Stock of the week - Hewlett Packard Enterprise (11.01.2024)

• Hewlett Packard Enterprise to acquire Juniper Networks
• HPE stock dropped almost 9% after the announcement
• Takeover price assumes over-30% premium
• HPE struggled to match performance of US broad market indices
• A look at valuation

Hewlett Packard Enterprise (HPE.US) slumped almost 9% on Tuesday after announcing plans to acquire Juniper Networks (JNPR.US) for $40 per share, or over 30% above Monday's closing price. Part of the drop was erased on Wednesday as investors and analysts reassessed impact and rationale behind the acquisition. Let's take a look at the tie-up as well as the valuation of Hewlett Packard Enterprise!

Hewlett Packard Enterprise to acquire Juniper Networks

Hewlett Packard Enterprise (HPE), US company manufacturing data center hardware, announced on Tuesday that it has entered into definitive agreement with Juniper Networks, US company providing internet infrastructure solutions, to acquire the company in an all-cash transaction. Takeover price was set at $40 per share, representing an over 30% premium above Monday's closing price and giving the company's equity value of around $14 billion. HPE CEO said that networking will be a new core business of the company and size of this business line will double following the acquisition. 

However, there are some concerns over the deal. Deal value of $14 billion is more than half the value of HPE.  Given that it will be an all-cash transaction and that HPE had around $4.3 billion in cash at the end of fiscal-Q4 2023, the company will need to take on a lot of new debt. HPE has one of the highest debt-to-equity ratios among US companies from the Computer Hardware & Storage industry, and Juniper Networks acquisition risks doubling it.

Source: Bloomberg Finance LP, XTB Research

HPE stock locked in multi-year sideways move

In spite of US broad market indices posting strong gains in recent years, Hewlett Packard Enterprise stock struggled to match performance of Wall Street indices since it was founded in late-2015 as part of a split of the Hewlett Packard company. While HPE has been outperforming broad market indices at first, situation changed following 2020 Covid pandemic. Stock began to struggle and has traded mostly sideways since. Acquisitions made during this period failed to boost company's share price and this is poor M&A track record is the main concern when it comes to Juniper Networks acquisition.

Source: Bloomberg Finance LP, XTB Research

A look at valuation

Let's take a quick look at Hewlett Packard Enterprise's valuation with 3 often used valuation methods - DCF, multiples and Gordon Growth Model. We want to stress that those valuations are for presentation purposes only and should not be viewed as recommendations or target prices.

Discounted Cash Flow method

Let's start with probably the most popular fundamental model for valuing stocks - Discounted Cash Flow method (DCF). This model relies on a number of assumptions. We have decided to take a simplified approach and base those assumptions on averages for the past 5-years. Detailed forecasts for 10 years were made with terminal value assumptions being set as follows - 2% terminal revenue growth and 7% terminal weighted cost of capital (WACC). Such a set of assumptions provides us with the intrinsic value of Hewlett Packard Enterprise's shares of $20.88 per share - around 27%% above yesterday's closing price. Terminal value accounts for 62% of DCF forecast.

A point to note is that the intrinsic value obtained via the DCF method is highly sensitive to assumptions made. Two sensitivity matrices are provided below - one for different sets of Operating Margin and Revenue Growth assumptions and the other for different sets of Terminal WACC and Terminal Revenue Growth assumptions.

Source: Bloomberg Finance LP, XTB Research

Source: Bloomberg Finance LP, XTB Research

Multiples

Next, let's take a look at how Hewlett Packard Enterprise's valuation compares with peers. We have constructed a peer group consisting of Super Micro Computer, NetApp, Microsoft, IBM, Oracle, Dell Technologies Seagate Technology Holdings and Western Digital - public competitors to Hewlett Packard Enterprise. We have taken a look at 6 different valuation multiples - P/E, P/BV, P/S, P/FCF, EV/Sales and EV/EBITDA.

Taking a look at the table below, we can see that there is some volatility in multiples for Hewlett Packard Enterprise peers. Using median multiples provides us with valuation ranging from $35.73 in case of EV/sales multiple to $212.76 in case of P/BV multiple. A trimmed mean (excluding the highest and lowest valuations) provides us with an intrinsic value of $54.99 per share - over 200% above yesterday's closing price.

Source: Bloomberg Finance LP, XTB Research

Gordon Growth Model

Hewlett Packard Enterprise is a dividend paying company. While HPE kept its dividend payouts unchanged between fiscal-Q3 2020 and fiscal-Q3 2023, company began increasing them recently. This makes it a good candidate for valuation via a Gordon Growth Model - valuation method based on dividends. We have assumed a rather conservative 5% dividend growth rate as well as 8% required rate of return, based on averages and trends for the past 5-years. Running a model with such assumptions leads us to an intrinsic value of $16.80 per share, or around 2% above yesterday's closing price.

As it is usually the case with valuation models, the Gordon Growth Model is also highly sensitive to assumptions made. Sensitivity matrix for dividend growth and required rate of return assumptions is provided below. Green tiles show combinations that result in above-market valuation and red tiles show combinations that result in below-market valuations.

Source: Bloomberg Finance LP, XTB Research

A look at the chart

Taking a look at Hewlett Packard Enterprise (HPE.US) chart at D1 interval, we can see that the stock has been trading mostly sideways recently. Stock rallied and tested the medium-term resistance zone ranging above $17.50 mark on Monday, but Tuesday post-announcement slump pushed the stock down to a 1-month low. Drop was halted at the 50- and 200-session moving averages and started to recover on Wednesday. However, unless a strong catalysts surfaces, HPE stock may remain locked in a sideways move. Should the sell-off resume, the next major support to watch can be found in the $15.50 area. However, bears would need to break below the upward trendline in order to reach this zone.

Source: xStation5