As HPE's stock heads for another high, its bonds have been selling off

By Ciara Linnane

CreditSights is advising investors to await new bond issuance related to HPE's acquisition of Juniper Networks

As Hewlett Packard Enterprise Co.'s stock stretches to fresh record highs following blowout earnings last week, its bonds have seen net selling across the curve with limited buying coming in the short end.

The stock (HPE) has been on a roll since the company achieved a sizable revenue beat in its fiscal second quarter and called out artificial-intelligence services as a key driver.

Chief Financial Officer Marie Myers spoke of "a pipeline that has ...multitudes of the current orders."

Myers said that AI demand is broadening geographically and in terms of the customer base, while HPE's expansive portfolio and compute history is resonating with customers.

Myers also highlighted liquid-cooling technology, which was expected to be in demand once Nvidia Corp.'s (NVDA) most advanced graphics processing units, the Blackwell GPUs, are rolled out.

Overall server revenue grew 18%, but intelligent edge revenue fell 19%. While AI servers are a strong growth area for HPE, the company is seeing cyclical pressures in networking, which are weighing on margins.

CreditSights analyst Jordan Chalfin, who downgraded his view of HPE's bonds last week to underperform from market perform, is advising investors to hold off on buying the company's outstanding bonds and wait for new issuance.

HPE is currently in the midst of acquiring Juniper Networks Inc. (JNPR) in a deal worth around $14 billion. The company is expected to issue $6.5 billion in new bonds to help fund the deal, which is expected to close late this year or early next year.

"HPE is one of the tightest credits in our BBB tech coverage," Chalfin, who is head of tech at CreditSights, wrote in a note to clients. Spreads refer to the premium over comparable Treasurys that corporate bond issuers offer investors to compensate for higher risk.

"The tight spreads are in spite of a $14 billion pending deal to acquire Juniper which will lever up the balance sheet, currently weak trends in its Intelligent Edge segment (which is supposed to be the core business going forward, and has been its source of strength in recent years), and significant underperformance on AI server orders relative to Dell (although the equity market reactions this quarter didn't see it that way)."

The stock of HPE's bigger rival, Dell (DELL), fell about 18% to mark its worst single-day percentage decline in 51/2 years the day after that company posted earnings in late May. Investors were disappointed by the margin performance of Dell's infrastructure-solutions group, which houses the server business.

See more: Dell earnings show fervent AI demand, but margin talk sends stock sliding

"I think investors were too generous with HPE and too negative on Dell," Chalfin told MarketWatch in a phone interview, referring to their stocks.

HPE's leverage will be higher than Dell's when it completes its bond issuance, he said, even giving it the full benefit of expected synergies of $450 million over three years. And Dell is executing well on its AI strategy and outperforming HPE, in Chalfin's opinion.

With weakness in the core networking business and tight spreads ahead of new issuance, "there are a lot of reasons to short the bonds or stay on the sidelines," he said.

The following chart from data solutions provider BondCliQ Media Services shows the selling in HPE's bonds over the past week.

The next chart shows the one-week spread performance for the bonds, which moved wider immediately after the CreditSights downgrade before showing some recovery.

Yields, meanwhile, moved higher as the bonds sold off.

HPE has more than $10 billion of outstanding bonds, according to FactSet data. As the following chart shows, some $2.5 billion of that comes due in 2025.

"Dell also has greater scale and a solid PC business that should see a gradual recovery going forward,' said the Chalfin note.

"We recommend waiting for HPE's $6.5 billion senior notes issuance to partially fund the Juniper acquisition as a better entry point into the credit."

HPE's stock was last up 1.7% and has gained 23% in the year to date, while the S&P 500 SPX has gained 13.9%. Dell has gained 73% in the year to date, although it's down 5% in the month-to-date.

-Ciara Linnane

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06-12-24 1322ET

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