Monday, June 11, 2012

Ralph Whitworth & Ray Lane Buy Hewlett-Packard Shares

The buying and selling of stock by directors and senior executives is sometimes worth watching even if it's tough to come up with useful insights from their behavior.

With that in mind, recent buys that seem at least worth noting are the purchases at Hewlett-Packard (HPQ). Any move by a director or executive is necessarily difficult to interpret, but that doesn't mean the persistence of the behavior and amounts involved should be ignored.

Raymond Lane recently purchased approximately $ 4 million of stock at an average price of $ 22.17 per share. He then followed that by purchasing roughly $ 1 million more at an average of $ 21.50 per share.

Here's where it gets even more interesting.

Ralph Whitworth also recently purchased, over several days, just under $ 400 million of Hewlett-Packard stock at a price range of $ 21.67 to $ 22.71 per share.

The shares of Hewlett-Packard closed on Friday at $ 22.18 per share and are down as I write this.

Ralph Whitworth is an activist shareholder and the co-founder of Relational Investors. Last November he became one of Hewlett Packard's directors and likely a very important one. These are the first purchases since that happened.
(Relational did hold shares before Whitworth was added to the board. The latest moves more than doubles the stake).

Is this a sign that Whitworth's concluded, after getting a good look the company in the past months, that it is worth putting some more meaningful capital at risk?

Whitworth is known for investing in underperforming companies and pushing for necessary reforms and changes.

At a minimum, with just under $ 400 million of shares being bought near the current price, at least this isn't some minor purchase of the stock by Whitworth. It's real money by just about any standard.

Some think there are many possible reasons to sell a stock but only one reason to buy:

The buyer expects to make money.

I'm not convinced it is as simple as that, but anyone who already liked the shares of Hewlett-Packard shouldn't mind seeing this.

If nothing else governance at Hewlett-Packard may be finally getting stronger. Something that is sorely needed. Poor capital allocation and other blunders have been the norm.

When a high profile insider buys occurs it may or may not be a sign that a stock is cheap. It provides no protection from that cheap stock just getting cheaper.

And that's, of course, just the price action. In the near term or even longer just about anything can occur on that front.

More importantly, it's not like insiders aren't susceptible to misjudging the value of the shares they are buying.

As always the most important reason to buy a stock is because, after doing the necessary work, you've concluded with some conviction what the shares are worth and feel there's a comfortable margin of safety.

In my view, making purchases and sales based upon what others are buying or selling never supersedes this.

It's still sometimes useful to keep an eye on insider buying and selling.

Well, at least it is at the margin.

I'd like to see a more conservative balance sheet (especially for a technology business) but, at a bit more than 5x earnings or so, an awful lot has to continue going wrong at HP for a long-term investor.

Stabilization of the earnings stream (even if it turns out to be at a reduced level) combined with wise capital allocation is, at that valuation, all that is needed. No growth required.

Well, that and probably a whole lot of patience on the part of investors (again, what seems cheap will probably get even cheaper). I won't be surprised if owners of the stock experience substantial paper losses that persist for some time as the many problems are being sorted out. 

As I've said before, I'm generally not a fan of tech stocks as long-term investments. That doesn't mean I won't occasionally take a small stake in a troubled business like HP. If the price provides enough margin of safety, and there's reasonable prospects for the business problems to be fixed in the longer run, I will.

In fact, I do plan to build up a small long position in HP* over time but, in a world where the shares of many higher quality businesses are available at attractive valuations, it seems just barely worth the trouble. There are simpler ways to invest.

In fact, there's just no tech business that I really like owning for the long run. They've always been and always will be, at most, very small positions.

Adam

Small long position in HPQ

Related post:
Technology Stocks

* My position in HP is a small one and far from a favoriteUnlike the stocks I favor the most (those that have wide moats/less dynamic competitive environments), HP's shares will always remain, at most, a very small position that's accumulated slowly as the price declines. A much larger than typical margin of safety is neededAs I said in this post and others, there's just no technology company that I'm comfortable with as a long-term investment. That doesn't make owning shares of HP a short-term trade. A situation this challenging is unlikely to be resolved quickly. I rarely buy anything -- and that includes HP -- unless I'm willing to own the shares for several years or even longer (though frequent traders likely consider several years to be long-term). When I say long-term, I mean that shares of good businesses (bought initially at a fair price or better) can often be held indefinitely. That's just not the case with most tech stocks. So owning some HP shares fits a very different investing model than what I traditionally favor. (Long-term favorites are in the Six Stock Portfolio and Stocks to WatchMost of the stocks in those two posts are core long-term positions. I generally buy more shares of these if and when they sell at a discount to my judgment of value. Unfortunately, most are not all that cheap these days.) As always, I never have an opinion on what a stock will do in any time frame less than a few years. I'll let others try to figure out short or even intermediate run price action though I won't be surprised if HP's shares drop substantially from here and remain lower for quite some time. My focus is risk-adjusted returns over longer time frames. As I've said in other posts, it's actually beneficial when the stock price of a sound business franchise drops further for continuing long-term shareholders. Less money is required to buy each additional share over time while each buyback dollar goes further. The same amount of intrinsic value, whatever it happens to be, is bought for less. Of course, intrinsic value must be judged well and that's far from easy to do with HP. The question is always what the core economics of a business will be over the long haul. Well, HP company has -- to say the least -- difficult competitive threats to deal with and a history of poor capital allocation. Also, the balance sheet is not nearly as strong as most big tech companies (directly related to lots of expensive and dumb acquisitions). So whether it is a sound business franchise is reasonably in doubt. That's where the very low multiple of earnings comes into play. Time will tell whether it can all be sorted out in a way that generates attractive returns. Even if they turn the business around, the process could require lots of capital that may or may not be wisely allocated. There's certainly a wide range of outcomes. Considering all the above, clearly patience and the much larger margin of safety is necessary. Those that think HP's business prospects are on a path to negative free cash flow (or similar undesirable outcomes) are naturally wise to avoid the shares. Otherwise, the valuation is such that HP's business can actually shrink substantially from here and still deliver shareholders an attractive long-term result. 
(i.e. They don't have to become the next IBM: IBM but they do need to manage technology shifts, deal with the related operational challenges, enhance competitiveness in key areas, and prove they can allocate capital effectively. HP needs to develop sustainable advantages and avoid the high cost pursuit of growthLots to prove and it won't be easy.) 

There are huge execution risks and smart capital allocation will, again, be crucial (reducing debt, not overpaying for acquisitions, buying back the stock when cheap) along the way. Trying to understand the risks to a business franchise and whether a sufficient discount exists (considering those risks) is a good use of time and energy. Guessing what the near-term stock price action will be, at least for me, is not. A heavily price action oriented culture may dominate the market environment these days but it's still an option (and in my view wise) to choose to not participate in it.
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