Nicholas & Thread:
So there's the answer on what happens with Alpha ??.
Here is something positive about CPQ....
CPQ/H1 ESTS SHADED A BIT MORE; DEC DEAL VERY MUCH ON TRACK/BUY
08:57am EST 31-Mar-98 Cowen & Co. (Richard Chu)
Compaq (CPQ - $26)
Rating: Buy (2)
EPS Quarterly EPS
New Old +DEC# CYPE Q1 Q2 Q3 Q4
F96* 0.87 0.16 0.16 0.24 0.32
F97A 1.35 0.27 0.30 0.36 0.42
F98E 0.75 0.89 35X 0.02 0.02 0.27 0.44
F99E 1.60 1.60 2.00+ 13X
1585MM shares; Market Cap = $43B; TTMRevs = $24.6B
*Quarters do not add; recast for TDM pooling
#Pro-forma, assuming purchase acquisition of DEC.
Key Points:
1. DEC deal remains on track to close, possibly as early as end of April,
more likely May.
2. Promos/price & output cuts thus far having desired impact on sales
out.
3. However, build rate reduction will continue into Q2; hence we are
trimming Q2 net revenues and expect B/E type H1.
4. Still expect major synergies to drive pro forma EPS for 1999 to $2 or
better.
Bottom Line - Compaq remains the global market share leader in PCs and is
emerging as a significant player in NT-based enterprise systems, a position
which should be enhanced by the pending acquisition of Digital Equipment
which should significantly extend its services, expertise, and technology
in NT enterprise systems. Despite the extremely disappointing start to
1998, we expect CPQ to make headway to achieving a more streamlined
distribution/logistics model which should position well to gain further
share in the consolidation of the systems market. We are maintaining a
buy/2 rating for a 6-9 month target of about $36 as H2 and C99 EPS recovery
comes into focus.
1. DEC deal looks on track - We met with Compaq at our European Emerging
Technology Conference on 3/31; our impression is that the FTC review
process has moved well; management's sense is that that there is a strong
likelihood that the FTC is satisfied with the companys response to the
FTC's second request for information (March 6th); in this event, there is
now a distinct possibility that proxy mailings could commence as early as
this week, leading to a timeline for shareholder approval at the end of
April, perhaps the most optimistic scenario.
- Compaq has evidently taken a strong stance in outlining to the
Commission its full intent to back Alpha on a strategic basis (presumably,
the FTC fears Compaq may dum Alpha), a stance that makes full strategic
sense to us given the potential importance of Alpha to the Company's
enterprise NT strategy.
- Meanwhile, we don't sense any significant issues with the SEC with
respect to planned purchase accounting treatment, although obviously
management remains unprepared to address details of the the potential in-
processs R&D writedown and related charge provisions pending closing; that
said, proxy should provider much better insight into these variables.
- In short, we believe that the probability of a timely close has
improved, and this is important inasmuch as this transition limbo period
can be expected to be challenging for both Compaq and Digital from at least
two perspectives (a) inability to move forward with
organization/management/headcount changes, and (b) customer uncertainty.
On this latter point, investor fears have been rampant that business at
Digital has come to a dead halt, pending the deal, while we don't expect
DEC's results to meet our projections, our sense from Compaq management is
that DEC order rates have strengthened in recent weeks in part due to more
aggressive handholding and informal roadmapping.
- We continue to expect that the DEC deal will leverage Compaq's
enterprise aspirations by bringing on crucial NT technologies and expertise
along with potential jewels with Alta Vista, high-end storage and, of
course, enterprise services. At the same time, rather than focus on DEC
revenues, the more relevant dynamic for Compaq is that the acquisition will
provide aggressive cost/expense synergies (we have made tentative
assumptions suggesting that an 8-10,000 headcount reduction (relative to
pro-forma combined total of 84,000) could drive operating expense synergies
of upwards of $800MM annually and be accretive to CPQ EPS for 1999 by $0.40
or more (see below).
2. Current picture - so far so good - Compaq is evidently seeing a
meaningful pickup in sales-out in the North American commercial channels
following its aggressive pricing and promotional activity; most of the
initial effect of the recent pricing/promotion and production cutbacks have
been to reduce internal finished goods inventory of older product, with
product transition coming on in the middle of April. We expect internal
inventory turns to improve slightly from December year-end levels with more
of a shift away from finished goods. As new BX-class and other PII models
are launched in early Q2 with a BTO emphasis, and as build rates continue
to be held conservatively, channel inventories should begin to decline
noticeably towards Compaq's avowed 2-3 week goal by the end of June, for
commercial desktops. The picture in portables, we gather is pretty good
(ex perhaps the high end).
Roughcut Analysis of Gross Margin Impacts from Contra Items ($MM)
Q1:98 Q2:98 Q3:98 Q4:98 Comments/Factors
1/Additional Price 200 150 75 0 - Assumes channel stocks cut
Protection signif by Q2
2/Additional 150 115 25 25
Promotional Allowances
3/ Above Normal 350 265 100 25 - Direct reductions
Contra Items from gross rev; we had
previously assumed
$150MM for Q2
Gross Rev Bef Unsual $5,6 $5,3 $6,6 $7,9 -- We had previously
Contra Revs 50 65 75 15 assumed $5.7B for Q2
Net Revenue (As $5,3 $5,1 $6,5 $7,8 - previously $5.55B for Q2
Reported) 00 00 75 90
Gross Margin, Before 24.7% 25.1% 26.0% 26.9%
Unusual Contra
Gross Margin (As 19.8% 21.2% 24.9% 26.7%
Reported)
Cowen & Co Ests.
3. Trimming Q2 estimates - We are reducing our Q2 revenue and EPS
assumption (to closer to breakeven) as we are now assuming, more
realistically, that sales into the channel will decline sequentially from
Q1 and as build rate reduction continues into Q2. In addition, since we
assume that any significant decline in channel stocks will occur later
(rather than earlier) in the June quarter, we have boosted our "above-
normal" contra revenue deduction assumption for the June quarter by another
$100+MM; as result, we now project net revenue of about $5.1B, down from
Q1's estimated $5.3B and about $450MM below our previous $5.55B
guesstimate, formulated on the run in the immediate aftermath of the March
6th pre-release. We do, however, assume that contra-revenue drag will
diminish significantly in H2, helping to support a major uplift in reported
gross margins; this revised estimate assumes that server/systems margins,
given recent aggressive pricing, may remain under more pressure than we had
factored in before, as well. In the meantime, our sense remains that
final demand trends in the US commercial and European markets generally
remains solid, although the recently steep decline in component costs have
certainly contributed to the fuelling of far more aggressive pricing, a set
of conditions that may change as and when component cost declines shallow
somewhat in coming months and quarters. Compaq management continues to
characterize European demand as strong and not surprisingly, is very
cautious about Asia, which is now down to just about 5% of corporate
revenues.
4. Maintaining $1.60 EPS for 1999 pre DEC; DEC buy shoot drive $2+ EPS
power - Obviously, management has decided to take a bath in H1 to position
itself for the post merger H2 environment. We expect Q2 numbers, post
deal to be clearly segregated between CPQ and DEC. As summarized below, we
are maintaining our view that the Digital acquisition could be
significantly accretive to 1999 EPS, which we currently size at about
$1.60,unchanged from our recent thinking.
KAD |
