Aitch: Some reflections on the J.P. Morgan report.
We spent the morning of March 18th with four of CEO Eckhard Pfeiffer's direct reports: CFO Earl Mason, John Rose head of the enterprise business, John Rando, head of the services division, and Mike Winkler who runs the corporate non-server PC business.
Taken together with Mason's cc with Bear Sterns on Monday, this is hardly a company refusing to respond to market concerns. Note that they were meeting at about the time Kumar was crossing the "t's" on his report.
we came out of our meeting yesterday with the distinct feeling that Compaq's cost structure is considerably more competitive than it was as recently as a year ago
It is good to know that CPQ targets/promises in this regard are still operative.
This means there is a lot of pressure on March. Having said that, we are also hearing that pricing is still pretty disciplined in the PC business, which should help margins and there is the possibility of Compaq pulling more expenses out this quarter to help them at least come close to consensus earnings, particularly now that they have been brought down.
Oy maybe, come close to CPQ private targets.
The bad news is that by shying away from an aggressive market share push, the loftier revenue targets may have to be brought down. The better news is that EPS and cash flow are more likely to be protected.
Give me EPS and profits over market share.
Our meeting with John Rose left us feeling that Compaq is
sincerely willing to guide the enterprise business toward support for
multiple platforms, including both NT and Unix, and to enjoy the
profit potential from the proprietary platforms.......we still feel that Compaq's strategy is riddled with conflicts which the company has yet to resolve.
Good for COMPAQ. Make money where you can, confront the problems to do it, don't get squeezed into a single standard. The customer knows best.
.....the Alpha strategy. It is very gutsy. In
short, Compaq is betting that Merced will be delayed significantly
beyond the introduction of a 64-bit NT platform, giving Alpha an
opening as the only 64-bit microprocessor architecture supporting
64-bit NT when it comes out. That's quite a gamble....Having said that, the actual investment Compaq shoulders to support Alpha is small. John Rose used the figure of 5% of R&D, putting the total at less than $100 million per annum, which is commensurate we believe with Sun's annual commitment to its Sparc microprocessor design effort.
Playing the percentages.
......they still offer price protection up to four weeks,
the actual volumes of channel inventory are low enough for the contra-revenue exposure to have been brought way down. We are also hearing a lot less about convoluted channel relationship models, and more of a go with the flow approach, now that the cost structure has been brought down. Of course, the channel is suffering but Compaq's position is to let consolidation happen in the channel without interfering beyond supporting the channel's thrust into services.
So much for "channel stuffing" and "dislocation".
The services business is very straightforward and, given a free
rein, has accelerated its growth over the past year.. ... While the growth rate may trail IBM's service model, we think that by sticking to its service knitting, Compaq can keep its service margins in the 30% range, which does represent a good premium.
IBM's growth rate in services was 20% according to Dan Niles.
Our prior estimate ..is too high, and we have brought it down to
reflect the revenue shortfall in January and February.
A touch of trickery here. They brought their 1Q estimate down by 10 cents although the company has ascribed only 1 cent to slower revenues in the first six weeks (and 2 cents to devaluation).
While we are poised to be more positive on the stock in the wake of yesterday's session, we are retaining our Market Performer rating ...
Translation: we probably made a mistake in reacting too quickly and too radically to the report of January slowdown without checking with the company directly. We cannot change it back now, because we will lose face. So if, as is likely, CPQ will "come to close to consensus" we have already prepared the ground for ourselves to reverse direction and increase our estimates and upgrade our recommendation.
Table 1: CPQ Model Assumptions
P&L Line Item...............1Q/99E 1999E 2000E
Revenues ($MM)...............$10,033 $44,413 $53,663
Gross Margin(%)..............28.0% 29.1% 29.6%
SG&A as a % of Revenue.......14.8 14.0 14.0
R&D as a % of Revenue.........4.7% 4.7% 4.8%
Operating Margin (%)..........8.5% 10.4% 10.9%
Tax Rate (%).................32.0% 32.0% 32.0%
EPS (Diluted)................$0.33 $1.81 $2.28
They are using an unrealistic $10.033 for revenues. They are including the increased tax rate of 32%. Their operating margin of 8.5% seems unreasonably low. Their EPS of 33 is 5 cents too low. They do not seem to have made allowances for tax credits.
|
