Here is a good one from the Fool.
/Piotr
April 21, 1999 17:58
Compaq's Management Broke Compact
April 21, 1999/FOOLWIRE/ -- Morality tales leave us feeling a
righteous satisfaction because things end as they should, with villainous
characters getting their do. That's why I felt joyful when I first heard the
news that leading PC and enterprise computing firm Compaq (NYSE: CPQ) had
booted CEO Eckhard Pfeiffer and CFO Earl Mason from their jobs over the
weekend. They deserved it.
The proximate cause of this shakeup was Compaq's surprise Q1 earnings
disappointment, but that was simply the final shoe to fall. As I've said
several times, these guys repeatedly exhibited disdain for individual
investors by disclosing material news to a handful of analysts and money
managers. The capricious and arrogant way they handled disclosure not only
flouted the spirit of the securities laws but proved indicative of broader
problems regarding these executives' integrity and judgment. Bottom line:
the Pfeiffer-Mason regime had lost credibility. That's why investors
initially bid up Compaq shares Monday morning. Whatever challenges the
company faces -- and they're no doubt significant -- a change in leadership
was simply long overdue.
Let's review a little history. In September 1997, a member of Compaq's top
management appeared at an investment conference and told a small group of
Wall Street professionals that the firm was raising its year 2000 revenue
target by 25%, from $40 billion to $50 billion. With these institutional
investors racing to the phones, the stock hopped to a 14% gain by the
opening of trading the next day. No question, this was the kind of material
information an investor would want to know before making an investment
decision. The only trouble was, Compaq never bothered to issue a press
release with this news. Investors had to rely on a secondhand account
offered by Dow Jones, which got the news from an analyst attending the
meeting. A day late, 14% short.
Of course, Compaq hasn't just kept good news confined to select investors.
TheStreet.com reported last June that Mason told a closed-door meeting of
professional investors at the PaineWebber Growth & Technology conference
that the firm was "headed toward a money-losing quarter, according to two
people who attended the session." At the time, analysts were looking for
earnings of $0.01 a share, as Compaq was still suffering through an
inventory glut. While many companies still close their "breakout Q&A
sessions to reporters, few ever close their actual presentations, which
Compaq did in this case.
More recently, Compaq shares got hit in February after another case of
selective disclosure. According to a recent Bloomberg report, Credit Suisse
First Boston analyst Michael Kwatinetz was touring Compaq's facility in
February with a small group of investors when a Compaq executive (Mason, by
some accounts) confessed that PC sales had shown "softness" in January.
Kwatinetz immediately cut his estimates, with other analysts quickly
following. This was basically an unannounced earnings warning.
This news becomes more interesting in light of the fact that Mason sold
265,000 shares of Compaq for more than $12 million on February 1. That's an
average price of over $46 per share, nearly double today's close of $24. Did
Mason already know Compaq would miss its Q1 earnings estimates? The
attorneys behind a raft of shareowner lawsuits will certainly try to make
the case. Although lawsuits are a dime a dozen following huge price declines
in tech stocks, the plaintiffs here just might have a chance.
Of course, the credibility of both Mason and Pfeiffer has been in doubt for
a while. On January 21, 1998, Pfeiffer said he expected a "strong 1998" with
"improve[d] profitability." Yet, the firm was just six weeks away from
pre-announcing an absolutely disastrous first quarter due to massive amounts
of excess inventories in its reseller channel. Indeed, even as Compaq was
talking up a move to a build-to-order model a la Dell (Nasdaq: DELL), with
accompanying projected improvements in asset management, inventories were
getting even more out of hand.
That's one reason Compaq's stock could hardly get off the mat after being
pummeled during the October 1997 market break. Potential trouble soon began
registering not just with short-sellers but with analysts, too. The Wall
Street Journal ran a "Heard on the Street" column on February 12, 1998
addressing two questionable transactions that had an air of deceit about
them. Compaq had factored $732 million in receivables in both the third and
fourth quarter of 1997. That is, it had sold to a third party, at a
discount, some of its uncollected customer bills. Factoring allows a firm to
collect cash now rather than later, thus reducing the days sales outstanding
while improving cash flow. Although a legitimate asset management tool,
factoring is rare in the PC industry. In this case, it seemed designed to
spruce up Compaq's performance metrics while hiding the fact that channel
inventories were actually getting worse rather than better.
Donaldson, Lufkin & Jenrette analyst Kevin McCarthy noted at the time that
without these transactions, Compaq's return on invested capital (ROIC)
"would have been essentially flat over the past three quarters instead of
posting sequential improvement." In the summer of 1997, Mason had told
analysts that a move toward a build-to-order model would push ROIC from 50%
to over 100%, as inventories would fall from ten weeks to three. However,
management was simply failing to deliver on its ambitious goals. To hide the
extent of that failure, the firm was pumping inventory into the channel and
thus off its books while giving resellers favorable terms to take it. Compaq
was then factoring the huge receivables to hide what was really going on.
None of this was illegal, but it was suspicious.
Pfeiffer took over the helm of Compaq in 1991, when the firm was in
disarray. He's credited with turning the company into the top PC
manufacturer by volume and a major technology success story of the 1990s.
Yet, after Mason's arrival at Compaq from Inland Steel in May 1996, the
company seemed to grow increasingly addicted to over-promising and
under-delivering. Management has found it hard to be straight with
investors. The recent Q1 earning warnings was another case in point.
Compaq's management blamed the trouble mostly on weak overall demand for
PCs. For its part, Dell immediately responded, "I don't think so." As Dale
Wettlaufer has rightly pointed out, PCs represent a much smaller part of
Compaq's business since it acquired Digital Equipment Corp. (DEC) and
Tandem. So management's account again seemed inadequate.
There's no question that Pfeiffer and Mason have mismanaged Compaq. At the
most basic level, Compaq is still building PCs for the channel while Dell is
building to order and gobbling up market share. Moreover, Compaq has tried
to maintain its channel partners while also selling direct, merely creating
a confused business model rather than improved service. All of this has
ensured that Compaq suffers from a price/profit disadvantage on the PC
front, especially in an environment of falling component prices.
But Compaq hasn't just failed to address Dell's competitive advantage on the
manufacturing/distribution end. It's tried to use DEC's service wing to
refocus its entire business around providing enterprise computing solutions,
a la IBM (NYSE: IBM). Digesting huge acquisitions are a challenge. Trying to
refocus a company around acquired assets is doubly challenging. Yet to do so
while a competitor is kicking your butt in your supposed core competency
represents, at best, the hope that strategic bravado can compensate for
operating inefficiencies. Yet, the strategy only compounded those
inefficiencies.
The notion that such deal-making would answer the competitive threat from
Dell was a case of managerial hubris. Yet, such hubris was apparent at every
turn. Last summer, the company launched a pointless $300 million branding
campaign that said, "Look how much money we're willing to blow." Compaq
devoted more millions to high-speed cable outfit RoadRunner, which has
stumbled along pretty aimlessly. It blew another $220 million in cash buying
the suspect Shopping.com, part of a cynical strategy to repackage its Alta
Vista search engine, which it has shown no more ability to exploit than DEC
had, and cash in on the Internet. Wipe away all the hype, and it's clear
that Compaq has been in trouble for over two years.
While money managers were angry that Compaq warned of the Q1 shortfall only
after the quarter actually ended, that disclosure mistake simply reflects
lots of others that were arguably more serious for being highly selective.
Investors should simply run from companies that indulge in selective
disclosure because it represents such a fundamental violation of the compact
that exists between owner and manager. If you can't trust management to
treat you like an owner, then you can't trust management. Period. It's a
signal of fundamental troubles with a company's top leadership. That's why I
always thought it laughable that Business Week would honor Compaq's board of
directors as among the best. Let's be clear: the board was asleep. The
problems with Pfeiffer and Mason have been a long time coming, and the board
did nothing until had suffered plenty.
by Louis Corrigan
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