Sales to the channel are going to be off for the next quarter and a half due to stuffing
Its getting to be a full-time job pointing out all the times you are wrong. Pay special attention to the bold print.
CPQ: No Change In Guidance; Maintain Buy, Estimates
07:14am EST 16-Mar-99 Bear Stearns (Andy Neff)
BEAR, STEARNS & CO. INC.
EQUITY RESEARCH
Compaq Computer Corporation (CPQ-31 3/8) - Buy
CFO: No Change In Guidance; Maintain Buy, Estimates
-----------------------------------------------------------------
*** Key Points. Yesterday afternoon we hosted a conference call
with Compaq CFO Earl Mason who updated us on the quarter and
discussed the company's long term strategy and outlook:
* There was no change in company guidance - the company had
previously noted that it had seen weaker than expected January
sales in the small and medium business segments, primarily in
desktops in the US and Europe. Our forecast for 1Q99 is $0.29
vs. $0.01.
* The last week in February and the first week in March were
seasonally normal and on plan. Compaq believes that the quarter
will be back-end loaded and dependent on high-end sales that
traditionally come late in the quarter and are slightly ahead of
plan.
* The company put forward the theory, citing anecdotal
evidence, that small and medium businesses may have held off on
purchases in front of the February 28 release of the Pentium III
because they wanted to benefit from follow-on pricing actions on
the Pentium II. This implies a possible snap-back in March.
* Compaq stated that Japan has been stronger than expected and
that they are seeing healthy economies in the US and Europe.
* We think that the normal indications of a slowdown in demand
are not in evidence: major players such as Microsoft and Intel
have indicated that business trends are in line with expectations
and channel checks have not turned up evidence of channel
stuffing.
We are maintaining our 1999 estimate of $1.65 and our 2000
estimate of $2.25 as we believe CPQ is weathering short-term
issues that will be fixed by next year. We reiterate our Buy
rating on the stock because we believe that the company is
successfully transforming itself from a box builder to a
systems/solutions provider (implying an improvement in gross
margins from mid-20s to 30% with operating expenses around 15%-
17% of sales), thus gaining access to a bigger share of total IT
revenues. We view the weakness as an opportunity.
-----------------------------------------------------------------
EARNINGS Q1 Q2 Q3 Q4
Mar Jun Sep Dec Year P/E
Current 1998 $0.02A $0.02A $0.08A $0.43A $0.56E 62.8x
Current 1999 $0.29E $0.35E $0.42E $0.60E $1.65E 21.3x
Current 2000 $0.47E $0.52E $0.55E $0.71E $2.25E 15.6x
-----------------------------------------------------------------
***Why the Shortfall? In our call, Compaq cited anecdotal
evidence from resellers such as Compucom that small and medium
businesses may have held off on purchasing desktops in front of
the February 28 release of the Pentium III because they wanted to
benefit from anticipated follow-on pricing actions by Intel on
the Pentium II. This implies a possible snap-back in March and
would explain the very specific area of the softness: US and
Europe, desktop PCs.
From our perspective, this explanation makes sense, but, as we
stated following our estimate reduction in early February, we
still believe the main reason for the unexpected shortfall in
January and early February in revenue in North America and Europe
(and in particular medium-sized businesses) is from the
dislocation in the distribution channel. What we mean by
"dislocation" is:
1. Distributors and resellers like Tech Data, Ingram Micro,
Inacom/Vanstar and othershave been experiencing shortfalls in
revenue as incentives have been cut back by computer systems
companies (Compaq, IBM, and H-P) who are trying to be more
competitive with Dell on price and cost.
2. The major computer systems vendors (again, Compaq, IBM, and
H-P) are also adding direct sales efforts to their indirect sales
channels thus shifting some business - that primarily based on
availability - to direct.
3. Distributors/resellers are shifting their business models
toward greater value-added services to make up for lost hardware
margin.
***Metamorphosis Continues. During the call, Earl Mason walked
us through Compaq's strategy, started in 1996 and now roughly 80%
complete, to change itself from a box maker to a systems and
solutions provider. Thus, a single Compaq account manager would
be able to address all of a client's IT needs and thereby capture
more revenue. The company's plan has been to combine organic
growth with acquisitions such as that of Tandem (high-end sales
and service) and Digital (mid-range sales and service) to grow
revenue from $20 billion to $50 billion and top-line growth 2x to
3x the market, and improve gross margins from 25% to 30%. We
believe this process is on track and think that this "bump in the
road" represents an opportunity.
***Why Real Devaluation Effect So Large? The company stated that
although Latin America represents only 4% of sales, around half
of which are in Brazil, the company was forced to write down $200
million in accounts receivable because of the devaluation which
translated into $0.03-$0.04 one-time negative effect on 1Q99 EPS.
***Insider Selling? Compaq addressed concerns about insider
selling - following a positive analyst meeting but prior to the
lowered guidance by saying that senior management have a
ownership policy and that members of the team had both exercised
options and bought shares.
***Maintain Buy. We continue to rate Compaq shares a Buy in
view of its low valuation of 16x our 2000 estimate of $2.25. We
believe the company is progressing on its metamorphosis from the
"box company" it was in 1996 into a systems company that should
fully emerge in 2000. The addition of Digital, which Compaq has
made great strides in integrating, positions the company as a
leading Wintel PC business with a high-end systems business. One
could argue that Compaq is comparable to Sun Microsystems (the
systems company), Dell (the PC company) and IBM (services) rolled
into one, thus enabling Compaq to "own a customer." The
challenge at this point is focus and execution, the calling cards
of Dell and Sun. However, we think Compaq's management has
demonstrated in its ability to overcome what have seemed like
insurmountable odds in the past.
*** Fundamentals Still Intact. We believe fundamental demand is
still strong as (1) the Internet is still the biggest driver as
corporations and individuals continue to spend on Internet
clients and Internet infrastructure (servers, storage,
networking, and software); (2) corporations continue to spend on
IT to lower costs, improve productivity, and leverage off their
information assets through datawarehousing and datamining.
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