Thread: This just in from e-mail version of Barron's Weekday Trader:
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Weekday Trader
A Comeback for Compaq?
By LISA R. GOLDBAUM
Until recently, Compaq Computer slept through the big 1998 bull market in
technology stocks. A stellar performer last year, Compaq's stock hit the
skids after its late January announcement that it intended to merge with
beleaguered Digital Equipment. That met with mixed reviews on Wall Street,
including a skeptical Weekday Trader column here ("Compaq Makes a Big Move;
Shareholders Cringe," January 26th, 1998).
Those worries were only exacerbated by a warning a month later that Compaq
would merely breakeven in its first quarter because of a glut of personal
computers in the marketplace. Indeed, profits wound up plummeting a
whopping 96% in the first quarter from the previous year, and Compaq has
since warned of another break-even quarter for the three months ending in
June. The stock, which lost almost three points after the merger
announcement but then snapped back, sank like a stone after the profit
warning to about 23, its 1998 low.
But in recent weeks, sentiment has brightened considerably for the PC
titan. The stock has climbed about 38% since the end of March, and both
Soundview Financial and A.G. Edwards upgraded their recommendations last
week. Moreover, the number of analysts who rate the stock a Strong Buy has
increased to 12 from 10 in the past month, while their Hold recommendations
fell to 9, from 12 a month ago, according to Zacks Investment Research.
Why the budding turnaround? Investors appear to be looking past a
potentially shaky second quarter to the second half of the year, when
Compaq's prospects may get a good deal rosier. For one thing, the company's
price cuts are helping to reduce bloated inventories. "There's no question
they're making progress in clearing out inventory from the first quarter,"
asserts Carl Howe, an analyst at Forrester Research. "The problem shouldn't
be as bad going forward." Indeed, Compaq managed to reduce inventories by
$314 million, or about 20%, during the first quarter, and it has said there
will be even more cuts in the current quarter.
Perhaps more importantly, the company is making a transition to the
"made-to-order" model that has driven the tremendous success of rival Dell
Computer. Under this system, Compaq would make customized machines only
when people or companies actually ordered them. This has helped Dell avoid
the pitfalls of forecasting consumer demand, thus sidestepping the whole
problem of inventory gluts.
Of course, Compaq's own efforts to whittle down its inventory bloat by
slashing prices have taken a big toll on profits. That price cutting is
likely to continue, especially with the growing demand for PCs costing less
than $1,000. But Compaq may be able to compensate for this by selling more
high-end products, like servers, notes Forrester's Howe.
In its first-quarter earnings release, president and CEO Eckhard Pfeiffer
hinted as much when he described the second quarter as a "time the company
repositions itself with almost a complete new product line" -- including
hand-held devices and high-end servers. Higher-margin notebooks and
enterprise computers combined represent about half Compaq's revenues,
according to Piper Jaffray analyst Ashok Kumar. Kumar believes that by the
third quarter, the company will have worked through the inventory problems
and will be able to get better prices for many of its PCs. That, he
believes, will help lift operating margins to the low 20% range from their
first-quarter levels of about 13-14%.
Meanwhile, Compaq has a lot going for it -- besides its powerful brand
name. For one, it is very flexible: It's willing and able to use chips from
companies other than mighty Intel, such as the K6 processor from Advanced
Micro Devices. That should allow Compaq to keep costs down by playing rival
chip makers against each other in price wars for Compaq's business.
And while Compaq struggles to digest its nearly $9-billion purchase of
Digital Equipment in the short run, that deal may well provide a boost to
earnings longer term. Tom Burnett, director of Merger Insight, notes that
because Compaq didn't overpay for Digital, the businesses it is getting
from the merger should prove to be the icing on the cake. "It did not pay a
super-huge premium like you see in other transactions, and it should get
lots of leverage from the services business," he argues. Compaq is expected
to lay off some 15,000 employees when the merger is complete, according to
published reports.
In addition, says Burnett, Digital's search engine Alta Vista also could
garner "a nice piece of change" for Compaq if the company decides to spin
it off or sell it to a major Internet player like Yahoo!, which already
uses Alta Vista as its search engine. "It's a hidden asset that most people
haven't recognized," he contends.
For many of these reasons, Phil Schettewi, managing partner at asset
manager Loomis, Sayles & Co., still likes Compaq despite its recent
problems. He notes that stocks of Gateway and other PC makers have bounced
back from inventory gluts and price wars (Gateway's stock has more than
doubled since November to its current price of 56 1/8), and that Compaq's
stock could have plenty of room to run.
With the stock's recent rise, it doesn't look dirt cheap. At Monday's
closing price of 31 3/4, it trades at around 20 times the $1.60 per share
analysts tracked by Zacks expect the company will earn in 1999 -- about in
line with its projected five-year growth rate. Still, the current price is
a good 20% below its 52-week high of 39 3/4, and Piper Jaffray's Kumar
believes the shares can retest those old highs.
If Compaq can blow out some more inventory, sell more higher-margin
products and reap some unexpected benefits from the Digital acquisition --
all big 'ifs,' of course -- it may silence its remaining doubters and
return to its accustomed place in the stock market's technology elite.
BARRON'S Online Weekday Trader is located at
interactive.wsj.com
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