EUR 850.00 For Business Accounts Only

Morningstar | Formidable Foes Expected to Challenge HPE's Transformational Plan; Lowering FVE to $15. See Updated Analyst Note from 10 Nov 2018

Hewlett Packard Enterprise's concerted effort to shift toward nascent IT infrastructure trends should help make fiscal 2018 its first year of growth as a standalone company. Although we expect strong demand for HPE's embryonic products and services in the near-term, HPE's largest revenue streams are commoditized products within competitive markets. In our view, the challenge facing HPE is the ability to deliver durable technological advantages over peers in the long run. For this no-moat name, we are decreasing our fair value estimate to $15 per share from $19.50.

We posit HPE may expand its operating performance by selling higher-margin offerings such as hybrid cloud solutions, hyperconverged infrastructure, and intelligent edge products. Additionally, HPE is focused on streamlining its operating model while consolidating manufacturing and support services. While we like HPE's decision to pare back selling servers to the public cloud titans because of profitability issues, we remain concerned about the competitiveness within HPE's largest markets. As enterprises migrate to cloud environments, the need for HPE's hardware and services may decline; however, we posit that HPE has intelligently acquired cloud migration and analytics firms which allow the firm to profit from clouds as well. Although HPE's strategic shift may help stem losses from any IT infrastructure slowdowns in the near-term, we note that the hybrid cloud model is shared with its industry-leading peers.

As data proliferates expeditiously, networks are transforming to process data closer to the end users, or the network edge, for efficiency purposes. HPE's business outlook may hinge on its strategic network edge focus and its ability to cross-sell hybrid cloud solutions to permeate HPE solutions throughout enterprise networks. Although we like HPE's strategic direction, we are concerned about HPE's ability to be less reliant on server revenue while showcasing success in difficult adjacent markets.

HPE is a leading supplier of IT infrastructure products and services. Revenue is generated by selling computing servers, data storage arrays, networking equipment as well as providing technical and financial services. After appointing a new CEO in 2018, HPE is focused on profitability and exceling within nascent IT infrastructure trends.

HPE's largest revenue stream, commoditized industry standard servers, is within a competitive market with large brand name foes and low margin white box manufacturers. To combat profitability concerns, HPE pared back its sales of servers to hyperscale cloud providers and shifted toward expanding margin accretive areas like hyperconverged infrastructure, network edge products, and hybrid cloud solutions. We posit that HPE should benefit from IT infrastructure upgrades in the short-term. However, we do not expect HPE to gain a long-term competitive advantage over peers who offer similar portfolios or pure-play companies focused on a sole aspect of HPE's offerings.

We do appreciate HPE's hybrid cloud strategy that contains Pointnext, GreenLake and OneSphere. HPE offers the capital expenditures-favorable public cloud pay-per-usage model for on-premises and private clouds. To bolster its cloud strategy, HPE acquired firms with public cloud integration and cloud analytics expertise. In our view, HPE can position itself as a one stop shop with hardware for on-premises and private clouds while selling software and services to manage and optimize an enterprise's entire network. While we like this flexible sales approach, we believe that competitors mimicking this consumption-based model may limit the quantity of enterprises that chose HPE.

Our forecast five-year revenue CAGR of 1% assumes HPE starts to experience top-line contraction in fiscal 2021. We expect HPE's intelligent edge to post strong growth as enterprises install more software-defined networking and use more wireless products closer to the end users. Alternatively, we expect a difficult pricing environment for servers and storage to outweigh the benefits for nascent IT networking product sales.

We model operating margins to increase to the high-single-digits through our explicit forecast period from fiscal 2017's result of 6.5%. Better operating performance may be realized through HPE expanding its gross margins, and we expect HPE's restructuring, consolidation, and cost savings program to enable lower product costs while gaining some SG&A and R&D efficiencies. However, we model that HPE's compute and storage segments will drag on HPE's hybrid IT segment's performance long-term. Although we believe HPE will benefit from hybrid cloud solutions, hyperconverged infrastructure, and all-flash array storage spending, we expect a competitive pricing environment for commoditized servers and storage to weigh on HPE's consolidated results.