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TheStreet Open House

Autonomy Disappoints a Year After HP's Big Software Bet

Stocks in this article: HPQ IBM DELL

When HP first took control of Autonomy it planned to run the company independently, keeping Lynch, who founded the firm in 1996, at the helm. The drastic second quarter management change for Autonomy, a maker of software analytics that search unstructured data like emails, phone calls and social media, was a troubling sign for investors worried about whether HP will get a bang for its buck on the acquisition.

Under new unit head Veghte, HP expects to tie Autonomy to the company's existing services, server storage, networking businesses and its sales force, in an "organizational structure to support a $1 billion company," according to May comments from Whitman.

Whitman's closer alignment of Autonomy with core HP, and an overall restructuring and simplification of HP mirrors the decade-ago turnaround of IBM that took shape through a strategy to quickly integrate acquisitions.

A year into the turnaround push, HP's earnings confirm a transformation will not come quickly, as doubters mount.

Third quarter earnings did little to reverse a trend of falling profit margins and a growth slowdown at HP's software and services units, integral to any transformation. HP's software license growth fell to 2% in the third quarter from 7% in the second quarter and from 12% in the first, while the unit's operating margins rose slightly to 18% after dropping to 17.7% in the second quarter.

Earlier in August, UBS analyst Steven Milunovich said HP has so far assembled a mediocre set of assets that's unlikely to pull business from entrenched enterprise players IBM and EMC (EMC).

"HP lacks the pure enterprise focus of IBM and EMC yet will have trouble competing for consumers without strong tablet and phone businesses like Apple and Samsung," wrote Milunovich in an Aug 8 initiation of HP shares with a sell rating and a $16 price target.

"We question whether HP is 'better together' and that it might be 'smart to be apart,' specifically spinning off printers and PCs," he added.

In May, Jefferies analyst Peter Misek said that the company's future stock gains hinge on improving performance at Autonomy.

"We believe HP is one of a handful of players that has or is close to having the components of a full stack (i.e., software, storage, networking, services)," wrote Misek in a May note to clients. Were Whitman's restructuring efforts to work, Misek calculated that cross selling opportunities from Autonomy could lift HP's 2012 earnings per share to $4.20 from a base of $4.07. Such improvements would warrant a $40 share price because HP's price-to-earnings multiple could rise to 9.5 times 2012 earnings from a base of 7.5x.

Full year EPS guidance of $4.06 - unveiled on Wednesday - signal that software's not been the cure to declining PC sales, which fell 10% in the quarter. Meanwhile, the company's stock remains over 50% below Misek's bullish estimate.

In a decisive call, Whitman retained HP's PC unit -- contrary to Apotheker's plan -- and cast high expectations on the benefits of Autonomy. HP chairman Ray Lane said in September that Autonomy's software and analytics revenue could grow from present levels of $1 billion to $5 billion or even $10 billion. "Hopefully, we'll see a bigger software portfolio and we'll see more value-added services at HP, but we have $120 billion of hardware business that we care dearly about," said Lane in September.

Since then, HP has enacted other turnaround efforts under Whitman, including a merger of its PC and printers divisions in a move to cut costs.

"When you try to go from $40 million to $400 million to $1 billion to $2 billion, boy it takes -- it's a whole different ball game," Whitman said in May, of weak Autonomy's-based results.

Whitman didn't think Autonomy should stand on its own two feet, but as part of HP's larger software unit, the legs seem equally shaky.

For more on tech sector M&A and turnaround efforts, see why a BMC Software (BMC) deal is caught between a cloud boom and tech gloom.

Interested in more on HP? See TheStreet Ratings' report card for this stock.

Check out our new tech blog, Tech Trends.

-- Written by Antoine Gara in New York

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