Is It Turnaround Time for Compaq?
July 12, 1999
By Carolyn Whelan
In China 1999 is the Year of the Rabbit, but for Compaq Computer so far
it's been the Year of the Dog.
Operational nightmares and strategic blunders led chairman Benjamin Rosen
and Compaq's board of directors to boot CEO Eckhart Pfeiffer -- the man
who led the Houston-based company through a successful turnaround in the
early 1990s and built it into the world's largest manufacturer of personal
computers.
Obsessed with gaining market share and
changing Compaq's business model to
compete more effectively with Dell
Computer's direct-sales approach,
Pfeiffer got squeezed when cutthroat
pricing decimated margins in the
consumer PC business.
Compaq's clumsy hybrid strategy also
alienated its distributors while the
manufacturer stuffed the channel with
inventory. That led to earnings shortfalls
that were even bigger than management had projected. It was the worst of all
worlds, costing Pfeiffer his job and slicing the value of the stock in half.
Compaq stock closed at 26 3/8 Monday -- 46% off its 52-week high of 49
¼ -- although it has rebounded nicely from its 52-week low of 22 3/16.
But now, there's turnaround talk in the air, though it's clearly in its early stages.
Since last week, Compaq shares have advanced 13% amid a general rebound
in the stocks of PC manufacturers and a Buy recommendation in The
Turnaround Letter, which said: "Sure, Compaq has some work ahead of it to
get back on track, but its current valuation looks very attractive."
Other bulls are beginning to crawl out of the woodwork, too. They call
Compaq undervalued, saying the problems in its PC business are fixable and
that its real jewel -- the service business it got in the $9-billion acquisition of
Digital Equipment -- is being overlooked. All it awaits, they say, is a new
CEO who can fix what's broken and unlock the value of the rest.
"Compaq is not just a PC company -- it's much more," says Martin Hingley, a
UK-based industry analyst at the International Data Corporation (IDC).
"Compaq has not yet figured out how to position what it bought [from
Digital]," explains Jennifer Beck, group vice president for IT services at San
Jose-based Dataquest, a unit of the Gartner Group. "But they've got all the
goods. It rivals IBM Global Services."
"The services aspect hasn't been given full measure in the valuation," says Bob
Colin, comanager of the Pax World Fund.
Maybe that's because most of Wall Street is still hiding. Only one sell-side
analyst of the 11 Barron's Online contacted for this story returned our
telephone calls. Yet some industry analysts and portfolio managers expect
positive news -- and upside to the stock -- very soon.
"You'll see very different messages coming from Compaq over the next six
months," says Beck.
"Management issues have clouded their image, but much of their underlying
business is intact," adds Roger Kay, another IDC analyst.
Such as? Compaq is still number one in entry-level servers, servers for
Windows NT and multiuser storage, and it is in the top tier of computer
services providers, according to IDC.
Information technology (IT) services is the largest and
fastest-growing part of the technology business, with profit
margins of 20-40%, versus only 15-20% margins for PC
hardware.
But investors still view Compaq as a PC company, and thereby subject to
price wars. Yet even there, Compaq can turn things around. "There's a lot of
things to do to improve efficiencies," says Hingley.
Indeed, while the search for a new CEO goes on, Rosen and the board have
begun to restructure the business, reorganizing sales operations, shrinking
Compaq's distribution network sharply and announcing layoffs beyond the
15,000 connected with the Digital merger. Those measures should cut
expenses by about $2 billion. Compaq also will sell the popular Alta Vista
search engine and portal it got from Digital to CMGI for $2.3 billion (see
Weekday Trader, "Alta Vista May be a Key Part in CMGI's Puzzle," July 7).
"They're making the moves they need to," says Jim Savage, portfolio manager
of the Regions Value Fund, who holds Compaq stock and says he would
consider buying more.
The missing piece: a new CEO. On July 2 Rosen announced that a new CEO
would be appointed within four to six weeks. That will certainly be critical.
(Just look at the impact CEO Michael Armstrong has had on AT&T's stock.)
But regardless of who the new CEO is, the bulls say the stock has probably
bottomed out.
"It obviously has tremendous support at 20, and I don't think it could get
worse," says Savage. "If they have a good stretch, the stock could go to 40
pretty quickly."
"It could be considered one of those diamonds in the rough," agrees Dennis
Fitzpatrick, portfolio manager of the First Investor Growth and Income Fund.
At Monday's closing price the shares changed hands at a reasonable 21x
times 2000 consensus estimated earnings of $1.24 a share. That's a pretty
good discount to Compaq's five-year average P/E of 25x and is in line with its
projected long-term earnings growth rate of 20%, according to First Call.
Of course there are risks -- not least the pricing turmoil that has plagued the
PC sector (see Weekday Trader, "RIP PCs?," April 15). Plus, the longer it
takes Compaq to launch a turnaround, the further ahead some of its
competitors are likely to get. And, of course, the new CEO could turn out to
be a real turkey, which -- along with a quarterly earnings report due July 28 --
is probably why analysts remain silent.
But after all the bad news, it's hard to see how things could get much worse.
And now some people are beginning to say they're about to get a whole lot
better.
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