Stephen & Thread
The Bear Stearns 10 Reasons article .. don't know if it was posted earlier but here it is:
Ten Reasons Why Compaq Could Surprise on the Upside: More Than Meets the Eye
07:34am EST 4-Feb-98 Bear Stearns (Andy Neff / Shaw Wu)
It's Better Than You May Think
While there are clearly risks in the short-term as Compaq works
through the integration of DEC, we believe that there are
numerous factors that could lead to upside surprises relative to
expectations. Keeping in mind that Compaq management has not put
out many specifics yet, here is our analysis 10 factors that
investors should focus on:
#1 Strategic Fit Is Good For All Three
While most of the focus has been on what Compaq gets out of this
acquisition, there are two other beneficiaries: Digital and IT
customers. Digital benefits by get access to a broader product
array. DEC customers get a sense of comfort that their vendor
will be around. Compaq customers get the ability to use a single
vendor to meet more of their needs with mid-range products
(relative to Tandem) and services offerings.
As to the issue of different cultures, we would argue that DEC
employees must feel a sense of relief - some anxiety as well to
be sure - that there is some closure in their five-year saga of
restructuring.
# 2 Compaq Paid Below Market For DEC
Although the Compaq/DEC deal was headlined as a $9.6 billion deal
(150 million Compaq shares and $4.8 billion in cash) or around
$60 per share of DEC (which was selling at $43), our analysis
shows that Compaq may actually pay below market price for DEC we
look at the cash impact from DEC's cash, working capital and tax
credits. In fact, we estimate that the net price tag closer to
$25-$30 per share or about 10x our EPS estimate for DEC's -- and
this is before taking any synergies into account.
As shown above, we estimate that DEC's balance sheet can generate
around $4 billion in cash. Here's how we get to that figure: we
add DEC's cash on hand of $2.0 billion to the cash that Compaq
can pull out of the DEC balance sheet by bringing its ratios on
receivables and inventory to parity with Compaq's ratios today
which generates an incremental $2.1 billion. (To be
conservative, we did not assume any cash from payables despite
Compaq's 48 days vs. DEC's 30 days.) However, we reduce this $4.1
billion by its long-term debt of $744 million, but add back
another $600-800 million to reflect the expected net cash from
Cabletron and Intel transactions.
Beyond this, DEC has tax loss carryforwards of around $3.4
billion, which can shelter around $1.2 billion of income (but
spread over about seven years per IRS guidelines). We figure
that these credits are worth $5-6 per share in net present value
terms.
#3 We're Number One In Storage
As an incremental side benefit of this deal, Compaq - along with
Digital and Tandem - have displaced IBM to become the largest
vendor of storage systems.
According to IDC, the combined entities have storage sales of
$4.9 billion, compared to $3.9 billion for IBM and $2.5 billion
for EMC. In addition, Compaq gets DEC's StorageWorks operation,
which is one of the strongest mid-range storage brands.
#4 Compaq's Now A Player In Services
Compaq's broader presence in the services business is important
for several reasons. To begin with, it removes a competitive
advantage that IBM (25% of its revenues from services) and H-P
(14%) could wield. In comparison, we estimate that the combined
Compaq/DEC entity would derive 15%-20% from computer services.
Strategically, it's even more important because customers want
fewer vendors to provide more of their solutions. As we look at
trends in the computer industry, we believe that average selling
prices (ASPs) will become less meaningful as companies compete on
a broader front.
#5 Japan: We Shall (Earn A) Return
Leveraging the positions of both DEC and Tandem, Compaq may be
able to now expand its presence in Japan - its last frontier.
With Digital generating 8% of sales (around $265 million in the
December quarter from Japan (compared to 3% for Compaq or around
$220 million in 4Q97) and with Tandem's stronger position there,
Compaq is positioned to expand its share in that market. To
date, Compaq - which is number one in the U.S., Europe, Latin
America -- has fared poorly: ranked number seven with 3% share
(below Apple).
#6 Compaq Has Multiple Personalities
The acquisitions of DEC and Tandem may finally convince investors
that they are not just a PC company. At the same time - as we
saw from the concurrent news of getting into Radio Shack - Compaq
continues to operate on multiple fronts, giving it multiple
engines of growth and a depth beyond that of other "only
children" companies that depend on a single channel or market.
#7 Compaq Sales Gets All DEC'd Out
As Compaq addresses the issue of selling from the "CIO (chief
information officer) down" as opposed to from the purchasing
manager upwards, it needs products and a sales force to change
customer perception. That was the rationale behind the Tandem
acquisition, but DEC gives Compaq products in the middle and a
sales force that can sell to the enterprise.
#8 Alpha Is A Great Merced Placeholder
As we have discussed before, we believe that the key strategic
issue for the computer industry is getting ready for the launch
of Merced and other 64-bit chips from Intel, because that will
change the dynamics of the high-end of the computer business over
the next decade.
In our view, Alpha, which has been a performance leader since its
introduction, should give Compaq a "camel's nose under the tent"
as it prepares for the launch of Merced in late 1999.
From a competitive standpoint, this factor is even more critical
than many realize if reports are accurate that the Merced chip
includes H-P's PA architecture on the Intel chip, giving H-P an
edge in transitioning its high-end customers.
Moreover, if Merced is late or if the operating systems for it
are late, Compaq will be able to use the Alpha line to fill in
the gap.
Some will argue that Compaq will want to keep the Alpha line
around, but we don't think that it could justify that effort
based on its insignificant market share and, more importantly,
semiconductor economics. Another argument - with which we
disagree - is that Alpha gives Compaq leverage over Intel.
However, to us, we do believe that the growing share accorded to
the "Big Four" leads to greater power for the vendors.
#9 Two Plus Two May Equal More Than $3
We are also encouraged that Compaq management - which met its
stated goals with Tandem - has stated that the acquisition should
be accretive to earnings by 4Q98 and for the full year 1999. At
this point, our EPS estimates for Compaq - before any charges and
any dilution in 2Q98 and 3Q98 - are $1.75 for 1998, $2.35 for
1999 and $3.00 for the year 2000. We believe that these
estimates could be conservative if Compaq can generate savings
from headcount and other cost reductions.
#10 It's Not Over 'Til It's Over
What is encouraging to us is that there is still more to come for
the Compaq story. In particular, we are waiting to see how it
fills out the communications part of the company - currently only
1% of revenues - but the remaining strategic element. Compaq
tends to telegraph its moves fairly openly. While the timing is
never certain, few have been shocked by its moves since the
company has laid out its direction for investors.
However, It Is Not A Risk-Free Investment
Having said all these positive things, we want to be clear that
there are short-term risks for investors owing to the lack of any
information until the closing of the deal in April (at the
earliest) as well as the usual rumors that tend to focus on
Compaq.
BRAND NEWS
* Good Start. Despite weakness in Asia, computer demand in
January seems robust based on our checks with strength in the
U.S. and Europe.
* One More Time. The Big Four (IBM, Compaq, Dell, H-P) gained
share in 4Q97, gaining 37% compared to 14% for the overall market
and 5% for the rest (excluding those four).
* Strong Servers. Server unit demand remained strong in 4Q97,
climbing 38% with gains in U.S. and Europe, decline in Japan and
flat Asia/Pacific.
* Compaq continued to see strong growth in business and
consumer. H-P also saw continued momentum in both corporate and
consumer. IBM seems on track with gains in business, but has
lagged because of its weakness in consumer. At the same time,
Dell's momentum remained strong with new products and new
services along with leverage on its internet site.
* Disks Rotating. With balance sheets becoming a bigger issue
for disk drive vendors, we look for restructuring or exits during
1Q or 2Q98.
Stock Picks: Who Benefits From Trends
Our recommendations include: PCs: Compaq Computer (CPQ-30), Dell
Computer (DELL-104); and Apple Computer (AAPL-17) (as a
turnaround); Server/Enterprise Hardware: Hewlett Packard (HWP-
61); IBM (IBM-100), and Sun Microsystems (SUNW-49); Storage:
Quantum (QNTM-26); Semiconductors (PC related): Adaptec (ADPT-
23).
Five Important Trends For Long-Term Demand
* Merging of computing and communications
* IT spending as a tool to increase competitiveness and spur
productivity
* Bottleneck elimination: any gain leads to new needs to
upgrade other hardware
* Advances in semiconductor process technology along the lines
of Moore's law
* Obsolescence and replacement demand stimulate increasingly
large waves of demand
KAD |
