HPQ: Are Hewlett Packard’s Customers Channel Surfing?

By William Trent, CFA of Stock Market Beat

When computer reseller CDW Corp. (CDWC) recently reported a blowout quarter, we said:

Even excluding the acquisition, CDW posted those double-digit sales gains. CDW is a major reseller of Hewlett Packard (HPQ – Annual Report) computers, but Hewlett’s recent blowout was attributed to Asia. CDW only sells in the US, where businesses have been parsimonious with regard to equipment and software spending. It looks like CDW could be gaining a good deal of market share.

According to a recent article at CRN, which is a trade magazine for IT resellers, they are doing so by pricing aggressively – even below the wholesale prices paid by most resellers.

How Low Can CDW Go? – IT Channel – IT Channel News by CRN and VARBusiness

One Midwestern solution provider said CDW has matched his price for Hewlett-Packard ProLiant servers through distribution before, but until recently it had never beat that number.Yet, late in the first quarter of this year, the solution provider, who asked not to be identified, said one of his longtime HP accounts was relocating its corporate offices and needed to buy new servers. He said CDW went below cost on the servers to wrest the deal away from him. “They had to use [HP] MDF to pad their margins,” he speculated.

CDW’s gross profit margins were up slightly in the quarter. However, the company has been underutilizing a new warehouse that doubled its capacity, and gross margins should naturally increase as the new facility reaches capacity. Therefore, the gross margin doesn’t necessarily indicate stronger pricing. In fact, pricing lower in order to increase utilization may be allowing the company to paradoxically increase its margins while selling at a lower price. Chalk it up to the power of operating leverage.

The CRN article provides one example where an apparent snafu on HP’s part cost the manufacturer some margin:

One East Coast solution provider, who requested anonymity, said that in the first quarter CDW came into one of his largest accounts and bid HP ProLiant servers at 13 points—or about $1,000 per server—below what he could buy the same servers for from Ingram Micro. “I found out that CDW had an HP Big Deal letter for the account,” the solution provider said.

Big Deal authorization allows HP solution providers to sell products at substantially reduced prices in order to win a deal against competing vendors such as Dell or IBM. But it wasn’t intended to shift share from one HP solution provider to another. The solution provider was ultimately able to obtain his own Big Deal authorization for the account and ward off the CDW incursion. But the upshot of the deal was that HP, Palo Alto, Calif., lost double-digit margins on an account it was already locked into.

Hewlett Packard announced its own upside surprise recently, saying its sales will be about $1 billion more than previously forecast for the quarter. Given the CRN story, investors may want to pay special attention to margins when the company reports tomorrow.

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