PC or not to PC, that is the question
Gateway, Compaq seen as strong, long-term value plays
By Deborah Adamson, CBS.MarketWatch.com
Last Update: 1:00 AM ET Dec. 19, 2001
LOS ANGELES (CBS.MW) - Personal computer makers are battling one another for supremacy in a maturing industry with dog-eat-dog price-cutting.
They've suffered severe stock losses as a result: The Dow Jones Computers Index is down 39 percent from its January high, even with the recent rebound in PC shares.
The personal-computer era is going through a seismic shift, as PCs become a commodity, brands matter less than functionality and networks and applications migrate to the Web, according to a Deutsche Banc Alex. Brown report. It's a shakeout that similarly plagued mainframes and minicomputers as newer technology arrived.
Amid this PC wreckage, intrepid and selective value investors can find bargains. Analysts say two stand out: Compaq (CPQ: news, chart, profile) and Gateway (GTW: news, chart, profile).
Compaq
Houston-based Compaq is the second-largest seller of desktop computers, fourth in laptops, and No. 1 in standard Intel-architecture servers, according to Deutsche Banc Alex. Brown.
This year, Wall Street is forecasting consensus earnings of 6 cents a share on revenue of $32.8 billion, down from 97 cents on sales of $42.4 billion in 2000. But analysts are projecting higher future earnings -- 16 cents next year and 50 cents in 2003.
Most notable is that the stock's "incredibly cheap," said John Schneider, portfolio manager of the large-cap Pimco Value Fund (PDLAX: news, chart, profile), who all together manages $400 million. At its Monday close of $9.49, Compaq traded near its book value of about $7 a share.
George Elling, an analyst at Deutsche Banc Alex. Brown, also found Compaq's valuation to be attractive.
By his calculation, Compaq's sum-of-the-parts value is $14 a share, conservatively. In addition, since the first quarter of 1996, the stock has traded at an average of 15 times forward EBITDA (earnings before interest, taxes, depreciation and amortization) with a median of 13. His $12 price target assumes that the stock would trade at only eight times his estimate for Compaq's EBITDA in 2003.
"We feel that whether (the merger with) H-P did or didn't happen, the company is still a pretty good value," said the analyst, who broke ranks with many of his Wall Street colleagues and gave it a "buy."
Besides the PC market challenges, another reason Compaq's share price has been pummeled is the trouble swirling around its planned merger with Hewlett-Packard (HWP: news, chart, profile). The latter's founding families have come out against the merger. See full story.
In January, Compaq hit a 52-week high of $25. Its 12-month low is $7.26.
Schneider likes Compaq even as a standalone. "It's a lot more than a PC company."
Moreover, he sees a coming catalyst - a spurt in computer orders The last wave of purchases came in 1999 as users prepared for the uncertainties of the Year 2000 bug. Since computers tend to last three to four years before they're replaced, Schneider reasoned, the next wave of purchases should start in mid-2002.
Gateway
Known for its bovine-pattern boxes, Gateway is the world's second-largest direct PC seller and operates 300 retail stores. Unlike Compaq, Gateway is almost solely a PC maker.
Among the industry leaders, Gateway has notably struggled in the competitive arena. A major drain was the high cost of maintaining its retail stores. This year, analysts forecast a loss of 21 cents a share, down from profits of $1.27 in 2000. Revenue should drop as well, to $6.3 billion from $9.7 billion last year.
Its shares, which rose 5 cents to $8 on Tuesday, reflect the business pressures: In January, Gateway hit a 52-week high of $24.21. The yearly low was $4.24.
Analysts say the bad news may be behind it since Gateway has finished a restructuring. It shutdown all international operations, cut its workforce by a fourth, consolidated stores and reduced costs.
Analysts forecasted the next two years' profits to be 16 and 15 cents a share, respectively.
In addition, Poway, Calif.-based Gateway has $2 a share in cash, a book value of $4 a share and "decent visibility" on a return to profitability in the second half of next year, Elling said. "The downside to Gateway shares is relatively limited."
Gillian Munson, an analyst at Morgan Stanley Dean Witter, says Gateway is an interesting, "risky value play." She noted the company reaffirmed, albeit cautiously, its expectation for fourth-quarter profitability.
Moreover, demand has rebounded to pre-Sept. 11 levels. The third quarter is looking like a "clean-up quarter" as Gateway got its house in order, Munson said. She gave it an "outperform" rating.
Elling has a "buy" on the stock based on its "valuation and turnaround potential."
His 12-month price target is $12 a share, based on a valuation of 10 times his 2003 EBITDA for Gateway. |
