having a European headquarters in Paris, there would have to be some other motivation for a takeover.

The potentially large and lucrative market in outfitting CSPs with cloud hosting infrastructure could provide that motivation, helped along by Alcatel-Lucent’s position in cloud-related enterprise markets.

HP’s CEO Meg Whitman says that, on her watch, HP will regain its focus as an infrastructure company. Alcatel-Lucent would add important infrastructure scope … and at a bargain. On Dec. 7, 2011, Alcatel-Lucent’s market capitalization was down to an astonishing $4-billion (at current Euro/Dollar exchange rates), equal to one times book value or just 25% of annual revenue.

HP and Autonomy — Mining data analytics for gold

Posted by Marc Brien, VP Research, Domicity Ltd.

This post is based on research for an upcoming Domicity CORProfile© report analyzing the strategies and operations of a global cloud leader.  CLICK HERE  for advance notice and 33% savings on early orders.

Hewlett-Packard is actively promoting new software, appliances, and services that integrate technology from Autonomy and Vertica, the two data analytics specialists that HP acquired earlier this year.

As Domicity discussed in two previous posts, HP Needs to Fatten Up and Apotheker or Whitman … HP’s challenge remains the same, the company needs a new business model that will generate fatter profit margins to power up its earnings per share and share price. HP is counting on a new Information Management business unit, built around Autonomy and Vertica, to help drive the transition to a higher profit business.

When HP’s previous CEO Léo Apotheker examined the problem of how to grow operating income at a faster rate, his solution centered on boosting the enterprise software sector because it typically returns much higher profitability than the company has delivered in recent years. Even though Apotheker’s choice was expected, because he had spent most of his career in enterprise software at SAP, others would likely have come up with the same answer.

Casting his eye over the current enterprise software landscape for an area where HP could stake out an early lead, Apotheker settled on real-time data analytics as the next ERP-style gold rush. As enterprises drown under a tsunami of digital alphanumeric, text, image, audio, and video Big Data from a proliferating array of sources, additional new traffic generated by smartphones, grids of sensors, and RFID tags, only promise to make an untenable situation worse.

Apotheker believed an IT company that could give enterprise customers the best set of tools and applications for managing and drawing competitive value from data, in real-time as it enters the enterprise, would tap into a mother lode of profit. Moving boldly, Apotheker talked the HP board into paying out major money to acquire structured data query up-and-comer Vertica (revenue an estimated $50-million), and unstructured data search leader Autonomy (revenue an estimated $1-billion). HP and Autonomy looked like as good a path to fatter margins as existed at the time.

The following table contrasts proportional income statements for HP and Autonomy. (Vertica, a private company, did not publish financials.)

Even though FY2010 was a good year for HP, the comparison shows why a big success in enterprise software would provide a needed boost to operating income. HP’s operating margin (operating income/revenue) was 9.5% in FY2010. Autonomy’s was 36.4% despite far higher levels than HP of investment in R&D and selling-related expense (SG&A). HP and Autonomy together helps the picture for the industry giant.

The graph above, Autonomy — Quarterly Revenue and Operating Income Indices, establishes that demand for Autonomy products has increased steadily over the last five years and that operating income is growing even faster than revenue.

Moving data analytics products from Autonomy and Vertica through HP’s powerful direct and indirect sales channels, as well as giving them an extra push with new professional services, should keep the combined operating income for Autonomy/Vertica growing at average rates above 20% for the next several years.

And much of the profitable new business coming to Autonomy and Vertica is cloud-based, which can only help HP’s larger cloud strategy.