M&A Chatter
Recent press discussion that F5 Networks, Inc. FFIV had hired bankers to explore a sale have led to investor questions that HPE could be a potential acquirer.
"Given the current market capitalization of FFIV (~$7 billion), it would seem low probability to us," analyst James Kisner wrote in a note.
In addition, Kisner said Arista Networks Inc ANET similarly would be a bit on the large side at $4.5 billion – "with an M&A premium it would also be even larger."
On the Brexit front, Kisner noted that post-spinoff Hewlett Packard Enterprise will have "a few points" less than 10 percent revenue exposure to the U.K. However, the company estimates 60–70 percent of RemainCo's operating profit will be coming off the balance sheet or is recurring in nature, potentially blunting the impacts of a potential recession in the U.K. should it occur.
Spin Outs Possible
Hewlett Packard Enterprise still expects a spin out of its Enterprise Services (ES) by March 31, 2017. The company sees no significant regulatory hurdles from the transaction given that the IT Services industry remains highly fragmented.
Moreover, Kisner highlighted that a company divestiture of ES could actually open up some opportunities for the remaining hardware business.
"HPE notes that Computer Sciences Corporation CSC had little incentive to bid deals including HPE hardware given that it was often competing with HPE on the Services side," the analyst elaborated.
The analyst continued that Accenture Plc ACN and International Business Machines Corp. IBM were also less likely to buy hardware from a competitor that they were bidding against in a service deal.
"We understand Dell, who had a smaller Services business, was sometimes a beneficiary of this competitive dynamic as its Services presence isn't as strong as HPE's," Kisner said.
Kisner expects the divestiture of Services to improve the revenue growth profile of the company from low- to mid-single-digits to perhaps mid- to high-single-digits. From an operating margin perspective, the analyst sees EBIT margin improving to the low double digits post-spin.
What It Means
On the cash flow perspective, Kisner noted that the company should see a $1 billion increase in free cash flow (FCF) in FY17. Notably, the company's most recent guidance calls for about $1.8 billion for FY16 FCF and long-term "normalized" FCF around $3.65 billion.
Further, the analyst said Server growth is expected to moderate and Networking is likely to remain the biggest revenue growth driver near-term. The analyst also expects continued growth from Storage and Technology Services units.
Commenting on the Oracle Corporation ORCL settlement, the analyst said, "While we believe that HPE's recent legal victory over ORCL is likely to withstand appeals, the timing and amount (the most recent verdict awarded $3 billion) of the cash inflow remains uncertain."
Kisner remains Buy rated on the stock and raised the price target to $25 from $24.
At time of writing, shares of Hewlett Packard Enterprise had fallen 2.14 percent to $18.09.
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