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CPQ: Lowering Q1 EPS To $0.31 From $0.36
08:03am EST 26-Feb-99 Credit Suisse First Boston (Kwatinetz, Michael
CREDIT SUISSE FIRST BOSTON CORPORATION
Equity Research
Americas
U.S./Technology/PC Hardware
Michael Kwatinetz 1-212-325-0751 Michael.Kwatinetz@csfb.com
Andrea Sawicki 1-212-325-5127 Andrea.Sawicki@csfb.com
Hans Roderich 1-212-325-6181 Hans.Roderich@csfb.com
Jake Hindelong 1-212-325-6159 Jake.Hindelong@csfb.com
BUY
LARGE CAP
Compaq (CPQ)
Lowering Compaq Q1 EPS to $0.31 from $0.36 due to weaker-than-
expected January
Summary
Lowering Q199 to $0.31 from $0.36, reducing 1999 to $1.70
Quarter appears to be more backend loaded causing us to lower
our Q1 forecast to $9.8B from $10.0B
Strategic Internet initiatives outlined by CEO Eckhard
Pfeiffer appear well targeted
Services business appears to be benefiting from integration,
but risk of increased channel friction remains
Maintain Compaq Buy
Price Target Mkt.Value 52-Week
02/25/991 (12mo.) Div. Yield (MM) Price Range
USD $41 $0 !Zero Divide 72B $50-23
Annual Prev. Abs. Rel. EV/ EBIT/
EPS EPS P/E P/E EBITDA Share
12/99E $1.70 1.75 24 89% NA $0
12/98A 0.30 137 507% NA
12/97A 1.27 32 119% NA 0.00
March June Sept. Dec. FY End
1999E $0.31 $0.39 $0.43 $0.55 Dec.
1998A 0.02 -0.14 0.07 0.42
1997A 0.25 0.31 0.31 0.40
ROIC (12/97) NA
Total Debt (12/97) NA
Book Value/Share (12/97) NA
WACC (12/97) NA
Debt/Total Capital (12/97) NA
Common Shares 1755
EP Trend2 NA
Est. 5-Yr. EPS Growth 15%
Est. 5-Yr. Div. Growth NA
1On 02/25/99 DJIA mid-day price was 9205 and S&P 500 at 1250.
2Economic profit trend.
Compaq is a leading provider of computer products and
services
Investment Summary
Our recent visit to Compaq on our Texas Tour has caused us to
lower estimates because sales in January were below plan in
the U.S. and in Europe. Currency issues in Brazil also hurt
both revenue and gross margin. Further, Compaq may have been
effected by some weakening of the channel.
Since Compaq appears to have had a shortfall in January, the
question arises: "How is the industry doing?" In retrospect,
Dell and HP's slight revenue shortfalls may have been more of
an industry issue than we previously believed. We'd have to
say that industry sales in January may have been 3-4% below
expectations. The problem does not seem to be ASPs or margin
pressure, as ASPs appear to be firming and gross margins
appear fine. February has shown signs of strengthening
despite Compaq telling us the first half was a bit weak. We
think Dell was above plan in February, Gateway was on track
and Compaq began to see second half strength.
We've reduced our Q199 EPS forecast to $0.31 from $0.36 as a
result of lowering our revenue forecast and gross margin
assumptions. Consensus is $0.35. For the year, we're lowering
our forecast to $1.70 from $1.75 (consensus is $1.80).
We're lowering our Q1 revenue forecast to $9.8B from $10.0B.
January and the first half of February were weaker-than-
expected. This comes despite our model already showing a
traditional sequentially down quarter. The company indicated
that demand was fine in services and at the high end but
overall business in North America and Europe had been
tracking below expectations for the first six weeks of the
quarter. More recently it had picked up and its possible
that a very strong March could offset the initial weakness.
Asia Pacific and Japan have been exhibiting robust growth.
Additionally, the recent 38% devaluation of the Brazilian
Real will likely impact the top line and gross margin. The
company did not hedge its inventory and receivables and its
assets are depreciated at historic cost (and $ conversion).
As a result, we've also lowered our Q1 gross margin forecast
to 27.2% from 27.6%.
Compaq CEO Eckhard Pfeiffer for the first time laid out the
company's strategy to become the leading Internet company.
The five key goals:
remaining the largest web server supplier in the world
remaining the largest client manufacturer & supplier to the
Internet
becoming the largest consumer Internet PC supplier
managing and running the company to meet the leading-edge
Internet standards
leveraging AltaVista into the most important Internet portal/
destination
To meet these goals, Compaq has focused all its product
groups onto web-based initiatives. The company will be
upgrading its web site Compaq.com in the next couple of weeks
, and like Dell, will roll out extranets directly with large
accounts and with channel partners. Its recent purchase of
Shopping.com brings the company a solid e-commerce engine
which could help it to drive further peripheral and SW sales,
especially for their direct customers. Compaq's custom
keyboard which includes an Internet access, search, e-
commerce and email buttons will be rolled out onto all PCs.
The search button will default to AltaVista. Compaq hopes to
move its Supply chain management process to a complete web-
based approach. This could improve manufacturing efficiency.
We believe Compaq, like other leading PC vendors, has
correctly viewed the web as a way to extend and cement
customer relationships, while improving operating efficiencies.
PC companies that do this can enrich revenue opportunities
by increasing the attach rate of services, support,
peripheral and other add-on sales. Compaq 's challenges
include executing this strategy without alienating the channel
further.
Compaq services appear to be benefiting from the Digital
acquisition. All segments (break fix, system integration and
professional services) are growing. The company appears
poised to take advantage of being the leading NT service
provider as NT continues to scale. Compaq service intends to
focus primarily on larger accounts. It hopes to relegate
channel players to the smaller business and consumer segments.
In those segments it hopes they will sell and deliver
Compaq-branded services and pay a royalty fee (100% gross
margin). With little room for maneuvering, conflicts could
arise from the financially strapped channel if they feel
Compaq saves all the large, lucrative deals for itself,
leaving them with leftovers. But if Compaq is successful with
its strategy, it could result in higher services growth and
margins.
BUY
LARGE CAP
Compaq (CPQ)
Lowering Compaq Q1 EPS to $0.31 from $0.36 due to weaker-than-
expected January
Compaq is trading around 24 times our revised forward four-
quarter consensus estimates and at a roughly 10% discount to
the S&P. Should the stock pull-back as a reaction to our
lowering Q1 earnings estimates, we would find it attractive.
We maintain our Buy rating and feel the stock should outperform
the S&P.
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