A big week in Silicon Valley.
Google buys Motorola Mobility for $12 Billion, HP shut down its WebOS hardware operation (shortly after purchasing Palm) and looks to sell off its entire PC hardware division (after purchasing Compaq), while at the same time purchasing Autonomy for the (insane) price of $10 Billion. Autonomy sells structured data search services — its clients are large firms. Autonomy is in the high margin monopolistic “space”, whereas PCs are in the commodity space.
The cited reason for HP wanting to divest itself of its (profitable) consumer hardware division is falling margins.
HP doesn’t want to be in the low margin business — it wants to be in the high margin business, and it would rather sell off or liquidate capital rather than accept lower margins. It is not enough merely to be profitable. HP wants a high operating margin, and high earnings growth rates.
The market responded by shaving 20% off the price of HP stock.
In other words, if firms do not get the margins that they believe are expected of them, they shrink.
The buzz is that Samsung (a
Japanese Korean firm) is the front-runner to become HP’s hardware partner.
IBM also got out of the PC hardware business — due to falling margins — selling its PC manufacturing assets to Lenovo — a Chinese firm. Again, in China interest rates are extremely low, at least for politically favored entities.
It seems that every firm in the U.S., if it comes to believe that it cannot obtain 20% earnings growth, liquidates.
It can sell of its capital to nations in which firms have low funding costs.
In the U.S. capital is expensive, while in other countries it is cheap, and the U.S. is systematically divesting itself of all but the most profitable firms even as other nations expand investment.
And yet this is happening in a low IR environment.
My only explanation — what my gut tells me — is that dynamic effects have caused the rental rates demanded of capital to remain high even though risk-free borrowing rates are low. By dynamic effects, I mean that as interest rates fall, share prices rise, and investors who see the total gain, come to expect the large gains, which must ultimately be realized as high earnings and/or high earnings growth rates. Paradoxically, a long period of cutting borrowing costs can lead to a high cost of capital, if the past gains become embedded into “sticky” expectations of future gains.
This doesn’t bode well for domestic investment or employment.
UPDATE: Fixed some typos, added details of Autonomy and some handwaving re: dynamic effects.
UPDATE 2: Changed Asian slur — calling a Korean Company Japanese, and thus removed reference to low CoC in Japan — thanks Max!