Debunking WSJ’s Hewlett-Packard Receivables Attack

This week, the Wall Street Journal’s Rolfe Winkler wrote an article that called Hewlett-Packard’s methods for generating cash flow into question. The article was inflammatory enough to elicit an official response from HP and set off a flurry of similar articles around the blogosphere.

Here’s the problem: Winkler’s concerns and allegations about HP’s receivables sales – and their impact on HP’s cash flow – are wrong.

Winkler alleges that the sale of $4.3 billion of trade receivables by HP in fiscal year 2012, “…is equal to nearly two-thirds of its overall free cash flow for the year, versus 35% for fiscal 2011.” But the allegation that nearly two-thirds of HP’s overall free cash flow came from these facilities is ludicrous.

These Facilities Do Not Provide Nearly Two-Thirds of HP’s Free Cash Flow –

The receivables sales arise under $1.512 billion in receivables financing facilities ($876 million in partial recourse and $636 million in non recourse) 1 that, “support [HP’s] partner and customer ecosystems” business 2.  The partial recourse program has been available since May 2011 and the non recourse program dates back to at least October 2010.  (HP’s press release mistakenly states that, “[These facilities have] been in place since May 2011.”)

The facilities had an incremental capacity increase of $12 million in fiscal year 2012 ending October 31, 2012 as their maximum capacity was $1.5 billion at October 31, 2011. Their outstanding balances totaled ~$712 million and ~$800 million at October 31, 2012 and October 31, 2011, respectively.

The fact that $4.3 billion of trade receivables was sold through these facilities in fiscal year 2012 simply demonstrates their velocity.  They are trade receivables; they turn frequently.  While with the limited information presented a precise DSO calculation can’t be made, they clearly are not, in the aggregate, long-dated.

Receivables sales did not produce $4.3 billion in cash flow in fiscal 2012.  Sales in HP’s “partner and customer ecosystems” business generated at least $4.3 billion in associated trade receivables on or about this period; they were financed through the facilities.  As collections on the sold receivables that are financed by the facilities come in, they are utilized to pay down the outstanding balances on the facilities.  This reduces the cash flow provided by the facilities while, as long as funding conditions are met, helping to restore their available balance.

A $1.512 (maximum) financing activity, or $12 million incremental financing activity, does not generate $4.3 billion in free cash flow. If it did, why wouldn’t HP finance its $16.407 billion of on-balance sheet receivables through similar facilities to generate even more remarkable cash flow?

Any Acceleration of Cash flow From Future Periods to Current Periods Would Be Modest –

Winkler states that these facilities are being utilized to shift future cash flow to the current period.  While this assertion cannot be proved or disproved with the limited disclosure provided, if true this effect would be modest at best, given the receivables’ turn.

Available Disclosure Suggests That The Discount on Sales Is Small –

Winkler further charges that “Also, since H-P doesn’t disclose the amount at which it is selling receivables, investors can’t tell how much future cash is being sacrificed to get paid more quickly.”

While HP does not disclose the discount at which it’s selling the trade receivables under these facilities, its limited disclosure in its latest 10-K should provide a measure of comfort that the discount is not great –

  • “trade receivables sold under these facilities were $4.3 billion and $2.8 billion, respectively, which approximates the amount of cash received” and
  • “The resulting costs associated with the sales of trade accounts receivable for the twelve months ended October 31, 2012 and 2011 were not material.”

As Winkler notes, even though HP provides “limited disclosure around the sales,” the “disclosures at some HP competitors offer even less information about receivables sales.”

Investors would benefit from knowing the terms (receivables eligibility criteria, expiration dates, program costs, program terms – advance rates, concentration limits, yield reserves, dilution reserves, termination triggers, and more) of these facilities.  The absence of such disclosure does not necessarily mean, however, that such facilities have subpar terms.

While it is unfortunate that the disclosure is limited, the consistently negative tone of Winkler’s article paints these receivables facilities and HP’s “Receivable Wisdom” in an unduly harsh, and incorrect, light.

These Receivables Facilities are Not Core Funding Facilities –

Of further note, while HP’s ongoing troubles have been widely and extensively reported on and its significant decline in free cash flow is cause for concern, the $1.512 billion in receivables financing facilities are not central to its financing mix and cash generation.

The significance of these trade receivables financing facilities to HP should be put in perspective.

HP has $108.768 billion in assets.  Its $85.935 billion of total liabilities includes$21.789 billion of long-term debt and $6.647 billion of notes payable and short-term borrowings.  While the sold trade receivables are off of HP’s balance sheet, if the maximum capacity of these facilities were to be included therein, they would equal less than 1.8% of HP’s total liabilities 3.

Unwarranted Castigation Of A Sound Financing Technique –

Picking up on Winkler’s story, The Motley Fool called Hewlett-Packard “Un-receivable.” Blogs like Grumpy Old Accountants and others have picked up on Winklers’ assertions and expanded upon them.  Regrettably, these analyses further disparage these receivables facilities and HP’s cash flow generation techniques.

Trade receivable sales are, as Winkler notes, “common at many companies.”  These sales – through conduit programs, term securitizations, and other facilities – have been successfully completed for many years.  Receivables sales may expand an issuer’s funding base, reduce its cost of capital, and increase its liquidity.  Given these potential advantages – and their broad acceptance in the market – they should be encouraged and not lambasted.

Judicious Note

By Avi Oster

Managing Director

Judicious Advisors LLC

Notes:

  1. All numbers as of October 31, 2012, per HP’s latest 10-K.
  2. http://www8.hp.com/us/en/hp-news/press-release.html?id=1353755
  3. Ibid. 1

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