HPQ JPM Oct 9 - 11

This document is being provided for the exclusive use of EVAN TINDELL at BALLENTINE CAPITAL MANAGEMENT, INC.
North America Equity Research

05 October 2011
Hewlett-Packard
Resuming Coverage with an Underweight Rating and a $20 Price Target
Due to the completion of J.P. Morgans involvement in the transaction announced on August 18, 2011, we are resuming coverage with an Underweight rating (previously Neutral) and a Dec-2012 price target of $20 (previously Dec-11 price target of $42). The road ahead appears fraught with macro, secular, and company-specific factors that stand to underpin below-peer revenue and earnings growth potential in our view. While the discounted price-to-earnings valuation multiple could improve as investors contemplate a potential bottoming in the bad news, we see a big offset in chronic downside risk to HPs earnings profile. History is not on HPs side. We think the value status of HPs stock, given the historical low price-to-earnings multiple, is not an attractive one for investors. There are few examples of value stories in large cap technology where high-profile turnarounds both worked and occurred in short order. We can name only two that worked, IBM and Apple, but both of those took more than five years to achieve positive outcomes. HP is just entering year two, implying more pain ahead. Prepare for downside risk from printing, services, and PCs. Our recent J.P. Morgan CIO Survey indicated that CIOs rank printing low on their priorities list. Moreover, services ranked high on the list to be cut first and cut most in a protracted downturn. Given the recent Global PMI reading, which indicated a contraction phase has begun, we expect the low CIO priority status of printing and services to hurt HPs earnings. Add in the fallout from the preannounced PC spinoff plans, and we expect HPs earnings to be at risk to the downside. Autonomy sets an unfavorable precedent for future acquisitions to come. In our view, HP will need to make more organic and inorganic investments to restore above-peer growth potential over the long run. Unfortunately, we think that the Autonomy acquisition set an expensive, unfavorable precedent. We estimate the purchase price equates to 10x TTM total revenue and 20x TTM maintenance revenue, which appear excessive when considering prior IT-related software deals. Kitchen sink reset would be nice, but it is likely deferred. Our new F2012 EPS estimate is $4.33, versus consensus of $4.79. We think that macro-related and company-specific factors could drive our estimate lower, particularly given likely investments in R&D and S&M to restore muscle in the model. A kitchen sink reset would accelerate a potential bottoming, but with a new CEO trying to be more patient than the last one, we think a big reset stands to be deferred.
Hewlett-Packard (HPQ;HPQ US) FYE Oct EPS Reported ($) Q1 (Jan) Q2 (Apr) Q3 (Jul) Q4 (Oct) FY CY Bloomberg EPS FY ($) Revenues FY ($ mn) 2010A 1.07 1.09 1.08 1.33 4.57 4.87 4.52 126,033 2011E 1.36A 1.24A 1.10A 1.12 4.84 4.55 4.83 126,977 2012E 1.09 1.09 1.04 1.11 4.33 4.38 4.79 125,357
Underweight
HPQ, HPQ US Price: $23.02 Price Target: $20.00
IT Hardware Mark Moskowitz

AC
(1-415) 315-6704 mark.a.moskowitz@jpmorgan.com
Anthony Luscri
(1-415) 315-6702 anthony.s.luscri@jpmorgan.com
Mike Kim
(1-415) 315-6755 mike.j.kim@jpmorgan.com J.P. Morgan Securities LLC
Price Performance
50 45 40 $ 35 30 25 20
Oct-10 Jan-11 Apr-11 Jul-11 Oct-11
Abs
YTD -46.1%
1m -2.6%
3m -36.9%
12m -43.4%
Company Data Price ($) Date Of Price 52-week Range ($) Mkt Cap ($ bn) Fiscal Year End Shares O/S (mn) Price Target ($) Price Target End Date
23.02 04 Oct 11 49.39 - 21.50 47.88 Oct 2,080 20.00 31 Dec 12
Source: Company reports, Bloomberg, and J.P. Morgan estimates.
See page 13 for analyst certification and important disclosures.

J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.morganmarkets.com
Mark Moskowitz (1-415) 315-6704 mark.a.moskowitz@jpmorgan.com North America Equity Research 05 October 2011
Investment Thesis
We are resuming coverage of Hewlett-Packard at Underweight. The road ahead appears fraught with macro, secular, and company-specific factors that stand to underpin below-peer revenue and earnings growth potential in our view. While the discounted price-to-earnings valuation multiple could improve as investors contemplate a potential bottoming in the bad news, we see a big offset in chronic downside risk to HPs earnings profile. In our view, the biggest risks to the stocks risk-reward profile are company-specific, relating to consistency, clarity, and competitiveness. These three Cs are what keep us guarded. HP has missed its quarterly earnings three times in a row, and we think there is still risk of more operating disappointments in the near to mid term. Despite the recent CEO change, we are concerned that HPs competitiveness already has been damaged, due to its unclear messaging and abrupt strategic decision-making (i.e., preannounced PC spinoff, sudden end to the TouchPad program, and the ongoing services overhaul).
Key Points
History is not on HPs side We think the value status of HPs stock, given the historical low price-to-earnings multiple, is not an attractive one for investors. Currently, HP trades at 5.3x our C2012 EPS estimate, versus its 5-year low of 7.0x (prior to the August 18 earnings call). There are few examples of value stories in large cap technology where highprofile turnarounds both worked and occurred in short order. We can name only two that worked, IBM and Apple, but both of those took more than five years to achieve positive outcomes. Both turnarounds began in the late 1990s and the successes did not manifest until middle part of last decade. In the case of HP, the companys turnaround is just entering year two, implying more pain ahead. We do not intend to recap in full the last 12 months of abrupt changes and pain in HPs strategy and model. One example, though, was HPs touting of the TouchPad tablet in May as an important growth driver, followed by the sudden termination of the device in August. Another example was the approximately $11 billion acquisition of software maker Autonomy (JPM analyst: Stacy Pollard). In our view, the expensive purchase price for a slowing organic growth profile was not in the best interest of shareholders. With Autonomy, we are concerned that the HP board possibly did not fully vet the software makers growth profile. Unfortunately, we think that the rodeo ride at HP is not over. Given the uncertain macroeconomic environment, we recommend that investors stand clear of HP. We think that the company faces competitive risks in PCs due to its preannounced plans to spin-off or divest the business. The unclear messaging related to the PC business has contributed to competitive displacements, based on our conversations with industry contacts. It is our view that Dell and Lenovo are the early beneficiaries. Also, HP faces challenges in printing and services, due to a combination of secular and macro-related factors, which we discuss later in this report.
On August 18, HP announced its intention to buy Autonomy for approximately $11 billion in cash.
Autonomy sets an unfavorable precedent for future acquisitions to come On October 3, HP closed the Autonomy deal for approximately $11 billion in cash. The acquisition is an expensive one, in our view. We estimate the purchase price equates to 10x TTM total revenue and 20x TTM maintenance revenue, which appears excessive when compared to prior IT-related software deals. Based on our analysis, prior software deals were consummated, on average, at 4-6x revenue and approximately 7-10x maintenance revenues. Although we think the enterprise information management sector is an attractive one for HP to participate in, we do not think it was worth the price paid for Autonomy. We think that Autonomys slowing organic revenue growth profile poses questions around the lofty valuation multiples paid by HP. We are not sure if Autonomys organic revenue growth is that strong, as the company had been increasingly active on the acquisition front. We think Autonomys core product (search for unstructured enterprise data) has seen healthy growth, but the company has been supplementing its overall growth profile with acquisitions to expand its addressable market and prop up the overall growth profile. As for the lingering impact of the expensive purchase price, we think that HP has set an unfavorable precedent that favors the sellers, not shareholders. This dynamic is concerning, in our view, as we believe HP will have to make a series of acquisitions over the next 5-10 years to become a full-fledged, one-stop IT shop. Paying very high prices sets an unfavorable precedent for future acquisitions, which could negatively impact shareholder value beyond the near term. In addition to Autonomy, we think that HPs 3PAR and ArcSight acquisitions made in the last year or so also were expensive ones. Until this strategic issue is tempered, we recommend that investors remain wary of HPs acquisition strategy. Printing not likely to provide much downside support With macro related factors weighing on global GDP and IT spending in general, the growth profile of the printing segment only stands to worsen in the near to mid term. The printing and imaging sector remains a low priority in IT budgets, in our view. Recall that spending for printers, i.e. hardware and supplies, follows worldwide GDP or less in the long run. We think HP, as well as other printing-related stocks, likely face murkier growth outlooks. With the recent recovery in printing completed, the printing segments challenges stand to reemerge as top issues for investors, in our view. The main issues are declining use cases among consumers due to increasing adoption of mobile devices (i.e., smartphones and tablets), and a focus on fleet consolidation and supplies containment in the enterprise segment. Also, HP ended its last quarter with higher than normal printing supplies channel inventory. These channel inventory issues could pose an overhang on HPs eventual recovery, as the related inventory could take longer to clear out. With slowing IT demand, the inventory overhang could persist. The printing segments low priority within IT budgets was highlighted by our recent J.P. Morgan CIO Survey results. The J.P. Morgan CIO Survey, published on September 29, pointed to tougher times ahead in both printing and services. As shown in Table 1 below, printing ranked as a low-priority in IT budgets, which we
think suggests that the segments laggard recovery has ended. As a result, imaging/printing is likely to return to GDP-like growth or less.
Table 1: J.P. Morgan CIO Survey What Are Your Companys Top Five IT Spending Priorities for the Next 12 Months?
100 respondents selected their top five IT spending priorities Priorities Applications software Virtualization of servers Storage hardware/software Server hardware Security Consulting/Sys. Integration PCs Data backup/recovery Virtualization of desktop PCs LAN/WAN optimization Infrastructure software Outsourcing/Mgd. Services Software-as-a-Service (SaaS) Systems mgmt software Printing Total 1 31 17 8 8 4 8 10 3 0 4 8 4 1 2 0 108 2 14 10 7 9 14 5 7 5 4 8 4 4 3 5 1 100 3 9 10 11 9 8 16 6 3 7 2 5 5 5 3 2 101 4 6 11 8 9 4 6 10 7 10 9 8 5 2 1 5 101 5 13 13 8 7 8 3 3 11 6 4 2 6 10 4 1 99 Total Count 73 61 42 42 38 38 36 29 27 27 27 24 21 15 9 509 Wgt. Score 108 91 45 44 36 34 30 26 23 19 17 16 14 6 3 509
Source: J.P. Morgan CIO Survey, September 2011. Note: there were a few respondents that submitted multiple top priorities, which is why the total count is 509 instead of 500.
Services turnaround stands to compound broader secular risks Another risk to the HP earnings story is that it could be a tough road ahead for HP services. Our recent J.P. Morgan CIO Survey indicated that the segment stands to be one of the items cut first and cut most in a protracted macroeconomic downturn. Plus, applications development projects ranked fairly high as top initiatives for the next 12 months. We point out that services vendors can benefit from applications projects, but this area is where HP continues to struggle, as reflected in the companys ongoing overhaul in that business. As a result, we do not think that HPs service business offers investors as much downside support as other service vendors may.
Figure 1: What Areas Are Likely to Bear the Brunt of Sudden IT Spending Cuts?
% of responses
7% 7% 7%
2% Services 36% Hardware Software Staff / Employees Communications Non-essential functions 29% Across the board
12%
Source: J.P. Morgan CIO Survey, September 2011.
HPs services revenue mix and profit issues are likely to be chronic in nature, in our view. We are preparing for a long, bumpy overhaul process. HPs proposed 4 to 6 quarter turnaround in services could take longer than expected due to a combination of macro-related pressures and management turmoil. Overall, the turnaround could be measured in years, in our view. HP has been grappling to improve its business
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since January 2011. The reshuffling of executive leadership earlier this year was only the start. In addition, we think that the recent fall in HPs stock price will likely make it difficult for the company to hire application consultants given the diminished hiring currency of its stock. Given the recent turmoil at the company, we think it could take a while before HP is viewed as a preferred employer. Finally, looking past HP-specific issues, the profit outlook of the services business is not that attractive in our view. While HP expects the operating margin to improve slightly into C2012, a return to prior levels of 15%-plus is not expected in the near to mid term. The company still needs to add additional higher value add capabilities in consulting and in offshore. In other words, HP needs to develop internally or acquire. In our view, either action can introduce incremental operating risk to the model, limiting the potential of achieving and sustaining above-peer revenue and earnings growth at the company level. Potential PC spin-off could hurt HPs channel prowess - an important asset Without tablet and smartphone offerings, we think that keeping the PC business may not be as important to HPs overall channel strategy. In our view, both the tablet and smartphone devices are required to position the PC as a hub. Plus, the PC business is better for revenue than it is for operating profit, as illustrated below in Table 2. In any event, as stated previously, though, we believe that HP already faces competitive risks in PCs due to its preannounced plans to potentially spin-off or divest the business.
Table 2: HP Operating Metrics including and excluding PCs
$ in millions F2007 REVENUE HP Total % Growth YoY HP ex PCs % Growth YoY PCs % Growth YoY % of HP Total OPERATING PROFIT HP Total % Growth YoY Operating margin % HP ex PCs % Growth YoY Operating margin % PCs % Growth YoY Operating margin % % of HP Total $126,292 12.4% $89,883 8.0% 36,409 24.8% 28.8% $10,816 35.1% 8.6% $8,877 29.5% 9.9% $1,939 68.3% 5.3% 17.9% F2008 $135,184 7.0% $92,889 3.3% 42,295 16.2% 31.3% $12,646 16.9% 9.4% $10,271 15.7% 11.1% $2,375 22.5% 5.6% 18.8% F2009 $114,552 -15.3% $79,247 -14.7% 35,305 -16.5% 30.8% $12,589 -0.5% 11.0% $10,928 6.4% 13.8% $1,661 -30.1% 4.7% 13.2% F2010 $126,033 10.0% $85,292 7.6% 40,741 15.4% 32.3% $14,400 14.4% 11.4% $12,368 13.2% 14.5% $2,032 22.3% 5.0% 14.1% F2011E $127,226 0.9% $88,209 3.4% 39,017 -4.2% 30.7% $13,716 -4.8% 10.8% $11,389 -7.9% 12.9% $2,327 14.5% 6.0% 17.0% F2012E $131,271 3.2% $91,352 3.6% 39,919 2.3% 30.4% $12,864 -6.2% 9.8% $10,727 -5.8% 11.7% $2,137 -8.2% 5.4% 16.6%
Source: Company reports and J.P. Morgan estamates
Overall, the unclear messaging related to the PC business has contributed to competitive displacement at customers, based on our conversations with industry
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contacts. We think that Dell and Lenovo are the early beneficiaries. In addition, we believe that the PC business is a critical component of HPs channel and supply chain relationships. If these relations are damaged or reduced as well from the potential spin-off, then there is risk to HPs revenue and cost of sales line items, in our view. Another potential victim is that the PC business is important to pushing the HP brand globally, as well as the pull-through of printer sales on the consumer side, albeit at a diminished rate in recent years. Servers could remain under pressure from the Oracle issue In addition to the printing, services, and PC risks, we believe that HPs high end sever business remains exposed due to the ongoing Oracle issue. Recall, Oracle announced in March that it would no longer support the Itanium platform, impacting about 140,000 joint customers, most of which run Oracle database software on Itanium-based HP Integrity systems. Unfortunately, we do not expect the issue and ongoing litigation to be resolved in the near to mid term. While we expect the megatrends of server virtualization and data center efficiency to provide a backstop to the overall server business, HPs low-end servers could be at risk if macroeconomic uncertainty persists. Without a tablet, HPs role in driving mobile ubiquity likely to fade fast We believe HPs decision to pull the plug on the TouchPad means any semblance of a hub approach to support mobile ubiquity has been tabled. Recall, mobile ubiquity is the mega-trend of providing multiple access points to content. The consumer and corporate shifts to mobile ubiquity are underpinning the increasing focus on mobility integration in the enterprise environment. Prior to the TouchPad termination, we believe HP had been positioning the PC and tablet businesses as a central hub for driving mobile ubiquity. Tablet and mobile device integration was highlighted as one of the top IT priorities in the recent J.P. Morgan CIO Survey. Given the increasing capabilities of mobile and tablet devices, we expect continued penetration of such devices into the enterprise. For example, Apples iPad and iPhone are gaining significant traction in the enterprise in varying application scenarios, and we expect the penetration to increase. Key drivers include product capability improvements and better network speeds. Without a table or smartphone product portfolio, HP will not have a role in the consumerization of IT in the enterprise. Our view on the new CEO: cautiously optimistic New CEO Meg Whitman possesses strong leadership and communication skills. We do have some concerns, though. When at eBay, Ms. Whitman oversaw a major growth phase from start-up to major ecommerce company, but when eBay had to react to changing market forces, eBay appeared flat-footed. Our research indicates that Ms. Whitman was not always willing to make the big changes at eBay near the end, and changes that investors had sought at eBay did not occur until after Ms. Whitmans tenure. This dynamic is why we are cautiously optimistic on the new CEO appointment. There is a big difference between running a web-auction company that at one time enjoyed emerging growth tailwinds and now having to refine the strategy of a large, mature IT company in HP.
J.P. Morgan Global Manufacturing PMI is a solid sanity check on the macro Here, we discuss a sign post for why we expect more macro-related pressures in the near to mid term. The J. P. Morgan Global Manufacturing PMI moved down to 49.9 in September versus the August reading of 50.2. This was the first sub-50 reading since June 2009. We think that September PMI reading going negative points to more pain ahead. We think that developed economies are entering uncharted territory. In particular, governments in the U.S. and EMEA are gradually realizing that the spending spree initiated with the onset of World War II has to be brought under control. As austerity measures usher in more fiscally-disciplined spending and government infrastructure decreases, we expect all industry verticals, including technology, to be impacted. This shift could take years and move at glacial speeds, but we think that the recent macroeconomic slowdown is a sobering preview. In our view, this preview is not likely to facilitate HPs turnaround. In Figure 2 below, we illustrate the trend of the J.P. Morgan Global Manufacturing PMI headline number versus the S&P 500 performance. We bring attention to this correlation given our earlier statement that the macro matters a lot because of the impact on spending conditions, and thus, tech stocks. As illustrated, there is a strong correlation between the global production environment and the business performance of the companies in the composite.
Figure 2: J.P. Morgan Global Manufacturing PMI Is a Solid Sanity Check on the Macro
Source: J.P. Morgan and Bloomberg.
As the above figure illustrates, the J.P. Morgan Global Manufacturing PMI began to roll-over in February and March of this year. A flow-through in deteriorating global production trends has been apparent in the J.P. Morgan Global Manufacturing PMI since then, as recently reported in the September reading. The headline number and new order activity has continued to decline as well.
What Could Make Us Become More Constructive on HP?

Our Underweight rating on HP is based on our view that macro, secular, and company-specific factors stand to weigh on HPs revenue and earnings growth profiles. In addition, HPs higher debt load due to the Autonomy acquisition and its ongoing need to invest in other parts of the data center stand to weigh on the stock in the near to mid term. Plus, the company may not have as much firepower to make impactful acquisitions given the debt load and the unfavorable precedent set with respect to purchase price. There are a few factors, however, that could make us more constructive on the HP story. Most are longer term in nature. In our view, issues at HP will not be easy to correct in the near to mid term. First, we would like to see consistent operational performance in coming quarters. Second, we would like to see a series of less-pricey acquisitions in software, networking, or other verticals. In terms of software, we would prefer organic growth in the near to mid term, versus any more expensive acquisitions. If HP were to make further acquisitions, we would need to see an approach more like IBMs. In other words, the pursuit of smaller, less mature businesses poised for growth, rather than ones fully valued. Other factors that could make us more constructive, but are less likely to occur, include: 1) an orderly PC business spin out, 2) a spin out of the printing business, which could generate significant cash flow for more enterprise acquisitions. Alternatively, HP could potentially even run IPG for cash to fund investments in its enterprise focus. In such a case, HP would need to pull back on IPG investments, so the division could become an even bigger cash flow generation machine. Finally, HP could throw in the kitchen sink reset regarding its EPS outlook. A big reset to the $3.50-4.00 level could reinvigorate investors' appetite for risk exposure to the stock and its long road ahead. In such a case, the valuation multiple likely would improve over time. A kitchen sink reset would give the company more flexibility with respect to its turnaround and investments in growth areas. In this case, HP could significantly expand sales and marketing efforts in software, networking and storage, and also invest incrementally in software research and development.
Earnings Outlook
A financial summary model is presented at the end of this report.
Our estimates for HP now include $1.2 billion in Autonomy-related revenues. The EPS risk could be high if the printing and services businesses deteriorate in the near to mid term. For F4Q11 (October), our revenue and non-GAAP EPS estimates are $31.854 billion and $1.12, versus the Street consensus of $32.110 billion and $1.14. Our gross and operating margin estimates are 23.5% and 9.8%.
Table 3: Hewlett-Packard - J.P. Morgan Estimates

$ in millions, except per share Revenues Gross Margin % Operating Margin % EPS Cash flow from operations Free cash flow Free cash flow as % of sales The Street consensus Revenues EPS
F4Q11 $31,854 23.5% 9.8% $1.12 $2,146 1,158 3.6% $32,110 $1.14
Fiscal 2012 $125,357 23.1% 9.6% $4.33 $12,335 8,607 6.9% $127,290 $4.79
For F2012, our revenue and non-GAAP EPS estimates are $125.4 billion and $4.33, versus the Street consensus of $127.3 billion and $4.79. Our gross and operating margin estimates are 23.1% and 9.6%.
Table 4: Hewlett-Packard Operating Segments - J.P. Morgan Estimates
$ in millions Revenue Segments: Enterprise systems and software Imaging and printing Personal systems Services Financing Total
Fiscal 2012 YoY Growth % 3.9% -3.4% -3.9% -2.0% 2.7% -1.3%
$26,410 25,148 37,262 34,867 3,670 $125,357
Valuation
We are resuming coverage of Hewlett-Packard with an Underweight rating (previously Neutral) and a Dec-2012 price target of $20 (previously a Dec-2011 price target of $42). Currently, HP trades at 5.3x our calendar 2012 EPS estimate (including stock options), versus the peer group average of 9.9x. Our price target is derived from a weighted blend of EV/EBITDA and P/E scenarios (see below tables) utilizing historical peak/trough multiples. The road ahead appears fraught with macro, secular, and company-specific factors that stand to underpin below-peer revenue and earnings growth potential in our view. While the discounted price-toearnings valuation multiple could improve as investors contemplate a bottoming in the bad news, the potential of deteriorating earnings growth could be a bigger offset.
Table 5: Hewlett-Packard P&L Scenarios

$ in millions, except per share data, C2012 Sales Y/Y growth % Operating profit % of sales Interest/other inc. (exp.) Pre-tax income Income taxes Tax rate EPS Y/Y growth % Diluted shares D&A EBITDA % of sales Worst Case $119,441 -5.0% $7,764 6.5% (635) $7,129 $1,568 22.0% $2.72 -40.1% 2,043 $5,044 $12,808 10.7% Base Case $126,110 0.3% $12,097 9.6% (635) $11,462 $2,522 22.0% $4.38 -3.7% 2,043 $5,044 $17,141 13.6% Best Case $132,013 5.0% $16,502 12.5% (635) $15,867 $3,491 22.0% $6.06 33.3% 2,043 $5,044 $21,546 16.3%
Source: J.P. Morgan estimates. Note: Base case represents current J.P. Morgan estimates.
Table 6: Hewlett-Packard EV/EBITDA

$ in millions, except per share data, C2012 EV/EBITDA multiple Implied enterprise value Net debt Implied market cap Implied stock price Probability Average stock price Worst Case 2.5x $32,020 $20,337 $11,683 $5.72 40% $17.56 Base Case 3.5x $59,995 $20,337 $39,658 $19.42 40% Best Case 4.5x $96,957 $20,337 $76,620 $37.51 20%
Table 7: Hewlett-Packard Forward P/E

P/E Multiple Implied stock price Probability Average stock price Worst Case 4.5x $12.25 40% $22.41 Base Case 5.5x $24.07 40% Best Case 6.5x $39.39 20%
Table 8: Hewlett-Packard Blended Price Target

EV/EBITDA P/E Average stock price
Source: J.P. Morgan estimates.
Price $17.56 $22.41 $20.00
Weight 50% 50%
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Risks to Rating and Price Target

Macroeconomic and end-market conditions We believe there are macro, secular, and company-specific factors that stand to underpin below-peer revenue and earnings growth potential for HP. Also, our recent J.P. Morgan CIO Survey indicates that printing and services is most at risk in a prolonged macroeconomic downturn. If global economic conditions do not worsen, or if demand patterns in the key business segments of services, PCs, enterprise systems, and imaging/printing dramatically improve, then our view and estimates related to HP could have upside risk. Competitive dynamics Our view on HP contemplates market share losses in PCs for the company due to its preannounced plans to divest or spin-out the PC business. We also believe that HP could be hurt by a lack of participation in tablets and stable to increasing share potential in servers, storage, and networking. Should competitive pressures ease and result in share gains for HP or an improving profit outlook, our view on HP and its operating model could have upside risk. CEO transition could impact HPs operating consistency We are concerned that HPs competitiveness has been hampered by the management turmoil and the decision to preannounce a potential PC spin-off. We assume that recent CEO turmoil at HP results in disruption to customers and channel partners from the unclear messaging. If the new CEO can construct a bottoming in the recent operating model resets by executing on the services overhaul and PC business spinoff, then our view and estimates could have upside risk. More organic and inorganic investments required We assume that HP will need to make more organic and inorganic investments to restore above-peer growth potential and to transition to more of an enterprise-centric revenue base over the long run. In our view, HPs acquisition of Autonomy was an expensive, unfavorable precedent. We believe HP could make a disruptive acquisition or two with elusive synergies and with the potential to disrupt the companys operating model. Should HP acquire assets at better valuation multiples to provide a better return on investment or not need to make larger acquisitions in the future, than our view and estimates could have upside risk. Incremental operating leverage Our rating and estimates for HP assume that the company faces incremental operating risk over time, particularly as S&M and R&D build-outs are required in the services, software, and networking business. It is our view that HPs services revenue mix and profit issues are likely to be chronic in nature, and will likely require additional investments and management focus. Also, we are concerned that Autonomys organic revenue growth is slowing, and as a result, the integration process may require additional investment to drive growth. If such actions result in sustained or incremental leverage, our view and estimates could have risk to upside over time. In addition, if the services turnaround or the integration of Autonomy require less than expected investment, then our view and estimates could have risk to upside.
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Hewlett-Packard: Summary of Financials

Income Statement - Annual
Revenues COGS Gross profit SG&A R&D Other expense Total operating expenses Operating income Interest expense Other income / (expense) Pretax income Income taxes Net Income EPS PF Options expense per share FAS 123 EPS Diluted shares outstanding
FY10A
126,033 96,089 29,944 12,142 2,904 498 15,544 14,400 (515) 13,885 3,019 10,866 4.79 (0.22) 4.57 2,377
FY11E
126,977 96,566 30,411 13,393 3,298 0 16,691 13,720 (444) 13,276 2,940 10,336 5.10 (0.27) 4.84 2,138
FY12E
125,357 96,349 29,007 13,494 3,523 0 17,017 11,991 (630) 11,361 2,499 8,861 4.61 (0.29) 4.33 2,048
Income Statement - Quarterly

Revenues COGS Gross profit SG&A R&D Other expense Total operating expenses Operating income Interest expense Other income / (expense) Pretax income Income taxes Net Income EPS PF Options expense per share FAS 123 EPS Diluted shares outstanding
1Q11A
32,302A 24,408A 7,894A 3,090A 798A 0A 3,888A 4,006A (97)A 3,909A 879A 3,030A 1.42A (0.06)A 1.36A 2,226A
2Q11A
3Q11A
4Q11E
31,854 24,369 7,485 3,504 873 4,377 3,108 (150) 2,958 651 2,307 1.19 (0.07) 1.12 2,060
Balance Sheet and Cash Flow Data

Cash and short-term investments Inventories Accounts receivable Other Total current assets Net property, plant and equipment Long-term portfolio investments Other assets Total assets Current debt Accounts payable Accrued expenses and other Total current liabilities Long-term debt Other non-current liabilities Total liabilities Shareholders' equity Total liabilities & shareholders' equity Net Income D&A Other Change in working capital Cash flow from operations Capex
FY10A
10,934 6,466 18,481 18,303 54,184 11,763 12,225 46,331 124,503 7,046 14,365 27,992 49,403 15,258 19,061 83,722 40,781 124,503 10,866 4,820 205 (3,969) 11,922 (3,531)
FY11E
5,734 7,498 18,327 17,711 49,269 11,689 11,416 45,956 118,331 6,733 14,688 28,031 49,452 23,059 5,542 78,053 40,277 118,331 10,336 4,964 (1,470) (1,671) 12,159 (3,359)
FY12E
5,811 7,563 18,750 17,949 50,073 11,739 11,570 47,822 121,204 6,590 14,930 28,279 49,799 20,414 7,344 77,558 43,647 121,204 8,861 4,996 (1,535) (237) 12,085 (3,728)
Ratio Analysis
Sales growth EBIT growth EPS growth Gross margin EBIT margin EBITDA margin Tax rate Net margin Return on assets (ROA) Return on equity (ROE) Free cash flow yield
FY10A
10.0% 14.4% 19.0% 23.8% 11.4% 15.2% 21.7% 8.6% 9.1% 26.7% 14.5%
FY11E
0.7% (4.7%) 5.8% 23.9% 10.8% 14.7% 22.1% 8.1% 8.5% 25.5% 12.4%
FY12E
(1.3%) (12.6%) (10.5%) 23.1% 9.6% 13.6% 22.0% 7.1% 7.4% 21.1% 12.3%
Source: Company reports and J.P. Morgan estimates. Note: $ in millions (except per-share data).Fiscal year ends Oct
12
Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.
Important Disclosures
Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for HewlettPackard within the past 12 months. Director: A senior employee, executive officer or director of JPMorgan Chase & Co. and/or J.P. Morgan is a director and/or officer of Hewlett-Packard. Analyst Position: The following analysts (and/or their associates or household members) own a long position in the shares of HewlettPackard: Anthony Luscri. Beneficial Ownership (1% or more): J.P. Morgan beneficially owns 1% or more of a class of common equity securities of Autonomy. Client: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients: Hewlett-Packard, Autonomy. Client/Investment Banking: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as investment banking clients: Hewlett-Packard. Client/Non-Investment Banking, Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients, and the services provided were non-investment-banking, securities-related: Hewlett-Packard. Client/Non-Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients, and the services provided were non-securities-related: Hewlett-Packard. Investment Banking (past 12 months): J.P. Morgan received in the past 12 months compensation for investment banking HewlettPackard. Investment Banking (next 3 months): J.P. Morgan expects to receive, or intend to seek, compensation for investment banking services in the next three months from Hewlett-Packard. Non-Investment Banking Compensation: J.P. Morgan has received compensation in the past 12 months for products or services other than investment banking from Hewlett-Packard.
Hewlett-Packard (HPQ) Price Chart
Date
90 OW $38.5 OW $50.5 $58 OW OW OW $55 OW $41.5 OW $49.5$55 OW OW $42 OW $40 OW $51.5 W $59 O N $42 OW $55 OW $55 OW $57
Rating Share Price ($) OW OW OW OW OW OW OW OW OW OW OW OW OW 45.00 46.42 36.47 36.03 34.08 36.33 44.35 43.83 46.87 49.16 49.70 47.59 39.85 48.14 43.59 36.91
Price Target ($) 55.00 -42.00 41.50 38.50 40.00 49.50 50.50 51.50 55.00 58.00 59.00 55.00 57.00 55.00 42.00
11-Jan-08 18-Mar-08
75
18-Dec-08 OW 05-Feb-09 19-Feb-09 13-Aug-09 19-Aug-09 25-Sep-09 06-Nov-09 12-Nov-09 09-Feb-10 20-Aug-10
60 Price($)
06-May-09 OW
45
30
15
0 Oct 06 Jul 07 Apr 08 Jan 09 Oct 09 Jul 10 Apr 11
07-Feb-11 23-Feb-11
Source: Bloomberg and J.P. Morgan; price data adjusted for stock splits and dividends. Break in coverage Mar 18, 2008 - Dec 18, 2008.
18-May-11 N
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The chart(s) show J.P. Morgan's continuing coverage of the stocks; the current analysts may or may not have covered it over the entire period. J.P. Morgan ratings: OW = Overweight, N= Neutral, UW = Underweight Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst's (or the analyst's team's) coverage universe.] In our Asia (ex-Australia) and UK small- and mid-cap equity research, each stocks expected total return is compared to the expected total return of a benchmark country market index, not to those analysts coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analysts coverage universe can be found on J.P. Morgans research website, www.morganmarkets.com. Coverage Universe: Moskowitz, Mark: Aeroflex (ARX), Apple Inc. (AAPL), Brocade (BRCD), Dell Inc. (DELL), EMC (EMC), Emulex Corp. (ELX), Fusion-io (FIO), Hewlett-Packard (HPQ), IBM (IBM), Lexmark International (LXK), NetApp (NTAP), Orbotech (ORBK), QLogic Corporation (QLGC), STEC (STEC), Seagate Technology (STX), Western Digital (WDC), Xerox Corporation (XRX) J.P. Morgan Equity Research Ratings Distribution, as of September 30, 2011
J.P. Morgan Global Equity Research Coverage IB clients* JPMS Equity Research Coverage IB clients* Overweight (buy) 47% 51% 45% 70% Neutral (hold) 42% 44% 47% 60% Underweight (sell) 11% 33% 7% 52%
*Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category.
Equity Valuation and Risks: For valuation methodology and risks associated with covered companies or price targets for covered companies, please see the most recent company-specific research report at http://www.morganmarkets.com , contact the primary analyst or your J.P. Morgan representative, or email research.disclosure.inquiries@jpmorgan.com . Equity Analysts' Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking.
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This document is being provided for the exclusive use of EVAN TINDELL at BALLENTINE CAPITAL MANAGEMENT, INC.

North America Equity Research

IT Hardware Mark Moskowitz

(1-415) 315-6704 mark.a.moskowitz@jpmorgan.com

23.02 04 Oct 11 49.39 - 21.50 47.88 Oct 2,080 20.00 31 Dec 12

Source: Company reports, Bloomberg, and J.P. Morgan estimates.

See page 13 for analyst certification and important disclosures.

Source: J.P. Morgan CIO Survey, September 2011.

Source: Company reports and J.P. Morgan estamates

Source: J.P. Morgan and Bloomberg.

What Could Make Us Become More Constructive on HP?

Table 3: Hewlett-Packard - J.P. Morgan Estimates

$26,410 25,148 37,262 34,867 3,670 $125,357

Table 5: Hewlett-Packard P&L Scenarios

Table 6: Hewlett-Packard EV/EBITDA

Table 7: Hewlett-Packard Forward P/E

Table 8: Hewlett-Packard Blended Price Target

Price $17.56 $22.41 $20.00

Weight 50% 50%

Risks to Rating and Price Target

Hewlett-Packard: Summary of Financials

Income Statement - Quarterly

Balance Sheet and Cash Flow Data

0 Oct 06 Jul 07 Apr 08 Jan 09 Oct 09 Jul 10 Apr 11

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