Tech's pioneers have been left behind. Their stocks are cheap—and complicated

  • By Eric J. Savitz,
  • Barron's
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Tech stocks are having their best year in a decade, with investors increasingly excited about future opportunities in the cloud, artificial intelligence, and data analytics.

That buzz, however, is leaving a group of legacy tech companies in an awkward spot, as they struggle to stay relevant.

Cisco Systems (CSCO), IBM (IBM), Intel (INTC), Oracle (ORCL), Seagate Technology (STX), Western Digital (WDC), Xerox Holdings (XRX), HP Inc. (HPQ), and Hewlett Packard Enterprise (HPE) still employ a total of 900,000 people. They account for $363 billion in annual revenue and $840 billion in stock market value. But their sales, accounting for inflation, are mostly going in reverse. The best of the bunch, Western Digital, is forecast to grow 4.4% next year. Xerox, the worst, is likely to see a 4.7% decline.

Wall Street bankers have begun to mount a rescue effort. In early November, Xerox made a surprising $33 billion offer to buy HP Inc., trying to jump-start its moribund growth strategy. HP Inc.,no paragon of expansion itself, has rejected the deal. Xerox is threatening to take its offer directly to HP Inc. shareholders, setting up a bruising battle. The skirmish is symbolic of a larger issue: Legacy tech has stopped growing, and there are no easy fixes.

Technology is going through simultaneous revolutions, but it all starts with the cloud. By 2025, half of the world’s data will sit in public clouds, according to market research firm IDC. Amazon Web Services, Microsoft Azure, and Alphabet’s Google Cloud are vacuuming up the enterprise sales that once went to on-premises data-center providers, a world dominated by companies like Oracle, Cisco, and IBM.

Meanwhile, there is a parallel, but related, business-model transformation. Software and even hardware are increasingly being sold via subscriptions. Microsoft (MSFT) sells Office as a service. Adobe (ADBE) sells its Creative Suite design software as a service. Apple (AAPL) sells TV, music, storage, and videogames, all via subscription. Those tech pioneers have remade themselves, and no investor would use legacy to describe their businesses. Their stocks all trade north of 20 times earnings.

The companies in our legacy tech universe, in comparison, all trade from nine to 14 times earnings, well below the broader market.

HP Inc. is trying to turn printers and ink into a subscription service. Cisco and IBM are aggressively building recurring models that blend hardware and software sales. HP Enterprise, which makes enterprise servers and storage systems, has vowed to convert its entire product suite into “as a service” offerings by 2022.

Steve Milunovich, technology strategist with Wolfe Research, notes that all seven of the tech companies with the largest market caps are platform businesses: Apple, Microsoft, Alphabet (GOOGL), (AMZN), Facebook (FB), Alibaba Group Holding (BABA), and Tencent Holdings (TCEHY). What they have in common is that their value comes from their users—they attract crowds. That’s true for public clouds, social networks, media platforms, and e-commerce, but not for purveyors of hardware to a small group of corporate tech buyers.

Forrester Research founder and CEO George Colony, who has been analyzing the tech industry for more than 35 years, says that we have entered “the age of the customer,” with corporations and governments losing power to users. “Companies focused on customers have massively higher market caps than those selling back-office technology,” he notes. Alphabet, Amazon, Apple, Facebook, and Microsoft together are worth $4.7 trillion.

Historically, tech companies have used two strategies to survive generational change: engineering, or financial engineering. They can innovate, or hire bankers.

The financial-engineering path rarely works, but hope springs eternal. Thus, Xerox is trying to fend off growing irrelevance and shrinking revenues by offering to buy the much larger HP Inc.

For any legacy tech executive or investor, the experience of Microsoft offers hope. The stock is up nearly fivefold since CEO Satya Nadella took the reins from Steve Ballmer in 2014. Double-digit revenue growth has helped push the company to a $1 trillion-plus valuation.

“Legacy companies rarely recover,” Wolfe’s Milunovich says. “Satya found a new leg of growth in the cloud, building on their enterprise strengths, but that’s the exception to the rule.”

Then again, few investors foresaw Microsoft’s resurgence. Here’s how we handicap legacy tech’s chances of pulling off another Microsoft-like feat.

HP Inc., Xerox Holdings

Xerox and HP Inc. have storied histories, and troubled presents. Xerox began over a century ago as a manufacturer of photographic paper. In the 1970s, the Xerox Palo Alto Research Center, or PARC, produced an astonishing wave of innovation, including Ethernet networking, laser printers, graphical user interfaces, and the computer mouse.

Now an enterprise copier company, Xerox has been shrinking for nearly a decade. Revenue, which peaked at $22.6 billion in 2011, is forecast to be $9.1 billion this year.

Hewlett-Packard, meanwhile, laid the foundation for modern-day Silicon Valley: William Hewlett and David Packard teamed up in 1939, building an audio oscillator for Walt Disney.Bill and Dave’s Palo Alto garage is on the National Register of Historic Places; HP Inc. maintains the old HP Labs offices as a shrine. HP’s latest effort at rediscovering growth was splitting the company into two parts: Hewlett Packard Enterprise, which sells servers and other enterprise gear, and HP Inc., which makes PCs and printers.

For Xerox, the HP Inc. offer is a Hail Mary. HP Inc. has sales of nearly $60 billion, more than six times those of Xerox, and a market value about 3.5 times greater. Xerox can’t do the deal without taking on a huge amount of debt.

Both companies are already cutting costs — HP Inc. has a $1 billion reduction plan, while Xerox has identified $640 million in expense cuts. The new discipline has helped push Xerox’s stock up 96% this year. An HP Inc.–Xerox combo could offer some additional cost-cutting opportunities and create a more robust competitor to copier rivals like Canonand Ricoh.But this isn’t a fix for growth; neither company is expanding. And the combination would do nothing to address HP Inc.’s core woes: a secular decline in printing and the steady deterioration of its consumables business, as more customers buy cheap third-party ink.

Forrester Research’s Colony says of a potential HP Inc. – Xerox tie-up: “It’s the mating of zombies.”

Xerox says a deal “would create an industry leader — with enhanced scale and best-in-class offerings across a complete product portfolio — that will be positioned to invest more in innovation and generate greater returns for shareholders.” HP Inc. says the offer undervalues its business and would require massive leverage, and that it is confident in its own business plan.


Big Blue might have the best chance at transforming itself for the cloud era. To be sure, the company has been trying to find the right formula for years, with a more recent focus on artificial-intelligence platform Watson and “cognitive computing.” In 2011, the Watson supercomputer’s appearance on Jeopardy! earned the AI platform plenty of fame, but not much else; humans are again breaking records on the game show. But Watson hasn’t put IBM in the AI or cloud elite. The company’s latest effort relies on its $34 billion acquisition of Red Hat in June. IBM hopes the open-source software leader can help it gain ground in the cloud—the clear target is Google, the No. 3 public cloud player after AWS and Azure.

IBM’s enterprise computing knowhow gives the company some advantages. And the company has a successful history of reinvention. It has built and sold large businesses in desktop PCs, laptops, printers, disk drives, and semiconductors. Today, IBM’s vast workforce—more than 350,000—is mostly in services and information-technology consulting.

Colony thinks that IBM can nose past Google into the cloud-computing leadership tier.

“If I had to handicap, it’s really a two-horse race between AWS and Microsoft,” he says. “Microsoft in its DNA is a software company. And the cloud is not about storage. It’s about processing data and creating software. Microsoft has succeeded in cloud as an enterprise player. Google has never really taken the enterprise very seriously. It’s their hobby, not their business. Enterprise is IBM’s business. It’s what they do, and they can pass Google.”

IBM stock is up 18% this year—well below the broad market—and it trades near an all-time low valuation of 10 times earnings estimates for the next 12 months. Investors aren’t giving the stock much chance, which means that any positive surprises could deliver big results for shareholders.

Cisco Systems

Cisco’s routers and switches remain vital cogs in a cloud-based world. But the company is facing serious near-term issues. In mid-November, Cisco shook the market by warning that January-quarter revenue would be down 3% to 5% from the level a year earlier, far worse than investors had anticipated.

In an interview with Barron’s after the warning, Cisco Chief Financial Officer Kelly Kramer said order weakness, which emerged a quarter earlier, “got a little worse.” She pointed to softness from both telecom-service providers and emerging markets, but added that the issues are spreading, with “order pressure in all of our regions.”

Cisco, long a diversified global company, has been candid about pressures from the trade war. The macro noise is overshadowing Cisco’s progress in transforming its underlying business. The company remains the dominant player in enterprise networking—and several years ago began the process of building subscription services on top of its networking business. Wolfe’s Milunovich calls Cisco “the best house on a bad block,” and argues that networking is less secularly challenged than servers, storage, printers, or PCs. CEO Chuck Robbins, he says, “has done a good job reinvigorating innovation.”

Anuj Kapur, Cisco’s chief strategy officer, remains optimistic about the company’s growth prospects. He points out that global IT spending, at $3.8 trillion, is just a fraction of global gross domestic product at $84 trillion. “There’s still room for IT to be more of the total,” he says.

“The cloud was supposed to simplify and enable agility,” Kapur says. “It’s also created a conversation around added complexity, with multiple operating environments. In the old world, we’d do updates over an 18-month development period. Now, we’re updating code six times a day. It’s an ephemeral environment, highly distributed, with operational complexity. Your applications live in the cloud, but your customers rarely do. We’re committed to helping customers drive growth on premise, at the edge of the network, and in the cloud.”

Cisco shares are down 18% since July, and the stock fetches less than 14 times year-ahead earnings estimates. Analysts have an average target price of $52, 15% above Cisco’s recent close of $45.

Hard-Disk Makers

Given the astonishing rate at which the world is generating data, you would think there would be a huge opportunity for disk-drive companies like Seagate and Western Digital. But for the drive companies, the picture is muddled, at best. PCs have already shifted to flash-based storage, and now lower-cost flash is also replacing disks in enterprise applications.

Seagate is betting on a new storage technology called heat-assisted magnetic recording, or HAMR, which should increase the capacity of the largest drives from 16 terabytes today to 50 TB by 2026. But the industry has a long history of growing storage capacity without much reward.

Buying disk-drive stocks is a bet on the boom in data growth. An IDC study for Seagate last year projected that the global “datasphere” will increase more than five times, to 175 zettabytes by 2025 from 33 ZB in 2018. (A zettabyte is 1,000,000,000,000,000,000,000 bytes.)

Jason Feist, Seagate’s managing technologist, says HAMR can drive 20% annual growth in “areal density” for at least another 10 years. “We continue to focus on innovating to make sure our customers can deploy the largest disk drives possible,” he says.

Drives are not disappearing, and both Seagate and Western Digital pay handsome dividends, with yields of 4%—but the math works against a return to significant top-line growth. Colony says the drive companies must contend with Hitachi’s Law, which is like Moore’s Law, but for storage: that the amount of data you can store for the same cost doubles every two years. “That’s what they’re fighting,” he says. “A commodity that is much more efficient every single year.”


Intel remains the dominant player in PC and server microprocessors, but it has been shut out of the mobile market. Smartphones rarely carry Intel processors. Now, the company is pushing aggressively into new markets like processors tuned for machine learning and AI. But Wolfe’s Milunovich cautions that Intel has lost its once-commanding advantage in semiconductor-process technology to contract chip maker Taiwan Semiconductor Manufacturing (TSM).

“It is not clear that Intel is going to catch up,” Milunovich says. He notes that conventional microprocessors have become less central to computing, with graphics processors from Nvidia (NVDA) and others playing a crucial role in AI applications.

Forrester’s Colony notes that some cloud players are building their own processors while quantum computing is on the horizon, posing a new long-term issue for Intel and traditional computing. “Massive changes are coming,” Colony says.


Oracle is bulking up spending and staffing on Oracle Cloud, as the database and enterprise application software giant adjusts to the “everything as a service” world. The company has a dual strategy, offering cloud versions of its own software, while taking aim at the public cloud market dominated by Azure, AWS, and Google. In a recent meeting with analysts, CEO Safra Catz said that Oracle expected to see revenue accelerate in 2020, driven in part by adoption of the company’s “second generation” cloud. That “is the architecture our customers have been waiting for,” she said.

Oracle has said that Amazon’s cloud is insufficient for robust enterprise applications. But Milunovich cautions that Oracle’s capital spending is small versus that of the three “hyperscalers”—and the reality is that the cloud lives on the ground in giant capital-intensive data centers. Long an aggressive acquirer (Sun Microsystems, PeopleSoft, and Siebel Systems, among others), Oracle will need to innovate its way into the cloud’s elite tier.

Despite negative revenue growth in four of the past six years, Oracle’s stock is up 24% this year. At 13.8 times forward earnings, the shares are pricier than many of its legacy tech counterparts.

Hewlett Packard Enterprise

HP Enterprise has vowed to adopt an everything-as-a-service model, while continuing to make niche hardware acquisitions.

“They’re in a tough spot,” Milunovich says. “To me, they’re a poor man’s Cisco and Dell, competing with larger companies, both in networking and computing.” He adds that CEO Antonio Neri “has done a good job with a tough hand,” but HPE’s business model revamp is “necessary, but not sufficient.”

Milunovich adds that HP Enterprise has been beating numbers by cutting costs, but that “they are just not capturing customers’ minds.”

This past week, HP Enterprise shares fell sharply after the company reported disappointing results for its fiscal fourth quarter, ended on Oct. 31. Revenue was $7.2 billion, flat sequentially, down 9% year over year, and below the Street consensus of $7.4 billion. While non-GAAP profits topped guidance, continuing a pattern of better profitability on shrinking revenue, investors have lost confidence in the company’s near-term return to top-line growth.

In the best of worlds, legacy players will come up with new business models. But even then, they will still be dealing with crumbling models for the businesses that have supported them for decades. “It’s like they’re running up the down escalator,” says Frank Gens, chief analyst at IDC.

Milunovich warns against excessive optimism for legacy tech. “As a group,” he says, “the secular winds are against them.”

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