Financial MGMT Assignment 1 - IT

Financial Analysis Assignment 1 IT-Industry
Hewlett Packard (HP) vs. IBM vs. Dell

Presented by: Bayer, Stefanie Hermann, Hans-Joachim Popescu, Christian Puzo, Edgars Stoll, Jrgen
Lecturer: Dirk Zimmermann MBA GM06 (Spring 2010)
Due Date: 23.04.2010
Table of contents
Index of Illustrations ......................................................................................................... ii Index of Tables ................................................................................................................. iii 1. 2. The IT Industry .......................................................................................................... 1 Hewlett Packard (HP), IBM and Dell ........................................................................ 4
2.1. Company Profile - HP................................................................................................ 4 2.2. Company Profile IBM ............................................................................................ 4 2.3. Company Profile - Dell .............................................................................................. 5 3. 4. Profit & Loss and financial ratios .............................................................................. 7 Other financial ratios ............................................................................................... 12
4.1. Liquidity................................................................................................................... 12 4.2. Leverage................................................................................................................... 14 4.3. Coverage .................................................................................................................. 15 4.4. Activity .................................................................................................................... 16 4.4.1. 4.4.2. 4.4.3. 4.4.4. 4.4.5. 5. Operating Cycle and Cash Cycle Analysis....................................................... 16 Receivables Turnover Analysis ........................................................................ 19 Payables Turnover Analysis ............................................................................. 20 Inventory Turnover Analysis ............................................................................ 21 Total Asset Turnover ........................................................................................ 22
Recommendations .................................................................................................... 24
Bibliography.................................................................................................................... 26 Appendix ......................................................................................................................... 28
Financial Management
Financial Analysis IT-Industry
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Index of Illustrations
Illustration 1: Forecasted IT Sales 2010 ........................................................................... 1 Illustration 2: Fiscal years of HP, IBM and Dell .............................................................. 7 Illustration 3: Comparison of Gross profit margins .......................................................... 9 Illustration 4: Comparison of Net profit margins ............................................................ 10 Illustration 5: Comparison of ROE ................................................................................. 10 Illustration 6: Comparison of number of shares outstanding .......................................... 11 Illustration 7: Comparison of Earnings per share ........................................................... 11 Illustration 8: Current Ratio of HP, IBM and Dell.......................................................... 13 Illustration 9: Quick Ratio of HP, IBM and Dell ............................................................ 13 Illustration 10: Comparison of D/E Ratio ....................................................................... 15 Illustration 11: Comparison of Debt to Total Assets Ratio ............................................. 15 Illustration 12: Comparison of Interest Coverage Ratio ................................................. 16 Illustration 13: Operating Cycle of HP, IBM and Dell ................................................... 17 Illustration 14: Cash cycle of HP, IBM and Dell ............................................................ 18 Illustration 15: Receivables Turnover of HP, IBM and Dell .......................................... 20 Illustration 16: Payables Turnover in days of HP, IBM and Dell ................................... 21 Illustration 17: Payables Turnover of HP, IBM and Dell ............................................... 21 Illustration 18: Inventory Turnover in days of HP, IBM and Dell.................................. 22 Illustration 19: Inventory Turnover of HP, IBM and Dell .............................................. 22 Illustration 20: Total Asset Turnover .............................................................................. 23 Illustration 21: HP Balance Sheet for October 31st 2007, 2008 and 2009 ..................... 29 Illustration 22: HP Income Statement for fiscal years 2007, 2008 and 2009 ................ 30 Illustration 23: HP Income Statement - Additional subtotals ......................................... 30 Illustration 24: IBM Balance Sheet for December 31st 2007, 2008 and 2009 ............... 31 Illustration 25: IBM Income Statement for fiscal years 2007, 2008 and 2009 ............... 32 Illustration 26: IBM Income Statement - Additional subtotals ....................................... 32 Illustration 27: Dell Balance Sheet for Feb 1st 2008, Jan 30th 2009 and Jan 29th 2010 33 Illustration 28: Dell Income Statement for the fiscal years 2008, 2009 and 2010 .......... 34 Illustration 29: Dell Income Statement Details ............................................................ 35
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Index of Tables
Table 1: Sales, Sales Development and CAGR of the three competitors ......................... 8 Table 2: Gross profit, Operating and Net profit margin of the three competitors ............ 8 Table 3: Liquidity Ratios for HP, IBM and Dell ............................................................ 12 Table 4: Financial Leverage (Debt) Ratios for HP, IBM and Dell ................................. 14 Table 5: Interest Coverage Ratio of HP, IBM and Dell over the last three fiscal years . 15 Table 6: Receivables Turnover for HP, IBM and Dell ................................................... 19 Table 7: Total Asset Turnover for HP, IBM and Dell .................................................... 23 Table 8: Financial Ratios HP .......................................................................................... 35 Table 9: Financial Ratios IBM ........................................................................................ 36 Table 10: Financial Ratios Dell....................................................................................... 37 Table 11: Comparison of HP's Financial Strength to Industry, Sector and S&P 500 ..... 37 Table 12: Interest Coverage Ratio of HP compared to Industry and S&P 500............... 37 Table 13: Direct Competitor Comparison HP, IBM, Dell and Industry Averages ......... 38
1. The IT Industry
Since beginning of 2010, the global IT Industry experienced increasing investment activities in new IT solutions by many companies around the world, reflecting renewed optimism and strengthening balance sheets among IT companies. The technology downturn of 2008 and 2009 is almost over and most pieces are in place for a 2010 tech spending rebound. Many macro-economic indicators have improved over the past six months, lending factual support to the positive perceptions of IT executives, said Tim Herbert, vice president, research at CompTIA (IT Industry Business Confidence Index), in a statement. The IT market of the industrialized countries will stabilize over 2010, France and Germany are expected to grow by 1.4% this year, the US market is still slightly negative and China is growing by 11%, representing the growth engine for the global IT business (Illustration 1).
Illustration 1: Forecasted IT Sales 2010
According to Forrester Research, global ICT (information and communication technology) spending of companies will increase more than 8% in 2010 to $1.6 trillion mainly on the strength of improved hardware and software sales. Focusing on the global IT industry, the market is divided into the three major categories Hardware, Software and IT-Services. Sales for the global IT industry will increase by 5.8% to $1.4 trillion in 2010 and the market will continue to grow by 4% in 2011, as
stated by the European Information Technology Observatory (EITO), an international market research firm. Forrester Research predicts an 8.2% improvement in computer equipment sales and a 9.7% jump in new software sales. IT consulting and systems integration services will grow 6.8%, according to Forrester's latest estimates. We are entering a new six- to seven-year cycle of IT growth and innovation, Andrew Bartels, a Forrester vice president and principal analyst, said 2010 marks the beginning of this next phase of technology advancement. Gartner Inc., the world's leading information technology research and advisory company, sees the biggest growth opportunity in IT-Services over the next years. Most companies within the industrialized countries are investing in modern IT systems again. Financial management companies, the public sector and energy providers are expected to spend more on IT. Therefore providers of software and IT-services are benefiting the most from the recovery. EITO has identified the emerging countries Brazil, China and India as driving forces for stimulating IT market growth over the next years. The BRIC countries are not yet as far advanced in IT as the industrial countries but they are catching up quickly said Prof. August-Wilhelm Scheer, president of the German EITO partner association BITKOM, during a speech at the CeBIT in Hanover, Germany. In the EU, the market will grow in 2010 by only 0.2%, to $423 billion. In the U.S., sales in IT hardware, software and IT services will drop slightly in 2010, down 0.8% to $425 billion but for the BRIC countries IT sales will grow by 11% in average in 2010. New developments in technology have changed the IT environment. Gartner Inc. has identified the driving trends and market opportunities for the IT goods and services industry: Cloud Computing (.allows even the smallest organization to access enterprise-class technology with minimal up-front costs and easy scalability), ITSecurity, Managed IT-Services (e.g. outsourcing services), Mobile Applications (Apple iPhone, mobile commerce etc.) and Green IT (e.g. use of e-documents, reducing travel and energy consumption) Cloud Computing is the biggest market opportunity in Europe assuming growth rates of 20% year over year. The principle of using software applications and computer
performance as needed will become widely established, said Prof. Scheer from the BITKOM association. Taking the potential shift from basic infrastructure investments to IT-solutions that are more focused on driving revenue and efficiency, technology providers that can leverage strong relationships and effectively communicate the business value of technology should continue to see opportunities. More and more customers want technology partners that truly understand their business needs and are able to provide scalable solutions. Providers that focus on these core values, while helping customers understand the potential business impact of IT investments, should see continued success despite the expected economic challenges in the coming year, as stated by CompTIA.
2. Hewlett Packard (HP), IBM and Dell 2.1. Company Profile - HP

HP is an integrated IT provider, which sells products, software and solutions to both consumers and enterprises. HP has a complex global organizational structure of the following business segments: Services, Enterprise Storage and Servers, Software, Personal Systems, Imaging and Printing, Financial Services and Investments. Despite the diversity in its portfolio, HP in the past years started to shift the portfolio mix to IT services direction ( the acquisition of Electronic Data Systems Corporation in August 2008.) by introducing IT outsourcing, Consulting and Technology Services. HP has a leading position in every key products and services segment. In parallel, HP is entering new high margin segments like Networks (in November 2009 definitive agreement to acquire 3Com Corporation). In addition, HP is strengthening regional presence by investing in emerging markets such as Brazil China and India. HP is using different selling channels (direct or partners) depending on the business segment and region. In fact, HP is widely cooperating both with outsourced manufacturers ("OMs") for products and the broad partners base for developing software and IT solutions. In addition, HP is cooperating with third-party OEMs in order to sell some part of their portfolio under HPs brand. The business models for HP products are based on building products to order and configuring products to order. HP is facing competition on different aspects, such as, price, technology and quality. HP has different portfolio elements have different life cycles As well, HP products life cycle is shorter, in opposite, HP services/projects life cycle is longer. HP is continuously investing research and development (2.8 USD billion in fiscal year 2009). Source: (10-K Report HP, 2009)
2.2. Company Profile IBM

IBM is one the largest IT companies in the world, having long history of success and innovations. Through recent years it has been working hard to optimize its portfolio and improve profit margins. And IBM was successful to move from low-margins product business to high-margins IT services and outsourcing.
Financial Management Financial Analysis IT-Industry
Despite having the great success and enjoying high profit margins, IBM is continuing this strategy by divesting the product business and strengthening services along with investments in growth markets. As well as, IBM is driving global programs like Business Analytics and Cloud Computing in order to move higher in value chain. IBM is having a flexible business model with the focus on long-term activities. This model relies on its global capabilities like services, software, systems, research and financing. IBM is accordingly structured into following business units Global Technology Services, Global Business Services, Software, Systems and Technology and Global Financing. IBM is operating on worldwide base, being a global IT provider operating in more than 170 countries. The majority of IBMs revenues come from 6 industries: Financial Services, Public, Industrial, Distribution, Communications, and General Businesses. IBM is facing fear competition on the global and local basis, across all its business units and product/services portfolios. In order to stay competitive, IBM is investing annually around 6 USD billion in research and development. Source: (Annual Report 2009 IBM, 2009)
2.3. Company Profile - Dell

Dell Corporation was setup in 1984 by its founder and current CEO Michael Dell. He brought and realized the new simple concept on the market selling customized computers directly to customers. And this simple concept made Dell the number two supplier of computers in the world. Starting from the narrow range of products Dell was able to expand its portfolio and to step in into IT services area. As well as, Dell was being capable to find new distribution channels to customers through retailers, VARs and distributors. In parallel, Dell was moving from US to new regions and countries around the world. Now Dell is operating in the following segments: Americas; Europe, Middle East and Africa; Asia Pacific-Japan and Globally. The production sites of Dell are setup on the worldwide basis. Nowadays, Dell is more and more using third-party OEMs. Dell is using standard technologies for producing its
products at the same time trying to include all features which can attract customers. Dell currently has the following products categories: mobility products, desktop PCs, software and peripherals, servers and networking, services, and storage. Dell is working in highly dynamic and technology-driven industry with continuous product and price competition. Dell has to manage two crucial aspects: Technological advance and Cost position. Dell is investing a lot in research and development and holds 2,253 patents in 2009. As well as, Dell has implemented several programs for reducing overall costs and reshaping the portfolio of the products in order to improve its product profit margins. Source: (Form 10-K for Fiscal Year 2009 Dell, 2009)
3. Profit & Loss and financial ratios

Looking at the P&L Statements of all 3 companies one can observe that the financial crisis has affected Revenue figures across the board. Costs, generally speaking, have also been reduced in order to weather the difficult economic environment as well as to face increased competition in the fight for market share. In the following, we will take an in-depth look at how HP has been managing their business by looking at its P&L for the last 3 full fiscal years (2007, 2008 and 2009) compared to its peers IBM and Dell. Our analysis is based on the official Financial Statements of the companies given for the fiscal years that overlapped the most. HP set its fiscal year from November 1st until October 31st. For our analysis we used the Financial Statements from 2007, 2008 and 2009 IBM uses the calendar year as the fiscal year. Therefore we also used the Financial Statements from 2007 to 2009. Dell accounts February 1st until January 31st as their fiscal year. To use the most recent numbers we decided to take the Financial Statements from 2008, 2009 and 2010 for our analysis. Below you find a table showing the fiscal years of the three companies and the overlapping months.
Illustration 2: Fiscal years of HP, IBM and Dell
First, in order to get a better picture of how difficult the environment proved to be, specifically in 2009, we can note that all three companies experienced negative growth in terms of Sales revenue. HPs Sales revenue figure dropped by 3.22% compared to 2008. Dells performance negatively outpaced HP by generating 13.42% less revenue during the same period. Although IBM did slightly better than Dell, the company wasnt able to match its 2008 figures. Instead, IBM generated 7.6% less Revenue in 2009. This translated into a CAGR (fiscal years 2007-2009) for HP, Dell and IBM of 4.81%, -1.54% and -6.98% respectively.
2007(08) Sales (in millions), Sales Development from 2007 HP IBM Dell $104,286 $98,786 $61,133
2008(09) $118,364 13.50% $103,630 4.90% $61,101 -0.05%
2009(10) 2009 $114,552 -3.22% $95,758 -7.60% $52,902 -13.42%
2008 and 2008
CAGR (Compound Annual Growth Rate) 2007 2009 HP IBM Dell 4.81% -1.54% -6.98%
Table 1: Sales, Sales Development and CAGR of the three competitors
Based on this underlying information, we begin our in-depth look by looking at the gross profit margin.
2007(08) Gross profit margin HP IBM Dell Operating margin HP IBM Dell Net profit margin HP IBM Dell 6.97% 10.55% 4.82% 7.04% 11.90% 4.06% 6.69% 14.02% 2.71% 24.55% 42.24% 19.09% 8.36% 14.65% 5.63% 24.22% 44.06% 17.93% 8.85% 16.49% 5.22% 23.59% 45.72% 17.51% 8.85% 19.00% 4.11% 2008(09) 2009(10)
Table 2: Gross profit, Operating and Net profit margin of the three competitors
HP has managed to keep this key profitability ratio relatively stable at 24.55% (2007), 24.22% (2008) and 23.59% (2009). This represents a cumulative 0.95% decrease and a negative gross profit margin growth of 3.9% over the three year period. Checking the underlying figures we see that the slight decrease was mainly due to a heavy increase in Costs of services incurred (+105.2%) over the same period. With regards to managing operating expenses, HP was able to maintain its operating margin relatively flat at 8.36% (2007), 8.85% (2008), and 8.85% (2009). The effect of this was passed on to its net profit margin which oscillated from 6.97% (2007), to 7.04% (2008) and finally down to 6.69% (2009). At the same time, Dell has been struggling with a deteriorating gross profit margin of 19.09% (2007), 17.93% (2008) and 17.51% (2009) respectively.
Dells operating margin did not fare any better. During the three year period the operating margin decreased from 5.63% (2007) and 5.22% (2008) to 4.11% (2009). Subsequently, its Net profit margin was almost cut in half beginning at 4.82% (2007), 4.06% (2008) and finally reaching 2.71% (2009). IBM, on the other hand, has not only kept its gross profit margin above an impressive 40%, but has constantly improved from 42,24% (2007) to 44.06% (2008) and 45.72% (2009) respectively. At the same time, IBM was able to reduce its operating expenses by 10.4% (yoy 2009 vs. 2008) which had a follow-through effect on IBMs net profit margin. Due to this effect, net profit margin has accelerated from 10.55% (2007) and 11.90% (2008) up to 14.02% (2009). This translates into an overall growth in net profit margin of 32.9% over the three year period, clearly making IBM Best-in-class with regards to not only maintaining but increasing profit margins (see Illustration 3 and Illustration 4) during an entire macroeconomic contraction.
Gross profit margin

50% 40% 30% 20% 10% 0% HP IBM Dell 2007 24,55% 42,24% 19,09% 2008 24,22% 44,06% 17,93% 2009 23,59% 45,72% 17,51%
Illustration 3: Comparison of Gross profit margins
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Net profit margin

15% 10% 5% 0% HP IBM Dell 2007 6,97% 10,55% 4,82% 2008 7,04% 11,90% 4,06% 2009 6,69% 14,02% 2,71%
Illustration 4: Comparison of Net profit margins
With regards to its stockholders, HP has been able to generate a ROE (Rate of return on common stockholders equity) of 18.47% (2007), 21.18% (2008) and 19.48% (2009). Over the same three year period, Dell generated a ROE of 64.78% (2007), 54.47% (2008), and 31.50% (2009). IBMs ROE increased from 48.40% (2007), 57.30% (2008) to 62.38% (2009). All three companies (see Illustration 5 and Illustration 6) reached these respective figures in part by continuously buying back shares in order to reduce the number of outstanding common stock and thus stabilize or in the case of IBM increase the ROE by 5.07% yoy 2008/2009. Dells fall in net income of 51.4% since 2007, however, has outweighed the positive effect of buying back its shares and therefore could not stop the negative ROE trend illustrated above.
ROE
70% 60% 50% 40% 30% 20% 10% 0% HP IBM Dell 2007 18,47% 48,40% 64,78% 2008 21,18% 57,30% 54,47% 2009 19,48% 62,37% 31,50%
Illustration 5: Comparison of ROE Financial Management Financial Analysis IT-Industry
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No. of shares outstanding (in millions)

3.000 2.500 2.000 1.500 1.000 500 0 HP IBM Dell 2007 2.630 1457 2.223 2008 2.438 1388 1.980 2009 2.388 1341 1.954
Illustration 6: Comparison of number of shares outstanding
Looking at bottom-line figures, HP has been able to keep 2009 EPS (Earnings per share) above the 2007 level of $2.76 at $3.21. However, 2009 EPS came in 4.2% lower than 2008 EPS. Dells 2009 EPS plummeted 41.4% to $0.73 compared to 2008 EPS due to the numerous follow-through effects stated above. IBM once again topped the list by generating a 12.6% increase in earnings to $10.01 for 2009 EPS compared to the year before.
EPS
12 10 8 6 4 2 0 HP IBM Dell 2007 2,76 7,15 1,33 2008 3,35 8,89 1,25 2009 3,21 10,01 0,73
Illustration 7: Comparison of Earnings per share
All in all, HP proves to be on the right track with its current strategy of entering the high margin service sector. Once, HP is able to get a better grip on cost of services while continuing to grow its service business it can replicate the profitability margins IBM enjoys today.
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4. Other financial ratios 4.1. Liquidity

Looking at the current ratios of the three companies, we can see that HP is the least liquid company.
2007(08) Current Ratio HP IBM Dell Acid-Test / Quick Ratio HP IBM Dell 1.00 1.14 1.01 0.83 1.09 1.30 1.08 1.29 1.22 1.21 1.20 1.07 0.98 1.15 1.36 1.22 1.36 1.28 2008(09) 2009(10)
Table 3: Liquidity Ratios for HP, IBM and Dell
The Current Ratio over the last two years as well as the Quick Ratio over the last three years is the lowest one in the group. Especially in the fiscal year 2008 both ratios were with 0.98 and 0.83 lower than 1 which might indicate that HP had difficulties meeting its short-term obligations. Even though both ratios improved last year up to 1.22 and 1.08, the liquidity of HP is not as good as IBMs, who is the best-in-class. IBM reached a Current Ratio of 1.20 in 2007 an improved this ratio up to 1.36 in 2009. In addition, the IBMs Quick Ratio starting with 1.14 in 2007 and a small downturn in 2008 where it dropped to 1.09 increased to 1.29 in 2009. Dell on the other hand has almost the same Current Ratio than HP with 1.28 in 2009. In contrast to HP, Dell had a higher Current Ratio the year before with 1.36, which was even better than IBMs. Looking at the Quick Ratio, Dell shows with 1.22 a much higher ratio than HP in 2009.
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Current Ratio
1,4 1,2 1,0 0,8 0,6 0,4 0,2 0,0 HP IBM Dell 2007 1,21 1,20 1,07 2008 0,98 1,15 1,36 2009 1,22 1,36 1,28
Illustration 8: Current Ratio of HP, IBM and Dell
Also in comparison to the industry average of 1.59 and 1.22 for Current and Quick Ratio (see Table 11), HP has room for improvement of their liquidity. The positive changes from 2008 to 2009 can be explained by HPs reduction of notes payable and short-term borrowings; current assets almost stayed the same (see HPs Balance Sheet, Illustration 21). To further improve liquidity HP could decrease their accounts receivable by paying back suppliers. The resources to do this could be provided for example by issuing stock.
Quick Ratio
1,4 1,2 1,0 0,8 0,6 0,4 0,2 0,0 HP IBM Dell 2007 1,00 1,14 1,01 2008 0,83 1,09 1,30 2009 1,08 1,29 1,22
Illustration 9: Quick Ratio of HP, IBM and Dell
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4.2. Leverage
The degree to which the companies are financed by debt can be analyzed with the Debtto-Equity Ratio.
2007(08) Debt-to-Equity Ratio HP IBM Dell Debt-to-Total-Assets Ratio HP IBM Dell 0.57 0.76 0.86 0.66 0.88 0.84 0.65 0.79 0.83 1.30 3.23 6.35 1.91 7.13 5.20 1.83 3.82 4.97 2008(09) 2009(10)
Table 4: Financial Leverage (Debt) Ratios for HP, IBM and Dell
HP has a very good leverage position which outruns those of its competitors. With a ratio of only 1.3, 1.91 and 1.83 for the fiscal years 2007, 2008 and 2009 HP can be satisfied; the level of usage of borrowed money to money provided by stockholders exceeds those of the two competitors. In comparison, IBMs D/E ratio increased from 3.23 to 7.13 in 2008 and decreased again to 3.82 in 2009. Dells position is worse. Even though the D/E ratio l with 6.35 in 2007, the ratio dropped to 5.20 for 2008 down to 4.97 in 2009, its still the worst of the three competitors. Subsequently the Debt-to-Total-Assets Ratio also shows HPs good position to finance its assets with debt. Around 35% of the financing for the firms assets was provided by shareholders equity in 2009 whereas Dell and IBM could finance only 20% or lower without using borrowed money. Also the years before, HP outperformed its competitors in this area as you can see in Table 4.
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Debt to Equity Ratio

8,0 7,0 6,0 5,0 4,0 3,0 2,0 1,0 0,0 HP IBM Dell 2007 1,30 3,23 6,35 2008 1,91 7,13 5,20 2009 1,83 3,82 4,97
Illustration 10: Comparison of D/E Ratio
Debt to Total Assets Ratio

0,9 0,8 0,7 0,6 0,5 0,4 0,3 0,2 0,1 0,0 HP IBM Dell 2007 0,57 0,76 0,86 2008 0,66 0,88 0,84 2009 0,65 0,79 0,83
Illustration 11: Comparison of Debt to Total Assets Ratio
4.3. Coverage
The Interest Coverage Ratio or Times Interest Earned indicates the ability of a company to cover the interest charges.
2007(08) Interest Coverage Ratio HP IBM Dell 16.42 23.69 76.44 22.43 25.40 34.30 16.98 45.25 13.58 2008(09) 2009(10)
Table 5: Interest Coverage Ratio of HP, IBM and Dell over the last three fiscal years Financial Management Financial Analysis IT-Industry
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Based on the earnings before taxes and the interest expense paid over the last year, HP was able to cover its financial charges 16.42, 22.43 and 16.98 times with its earnings in the years 2007 to 2009. Compared to IBM, who reached 23.69, 25.40 and exceptional 45.25 over the last three fiscal years, and the industry average with 29.3 (see Table 12) this number is relatively low. With exception of the last year also Dell performed better in this category reaching ratios of 76.44, 34.30 and 13.58. Even though this ratio is not dangerously low, HP should be careful issuing more debt and become obligated to pay more interest in the following years.
Interest Coverage Ratio

80 70 60 50 40 30 20 10 0 HP IBM Dell 2007 16,42 23,69 76,44 2008 22,43 25,40 34,30 2009 16,98 45,25 13,58
Illustration 12: Comparison of Interest Coverage Ratio
4.4. Activity 4.4.1. Operating Cycle and Cash Cycle Analysis

HPs operating cycle is between 89 and 80 days with an average of 82 days. Comparing with IBMs average 119 days and Dells 43 days operating cycle this ratio is mainly driven by the firms business model which significantly differs between the three companies. IBM is the IT reference company with a very high service share in their revenues. Consequently, IBM being a giant in the IT service industry is dependent on very large projects characterized by integrated customer financing terms and deferred cash collection. On the payable side internal salaries, fixed cost payments, HW/SW purchases and upfront payments to the supplier base extend the cycle time.
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On the receivable side extended customer payment terms of 102 days on average are a heavy financing burden. As IBM has a lot of financial power more than any competitor - to offer these terms to customers this is most likely also a differentiating factor in the acquisition of new customers and new projects in the market and therefore to some degree part of IBMs business model. Dell on the other hand is focused on HW sales of custom made products. The products are computers of various product lines, predominantly made to customer order. All components, accessories are kept in fast turning warehouses, finished products are shipping direct to the end customer. Inventory is driven by sophisticated forecasting models and employs vendor managed inventories, consignment stocks and well managed own stock for fast turning accessories. An overall operating cycle time of 43 days is proof of an extremely efficient operating model.
Operating Cycle (days)

140 120 100 80 60 40 20 0 HP IBM DELL 2007 89 119 41 2008 78 114 40 2009 80 124 47
Illustration 13: Operating Cycle of HP, IBM and Dell
Cash collection is extremely fast with payment in advance, credit card payments on shipment and cash on delivery (COD). Delivery on invoice is targeted at the business customers and involves short payment terms as well. As a consequence Dells cash cycle indicates a negative time interval of 22 to 25 days which is an outstanding performance. With such a cash model Dell collects payments
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from customers on average 23 days before the suppliers are paid. This allows Dell to keep a high cash amount for investment purposes. As mentioned this is due to a unique operating model (build-to-order and payment on order, shipment or delivery) which cannot be easily copied to the compared companies HP and IBM. HPs revenues have been dominated by HW sales of mainly high-end test- and measurement equipment (which were the roots of the company), computers and printers. During the recent decade HP has sold off the test- and measurement equipment in a spin-off (Agilent), has strengthened their computer product offering due to the acquisition of Compaq and continued to invest in their printer division. Gradually the product offering was complemented with a professional service offering, in particular to support the higher range industrial and server range computer platforms. There is one more distinction between HP and Dell: HP offers standard products off the shelf and hold inventory of finished products in their worldwide distribution network. The financial impact becomes visible in the ratio analysis. According to the HP operating model the operating cycle and cash cycle are characterized by larger time intervals than at Dell. HP has an 82 days average operating cycle vs. Dell 43 days. Keeping finished goods inventory in order to maintain short delivery intervals for buildto-stock products has a financial impact.
Cash Cycle (days)

100 80 60 40 20 0 -20 -40 HP IBM DELL 2007 40 91 -22 2008 35 88 -22 2009 36 95 -25
Illustration 14: Cash cycle of HP, IBM and Dell
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4.4.2. Receivables Turnover Analysis

We have identified the general differences of the receivable turnover for each firm and the relation to the operating model employed.
2007(08) HP IBM Dell 6.67 55 3.56 102 11.10 33 2008(09) 7.57 48 3.74 98 11.09 33 2009(10) 7.33 50 3.46 106 9.60 38
Receivables Turnover / Receivables Turnover in days
Table 6: Receivables Turnover for HP, IBM and Dell
Looking at the development over the past three year period HP shows a flat performance with a 7.5 average turnover rate. The trend line is slightly heading downward. IBM has increased their receivable interval from 102 to 106 days slightly, the turnover rate decreased by 0.1 point. A possible explanation is the competitive situation in the service business and the strategy of the industry heavyweights to use their financial power to keep competitors at a distance. Dell, however, lost ground and the industry leading 33 day receivable interval and 11.1 turns have decreased quite significantly in 2009 by 13% or receivables extended by full 5 days (+15%). This could be attributed to Dells venture into a new sales channel using traditional distribution channels with standard products. As an attempt to increase revenues and sustain growth rates the consequences are that some of the benefits of a made-to-order model are given up. Consequently the financial ratios begin to inch towards those of HP and other competitors in this regard.
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Receivables Turnover
12 10 8 6 4 2 0 HP IBM DELL 2007 7,5 1,5 11,1 2008 7,6 1,5 11,1 2009 7,3 1,4 9,6
Illustration 15: Receivables Turnover of HP, IBM and Dell
4.4.3. Payables Turnover Analysis

The main differences impacting the payable turnover rate are: HPs operating model is based on an outsourced manufacturing model partnering with EMS companies for material sourcing and product manufacturing. The payables intervals have been maintained in a small range of 48 to 43 days, trending lower. Assuming the payment intervals with the EMS companies being in the 30 to 45 day range and stable, the growing share of services may contribute to a shortened payable interval. Salaries and other upfront cost in service contracts may explain this trend. IBM has the shortest payable intervals in the comparison group ranging from 26 to 29 days. This can be attributed to people related cost burden in service and project basis be it internal or external personnel and the consequential short payment periods. Dell has succeeded in extending the payment terms to suppliers even further. Dell is manufacturing computers in their own factories as far as we could find out. Therefore Dell sources directly from the large component suppliers and can leverage its purchasing volume to agree on payment terms in the 60 to 90 day range. Improving the payables terms by 10 days in a 3-year period is a 16% improvement.
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Payables Turnover (days)

80 70 60 50 40 30 20 10 0 DELL IBM HP 2007 62 28 48 2008 62 26 43 2009 72 29 44
Illustration 16: Payables Turnover in days of HP, IBM and Dell
Payables Turnover
10 8 6 4 2 0 HP IBM DELL 2007 7,5 5,6 5,9 2008 8,6 5,6 5,9 2009 8,3 5,1 5,1
Illustration 17: Payables Turnover of HP, IBM and Dell
4.4.4. Inventory Turnover Analysis

HP has managed to reduce inventory from 34 to 31 days which is a very good value for an IT company generating sales from HW products. A continued outsourced manufacturing model and thus minimizing component inventory in combination with an increasing service business with less inventory involved is the explanation for this positive trend. IBM has a relatively flat performance on inventory carried and inventory turns. The service business model employ less inventory compared to its two peers, but does not provide much room for improvement either.
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Dell is setting the benchmark for a fast turning hardware product business. With a mere 8 to 9 days of inventory, ultra high turn rates of 42.3 turns could be achieved. As mentioned this is a result of a build-to-order model the company is built around. The loss of 6.3 turns in 2009 can be attributed to the increased share of sales into traditional computer distribution channels.
Inventory Turnover (days)

40 35 30 25 20 15 10 5 0 DELL IBM HP 2007 8 17 34 2008 8 16 30 2009 9 18 31
Illustration 18: Inventory Turnover in days of HP, IBM and Dell
Inventory Turnover
50 40 30 20 10 0 HP IBM DELL 2007 10,7 21,8 47,9 2008 12,2 22,1 48,6 2009 11,9 19,8 42,3
Illustration 19: Inventory Turnover of HP, IBM and Dell
4.4.5. Total Asset Turnover

This is a comparison of different operating models rather than individual company performance. While HP and IBM maintain their overall asset turns in a relatively small
23
corridor Dells drop in asset turnover is apparent in a decrease of turn rates from 10.2 in 2007, 8.8 in 2008 and 5.4 in 2009.
HP IBM DELL
Total asset turnover 2007 - 2009
Illustration 20: Total Asset Turnover
2007(08) Total Asset Turnover HP IBM Dell 0.074 0.098 0.102
2008(09) 0.083 0.115 0.088
2009(10) 0.078 0.122 0.054
Table 7: Total Asset Turnover for HP, IBM and Dell
24
5. Recommendations
From the preceding financial ratio analysis following key findings can be summarized: HP needs to significantly increase the gross margin HP 24% (2009) IBM 45% (2009) HP needs to significantly increase the net profit margin HP -4% (2007 2009) IBM +33% HP should shorten the operating cycle HPs operating cycle is 82 days on average HP is not as customer oriented as service-heavyweight IBM (119d) HP is not as efficient as Dell (43d) HPs inventory turnover needs improvement HP 31 days Dell 9 days Bottom line: comparing HP to the IT industry benchmarks HP is performing lower on profitability when compared to the #1 IT service provider (IBM) and performing lower on operational excellence compared to the leader in the IT hardware industry (Dell). Trying to become the recognized #1 leading company in one or both segments HP might consider following scenarios: Option 1: Focus on consumer business (B2C) and sell off the professional business (B2B) Option 2: Focus on B2B and sell off the B2C business Option 3: Spin-off professional and consumer business in 2 units, focus and grow each unit in their market to become best-in-class.
Option 3 is our preference. Main reasons are that the goals for each of the two units to become market leaders are achievable faster as synergies in form of technological resources can be leveraged while the risk of timely delays and legal risks are reduced.
25
HP professional: (
increase margins, grow profits)
Strengthen service business, acquire LCC based service resources (WIPRO)
HP consumer: (
increase revenues, margins, turns)
Tailor products to consumer market (cool products, services, marketing) Address mobile IT market; consider partnership with SonyEricsson and Google; leverage dominant printer position
26
Bibliography
10-K Report HP. (2008, 12 18). Retrieved from HP: http://ccbn.10kwizard.com/xml/download.php?repo=tenk&ipage=6033650&for mat=PDF Annual Report 2008 IBM. (2008). Retrieved from IBM: ftp://ftp.software.ibm.com/annualreport/2008/2008_ibm_annual.pdf 10-K Report HP. (2009, 12 17). Retrieved from HP: http://ccbn.10kwizard.com/xml/download.php?repo=tenk&ipage=6658291&for mat=PDF Annual Report 2009 IBM. (2009). Retrieved from IBM: http://www.ibm.com/annualreport/2009/2009_ibm_annual.pdf Form 10-K for Fiscal Year 2009 Dell. (2009, March 26). Retrieved from Dell: http://content.dell.com/us/en/corp/d/corporate~secure~en/Documents~FY09_SE CForm10K.pdf.aspx Form 10-K for Fiscal Year 2010 Dell. (2010, March 18). Retrieved from Dell: http://content.dell.com/us/en/corp/d/corporate~secure~en/Documents~Form 10K for Fiscal Year 2010.pdf.aspx CIO Update Staff. (2010, January 26). 2010 IT Industry Economic Outlook Looking Up. Retrieved from http://www.cioupdate.com/budgets/article.php/3860826 European Information Technology Obsevatory (EITO). (2010, March 3). Global hightech market is growing again. Retrieved from http://www.eito.com/pressinformation_20100303.htm Federal Association for Information Technology, Telecommunications and New Media in Germany (BITKOM). (2010). Annual press conference 2010 of BITKOM. Hanover. MSN Money Central. (n.d.). Retrieved April 5, 2010, from http://moneycentral.msn.com/investor/invsub/results/compare.asp?Page=Financi alCondition&Symbol=HPQ
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OECD. (2009). The OECD Information Technology Outlook 2008. Organization for Economic Co-Operation and Development (OECD). Reuters. (n.d.). Retrieved April 5, 2010, from http://www.reuters.com/finance/stocks/financialHighlights?symbol=HPQ.N Thibodeaux, T. (2010, March 23). Special Report-CompTIAs five Industry Trends to Watch in 2010. Retrieved from CIO Update: www.cioupdate.com Yahoo!Finance. (n.d.). Retrieved April 5, 2010, from http://finance.yahoo.com/q/co?s=HPQ
Appendix
29
Illustration 21: HP Balance Sheet for October 31st 2007, 2008 and 2009
Source: (10-K Report HP, 2008) and (10-K Report HP, 2009)
30
Illustration 22: HP Income Statement for fiscal years 2007, 2008 and 2009
Source: (10-K Report HP, 2008) and (10-K Report HP, 2009)
Illustration 23: HP Income Statement - Additional subtotals
Own calculations based on (10-K Report HP, 2008) and (10-K Report HP, 2009)
31
Illustration 24: IBM Balance Sheet for December 31st 2007, 2008 and 2009
Source: (Annual Report 2008 IBM, 2008) and (Annual Report 2009 IBM, 2009)
32
Illustration 25: IBM Income Statement for fiscal years 2007, 2008 and 2009
Source: (Annual Report 2008 IBM, 2008) and (Annual Report 2009 IBM, 2009)
2007 27.255 14.474 2008 28.570 17.091 2009 25.595 18.190
Operating Expenses (SG&A, R&D, Int. Property) Operating Income
Illustration 26: IBM Income Statement - Additional subtotals
Own calculations based on (Annual Report 2008 IBM, 2008) and (Annual Report 2009 IBM, 2009)
33
Illustration 27: Dell Balance Sheet for Feb 1st 2008, Jan 30th 2009 and Jan 29th 2010
Source: (Form 10-K for Fiscal Year 2009 Dell, 2009) and (Form 10-K for Fiscal Year 2010 Dell, 2010)
34
Illustration 28: Dell Income Statement for the fiscal years 2008, 2009 and 2010
Source: (Form 10-K for Fiscal Year 2009 Dell, 2009) and (Form 10-K for Fiscal Year 2010 Dell, 2010)
35
Illustration 29: Dell Income Statement Details
Own calculations based on (Form 10-K for Fiscal Year 2009 Dell, 2009) and (Form 10K for Fiscal Year 2010 Dell, 2010)
Table 8: Financial Ratios HP
Own calculations based on (10-K Report HP, 2008) and (10-K Report HP, 2009)
36
Table 9: Financial Ratios IBM
Own calculations based on (Annual Report 2008 IBM, 2008) and (Annual Report 2009 IBM, 2009)
37
Table 10: Financial Ratios Dell
Own calculations based on (Form 10-K for Fiscal Year 2009 Dell, 2009) and (Form 10K for Fiscal Year 2010 Dell, 2010)
Table 11: Comparison of HP's Financial Strength to Industry, Sector and S&P 500
Source: (Reuters)
Table 12: Interest Coverage Ratio of HP compared to Industry and S&P 500
Source: (MSN Money Central)

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Table 13: Direct Competitor Comparison HP, IBM, Dell and Industry Averages
Source: (Yahoo!Finance)

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Financial Analysis Assignment 1 IT-Industry

Hewlett Packard (HP) vs. IBM vs. Dell

Lecturer: Dirk Zimmermann MBA GM06 (Spring 2010)

Due Date: 23.04.2010

Bibliography.................................................................................................................... 26 Appendix ......................................................................................................................... 28

Financial Analysis IT-Industry

Financial Analysis IT-Industry

Financial Analysis IT-Industry

Illustration 1: Forecasted IT Sales 2010

Financial Analysis IT-Industry

Financial Analysis IT-Industry

Financial Analysis IT-Industry

2. Hewlett Packard (HP), IBM and Dell 2.1. Company Profile - HP

2.2. Company Profile IBM

2.3. Company Profile - Dell

Financial Analysis IT-Industry

3. Profit & Loss and financial ratios

Illustration 2: Fiscal years of HP, IBM and Dell

2008(09) $118,364 13.50% $103,630 4.90% $61,101 -0.05%

2009(10) 2009 $114,552 -3.22% $95,758 -7.60% $52,902 -13.42%

2008 and 2008

Gross profit margin

Illustration 3: Comparison of Gross profit margins

Financial Analysis IT-Industry

Net profit margin

Illustration 4: Comparison of Net profit margins

Illustration 5: Comparison of ROE Financial Management Financial Analysis IT-Industry

No. of shares outstanding (in millions)

Illustration 6: Comparison of number of shares outstanding

Illustration 7: Comparison of Earnings per share

4. Other financial ratios 4.1. Liquidity

Table 3: Liquidity Ratios for HP, IBM and Dell

Financial Analysis IT-Industry

Illustration 8: Current Ratio of HP, IBM and Dell

Illustration 9: Quick Ratio of HP, IBM and Dell

Financial Analysis IT-Industry

Financial Analysis IT-Industry

Debt to Equity Ratio

Illustration 10: Comparison of D/E Ratio

Debt to Total Assets Ratio

Illustration 11: Comparison of Debt to Total Assets Ratio

Interest Coverage Ratio

Illustration 12: Comparison of Interest Coverage Ratio

4.4. Activity 4.4.1. Operating Cycle and Cash Cycle Analysis

Financial Analysis IT-Industry

Operating Cycle (days)

Illustration 13: Operating Cycle of HP, IBM and Dell

Cash Cycle (days)

Illustration 14: Cash cycle of HP, IBM and Dell

Financial Analysis IT-Industry

4.4.2. Receivables Turnover Analysis

Receivables Turnover / Receivables Turnover in days

Table 6: Receivables Turnover for HP, IBM and Dell

Financial Analysis IT-Industry

Illustration 15: Receivables Turnover of HP, IBM and Dell

4.4.3. Payables Turnover Analysis

Financial Analysis IT-Industry

Payables Turnover (days)

Illustration 16: Payables Turnover in days of HP, IBM and Dell

Illustration 17: Payables Turnover of HP, IBM and Dell

4.4.4. Inventory Turnover Analysis

Financial Analysis IT-Industry