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Technology Stocks : Compaq -- Ignore unavailable to you. Want to Upgrade?

To: Night Writer who wrote (93976)	12/6/2001 9:23:45 AM
From: Elwood P. Dowd	Read Replies (1) \| Respond to of 97611

From The Street.com Compaq Can Survive -- Maybe Even Thrive -- Without H-P By Tish Williams Senior Writer 12/06/2001 09:09 AM EST Compaq's (CPQ:NYSE - news - commentary - research - analysis) friends are readying the support network in case it gets dumped. The computer and server maker will find out in one month whether its intended merger partner Hewlett-Packard (HWP:NYSE - news - commentary - research - analysis) has the needed pull with its shareholders. If approved, the two will stride forth together, beefing up their service-revenue potential, thinning out their PC offerings and solidifying server dominance in a hostile market. If denied, HP's management will dive into a deep depression and Compaq will be forced to dust itself off and renew its comeback efforts in earnest. The Street has good reason to look past the merger and love Compaq for its own assets. Make no mistake, Compaq is in the same trouble it's suffered through for the past several years. Dell (DELL:Nasdaq - news - commentary - research - analysis) is causing it pain in the PC market by producing increasingly cheap products. Compaq's better bet is with its server dominance and its quiet progress in its higher-margin Global Services segment. In the third quarter, service revenues climbed to 25% of depressed total revenues, working up to Compaq's long-term 33% goal for the segment's revenues. Even after a 38% climb since Sept. 20 -- Hewlett-Packard is up 55% in the same period -- several analysts have weighed in on Compaq's side, claiming that with cost cutting and some strategic moves, Compaq can add another 15% to 20% to its current price. Both Lehman Brothers' Dan Niles, who rates the company buy and whose bank has done underwriting for Compaq, and Vadim Zlotnikov of Sanford Bernstein, who rates the stock outperform and has no banking ties to the company, see Compaq as a potential $13 stock. (With another rally like Wednesday's, when Compaq jumped almost 8% to $11.65, that may not take long.) Many on the Street feel Compaq is not a lost cause. Most obvious of Compaq's faults, the PC business is a mess. Dell has overtaken the No. 1 spot in worldwide PC market share in a time of market declines. Dell uses its direct-sales model to pass on savings from low-priced components, while keeping its margins slightly above competitors'. Compaq's gross margin for its entire business fell to 19.9% in the third quarter, down from 24% a year earlier, despite the higher-percentage contribution from services revenues. The company attributed the fall-off to aggressive PC pricing in a weak market, but the Street sees that with a wider move to the direct-sales model, Compaq can regain its margins and eliminate some of Dell's advantage. Zlotnikov believes that without layoffs and the 12% margin improvement that direct sales afford, Compaq's PC business would "approach break-even in late calendar year 2002." AG Edwards analyst Brett Miller isn't convinced that direct sales is the only way for Compaq to compete with Dell. He figures Dell's current tactic of exploiting its efficiencies will take it only so far. He likes Compaq CEO Michael Capellas' notion to sell PCs that require less support and applauds Compaq for its ability to sell to smaller companies and a variety of geographic regions that won't warm to the bare-bones Dell operation. "Compaq has their own problems, but I don't think they're all about not being direct," he explains. "Michael's got the right idea and he's made some hard choices. He has to go where Compaq has intellectual property: storage, software, high-end clustering, iPaqs and the notion of lower cost of ownership." Miller rates Compaq hold. Of course, the server business is friendlier to Compaq. The company led the market in share of the server business in the third quarter, according to Gartner Dataquest. Morningstar's Joe Beaulieu considers the server business "pretty respectable." The threat, again, is that the technology will be commoditized and Compaq will see a repeat of the razor-thin margins in the PC business. UBS Warburg's Don Young adds in a note to clients, however, that Compaq's business model has "enabled it to maintain its storage margins as others (EMC) have seen margins deteriorate significantly" -- perhaps its PC experience is paying off. The difference in the long-term health of the server business could be a tie-in with services. "The strength of IBM services is not in its support, but in the consultants it has out there to push IBM products," Beaulieu says. "If Compaq wants to go [in] that direction, it's going to take a big push." Morningstar doesn't rate Compaq at the moment because it believes the HP acquisition will go through. The Street is unsure about Compaq's ability to stay competitive in the consumer PC business. "PCs will always be ball-and-chain to Compaq's earnings growth," says Miller. "Unless they make hard decisions, they will continue to lose money there." But there is confidence that the company can succeed at servers, and that it's on the right track with its service efforts. The Street hasn't given up on Compaq, even if Hewlett-Packard does.