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Morningstar | Hewlett Packard Enterprise Intends to Purchase Cray for Supercomputing and Big Data; $15 FVE Intact

No-moat Hewlett Packard Enterprise announced its intention to purchase Cray for $35 per share, for a transaction value of around $1.3 billion, net of cash. Cray is a leading provider of supercomputers and high-performance storage solutions; its products are used for data intensive processing. We view the acquisition positively. In the high-performance compute market, Hewlett Packard Enterprise mostly sells into enterprises with mid-tier products while Cray sells high-end solutions that have been government-centric. As data continues to expand exponentially and faster processing of enormously large and complex data sets is required, we believe Hewlett Packard Enterprise has gained technology it can integrate into enterprise solutions and its scale can help Cray's profitability and customer reach. After considering the acquisition's impact, we maintain our fair value estimate of $15 per share and the stock remains in 3-star territory.

Cray products are used in areas such as surveillance, security, weather forecasting, scientific modeling, financial applications, and various engineering and life sciences applications.  Cray products account for  28 of the top 100 supercomputers, and the company was awarded the first two U.S. Exascale computing contracts, worth over $700 million, which are forecast to be the fastest computing systems and to be used for artificial intelligence and research. The growth in high-performance compute as companies utilize artificial intelligence and machine learning to sift through big data collections should be a boon for Hewlett Packard Enterprise, although we still expect stiff competition from the likes of IBM, Google, and Microsoft. In our view, the firm's movement toward offering computing as a service became bolstered through this acquisition, as it can now offer multiple tiers of services depending on complexities. The transaction is subject to normal closing conditions and expected to close by the first quarter of fiscal 2020.

Cray's last year of operating profit and positive net income was in 2016. The company's top line grew by 16% in 2018, but gross margin declined to 29% from 33% year over year and operating margin in 2018 was a 16% loss (17% loss in 2017). We believe Hewlett Packard Enterprise's much larger economies of scale should help turn around the financial performance of Cray, and the acquisition comes at an opportunistic time as data proliferates and Cray has proven it still has strong technology via winning contracts for the next wave of supercomputing.