HP’s Bet on webOS Thwarted by Young Ecosystem and ‘Poorly Conceived Hardware,’ says CFO

One of the challenges facing the company now is how to leverage value from its $1.2 billion investment in Palm a year ago that folded the webOS platform into HP’s portfolio. At the time analysts were mixed on HP’s strategy to build its presence in the smartphone market via a platform that had been “relatively weak.” HP was attempting to leverage the webOS platform over a variety of mobile devices to mirror Apple’s market penetration with iOS.

Just a year later, however, HP is scrapping its fledgling webOS hardware business, including the TouchPad that began shipping last month. WebOS devices “haven’t gained enough traction with consumers,” Apotheker said, and “we see too long a ramp up” to gain acceptable market share. Citing market dynamics, “significant competition” and a “rapidly changing environment,” HP’s current webOS device approach “is no longer in the best interest of HP,” he said. It was a “difficult but necessary decision to shut down the webOS hardware business within Q4,” he said.

A year ago, “we made a bet on webOS and the opportunity to launch our own ecosystem around devices, applications and new markets,” said CFO Cathie Lesjak. The company set metrics and milestones to monitor success and “sell-through was not what we expected,” she said. HP’s intention to “solidify webOS as the clear number two platform for tablets” didn’t succeed with a “young ecosystem and poorly conceived hardware,” she said. A $100 price cut on the TouchPad in Q3 didn’t boost demand and added “near-term cost to our model,” Lesjak said. The company took a five-cent charge to earnings per share “in addition to the loss we were already experiencing in the business,” she said. HP would take “an even larger loss” for webOS if it continued to operate the business in its current form, she said. To make the webOS investment a success would require “significant investment” over the next couple of years, “creating risk without clear returns,” she said. As a result, HP “will be exploring strategic alternatives to optimize the value of software platform and development capability,” she said.

"They claim they're going to try to extract the value out of webOS,” ABI research analyst Mike Morgan told us. Finding another handset or tablet maker willing to commit to an OS that neither Palm nor HP could make work is “unlikely,” Morgan said. He noted that when Palm moved to webOS, “they divorced their historic customer base and had to start anew.” Palm didn’t have the capital to provide the marketing muscle or distribution channels to make the platform succeed, he said. The intellectual property surrounding webOS could give HP “the most bang for their buck,” he said, citing a recent “land rush for mobile IP” -- highlighted by Google’s decision to buy Motorola -- that has raised the importance and value of IP to levels “higher than it’s been in a long time."

Morgan speculated about which companies could find value in the webOS software. “It’s high-quality software that was very innovative when it came out,” he said, and it packs appealing user interface technology, one of the criticisms “Google is being attacked on,” he said. But Google just dropped $12.5 billion on Motorola. “Do they have enough spare cash to drop another $1.2 billion? They do, but if and when HP decides they're going to sell the IP, a lot of other people are going to bid on it,” Morgan said. “It wouldn’t be Google alone.” Even Microsoft or Apple could be potential suitors, he said, noting Apple’s heritage with Palm that would in effect be like “buying back its own DNA."

Other analysts have suggested parts of webOS could find their way into new applications outside the smartphone or tablet space, including in-car navigation or other mobile applications. “We might see the shell of it in something else,” DisplaySearch analyst Chris Connery told us. HP execs “threw it out there,” he said, and webOS could easily find its way into a technology “not on the radar yet.” A year from now, he added, “we won’t remember what webOS was."

Morgan of ABI sees the demise of webOS as an inevitable shakeout of the mobile OS market. “There are so many mobile OSs out there, it’s time to shed the excess and focus on the three runners going forward,” including Android, iOS and possibly Windows Phone 7, he said. RIM is facing pressure with BlackBerry and could be an “extraneous OS,” he said. “The question is, who’s next to drop?” He suggested Android could become the “Windows of mobile operating systems.” It becomes more valuable to each user as more users adopt the platform, he said.

Despite market conditions, Morgan was surprised HP gave up on webOS after such a short time. “There could have been something there,” if HP had made the investment to make webOS successful, he said. “But it was a smaller piece of a bigger problem -- the consumer side wasn’t producing the way they wanted,” he said.

HP’s Q3 desktop and notebook businesses each were down 4 percent year over year, due to weakness in consumer demand, Lesjak said during the HP webcast. Revenues from corporate investments including webOS were $266 million while operating loss was $332 million, she said. The company is exiting the consumer market while it holds number one market share, but it saw the writing on the wall, Apotheker said, referring to the rise of the tablet business at the expense of other PC categories.

HP held number one position in mobile PCs, too, until losing that spot to Apple last quarter, according to DisplaySearch. Apple shipped more than 13.5 million mobile PCs in Q2, for 21 percent market share, up 136 percent year over year, and 80 percent of those shipments were iPads. Apple’s total PC shipments for the quarter, including 10.7 million iPads, beat HP’s 9.7 million mobile PC shipments, or 15 percent market share, by nearly four million units, DisplaySearch said.

HP’s leading position in PCs has come at a price, said Connery of DisplaySearch. “They've traded off market share for revenue,” he said. P&L has been a losing proposition for HP for some time, he said. HP joins a long list of companies that have gone through the cycle of the “difficult” consumer space, Connery noted.

Tablets represented 17 percent of total PC shipments in Q1, according to DisplaySearch, and it’s that market shift Apotheker referred to when he said consumers’ transition to tablets is “changing the usage model for PCs.” The tablet effect “is real,” he said, with change occurring quickly and the competitive landscape becoming “more complex especially around the personal computing arena.” For HP’s PC business to remain the “largest personal computing business, it needs the flexibility and agility” to make the best decision for future direction, which could include a sale or spinoff of PSG. That decision will be made within the next 12-18 months, he said.

In commentary released Friday, IDC said HP had been getting pressure from Wall Street and stockholders to focus on high-margin businesses, a theme Dell executives expressed in that company’s earnings call earlier in the week. In HP’s case, the low-margin PC business “was a clear target” despite its 31 percent share of total revenues in the most recent quarter, IDC said. By announcing its intention to spin off or sell PSG without a clear plan or buyer in place, HP effectively “set the clock ticking” on the PC business’s viability and value, it said. Despite HP’s comments about the value of webOS software, the company’s decision has “effectively killed the already slim chance webOS had in the mobile OS market,” IDC said. HP shares finished down $5.91 (20 percent) Friday to $23.60.