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Hewlett Packard (HPE) Spin-Off News Dulls Q3 Earnings Beat

Hewlett Packard Enterprise CompanyHPE released its third quarterly earnings release yesterday post the split from Hewlett-Packard Company. The company reported mixed results for the third quarter of fiscal 2016, wherein its bottom line surpassed the Zacks Consensus Estimate but the top line missed the same.

However, quarterly results were overshadowed by the company's announcement of its decision to spin off the software business and merge the same with British software firm, Micro Focus International Plc, in a cash-stock deal worth $8.8 billion.

Details of the Spin-Off & Merger Transaction

The transaction, which is subject to some regulatory approvals, is anticipated to be tax free for Hewlett Packard Enterprise. Per the agreement, the company will receive $2.5 billion in cash and a 50.1% stake in the merged entity, currently estimated to be valued at $6.3 billion.

In 2015, Hewlett Packard Enterprise's software division generated revenues of $3.6 billion. It includes the highly controversial Autonomy takeover, which was mostly written down by the current CEO, Meg Whitman. It also includes acquisitions like Mercury Interactive and Vertica. However, the segment hasn't been doing too well of late due to the customer shift toward cloud-supported, as-a-service software purchasing.

The recent move is part of Whitman's massive restructuring plan, which started last year, post its split from the parent company. Since then, management has been focused on trimming the company's structure by shedding struggling and low-margin businesses, and shifting focus toward fast-growing, high-margin areas like networking, storage and technology services.

This May, Hewlett Packard Enterprise announced the spin-off its struggling IT services segment - Enterprise Services - and entered into an agreement to merge the same with Computer Sciences Corporation CSC . The transaction, which is scheduled to close in Mar 2017, will deliver approximately $8.5 billion to the company's shareholders on an after-tax basis. This includes $4.5 billion in the form of equity in the combined company, $1.5 billion in cash dividend and $2.5 billion of debt assumption.

Most recently, Hewlett Packard Enterprise completed the sell-off of 84% of its 60.5% equity stake in Mphasis Limited, an IT services provider in Bangalore, India to The Blackstone Group BX . The transaction has fetched the company around $700 million.

Hewlett Packard Enterprise believes that such massive restructuring moves will complement its focus on core businesses and enable it to compete with players like Oracle ORCL , Cisco and NetApp as well as the new entrant, Dell. Interestingly, with the acquisition of EMC Corporation, Dell has now emerged as one of the biggest competitors for Hewlett Packard Enterprise.

Although these strategies appear impressive, we believe that Hewlett Packard Enterprise's growth story depends largely on how well it is able to capture market share in the networking, storage and technology services space.

Now, let's discuss Hewlett Packard Enterprise's results in the third quarter of fiscal 2016.

Quarterly Results

Notably, Hewlett-Packard Company split itself into two standalone companies - HP Inc. HPQ and Hewlett Packard Enterprise - effective Nov 1, 2015. Post the split, Hewlett-Packard Company's PC and printer business operates under HP Inc., while Hewlett Packard Enterprise specializes in commercial tech products.

Revenues

Hewlett Packard Enterprise reported total revenue of $12.210 billion, lagging the Zacks Consensus Estimate of $12.588 billion and down 6.5% year over year. The year-over-year decline was mainly due a weak performance in Japan and the Europe, particularly in the UK. Unfavorable currency exchange rates negatively impacted revenues by 210 basis points (bps).

Segment-wise, revenues at the Enterprise Group were down 8% from the year-ago quarter to $6.5 billion. However, adjusting for divestures and currency, segment revenues were flat. Revenues from Servers, Storage, Networking and Technology Services were down 4%, 8%, 22% and 7%, respectively.

Enterprise Services revenues were down 5% to $4.7 billion. Revenues were hurt by a 4% decline in Application and Business Services and a 6% dip in IT Outsourcing. Adjusted for divestures and currency, the segment's revenues declined 3%.

Software revenues were down 18% to $738 million. Revenues from License, Support, Professional Services and SaaS were down 28%, 17%, 8% and 5%, respectively. Adjusted for divestures and currency, the segment's revenues fell 3%.

Financial Services revenues were up 1% to $812 million.

Operating Results

Hewlett Packard Enterprise's non-GAAP gross margin expanded 60 basis points (bps) on a year-over-year basis to 29.3%. Moreover, the company's non-GAAP operating margin expanded 30 bps to 8.8% mainly due to a higher gross margin, partially offset by increased operating expenses as a percentage of revenues.

Non-GAAP net income came in at $844 million or 49 cents per share, compared with $871 million or 47 cents per share reported a year ago. Moreover, non-GAAP earnings surpassed the Zacks Consensus Estimate.

Balance Sheet and Cash Flow

Hewlett Packard Enterprise ended the fiscal third quarter with $10.743 billion in cash and cash equivalents, compared with $9.010 billion at the end of the previous quarter. Long-term debt during the quarter was $15.354 billion, compared with $15.247 billion last quarter.

Hewlett Packard Enterprise generated cash flow of $1.7 billion from operational activities during the third quarter. Moreover, during the period, the company returned $1.591 billion through share repurchase and dividend payments. Year to date, the company has returned $2.9 billion to its shareholders.

Guidance

Hewlett Packard Enterprise raised the lower end of its earnings guidance for the full year. The company now expects non-GAAP earnings per share to be $1.90-$1.95 (mid-point: $1.925), up from earlier guidance of $1.85-$1.95 (mid-point: $1.90). The Zacks Consensus Estimate is pegged lower at $1.88.

The company now anticipates returning $3 billion in fiscal 2016, which is approximately thrice its original commitment made at the start of the fiscal year.

For fiscal fourth quarter, the company expects GAAP earnings per share in the range of 44 cents to 49 cents (mid-point: 46.5 cents) and non-GAAP earnings of 58-63 cents (mid-point: 60.5 cents). The Zacks Consensus Estimate is currently pegged at 60 cents.

HEWLETT PKD ENT Price, Consensus and EPS Surprise

HEWLETT PKD ENT Price, Consensus and EPS Surprise | HEWLETT PKD ENT Quote

Our Take

Hewlett Packard Enterprise reported mixed third-quarter fiscal 2016 results, wherein earnings surpassed the Zacks Consensus Estimate and increased on a year-over-year basis. On the other hand, revenues lagged our expectation and were also down from the year-ago figure.

Nonetheless, in our opinion, Hewlett-Packard Company's initiative to split the business is already reaping benefits for Hewlett Packard Enterprise. We believe that the decision enabled a customized approach for two different kinds of businesses, which might not have been possible as a single entity.

Hewlett Packard Enterprise has done considerably well in the enterprise class server and storage markets. The company concentrates its resources on the high-margin software and security markets as well. We believe that the company's traction in the cloud, security and Big Data segments will enhance its growth trajectory, going forward.

Furthermore, Hewlett Packard Enterprise's strategic divestments and initiatives to return value to shareholders in the form of dividend and share repurchases bode well.

However, macroeconomic challenges and tepid IT spending remain near-term concerns. Competition from other players in the space adds to its woes.

Currently, Hewlett Packard Enterprise carries a Zacks Rank #3 (Hold). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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