From The Motley Fool: must read for DELL and CPQ investors
Compaq Bull's Pen
by Chris Rugaber (tmfrfk@aol.com)
If I were just a company shill for Compaq, I could talk
about its four years of global PC market domination,
despite that market's cutthroat price competition. Or, I
could note that its server computers are so widely used
that, according to its 1997 annual report, "nearly 50
percent of e-mail transmissions, 60 percent of all credit
card transactions, 80 percent of all Automated Teller
Machine [ATM] transactions and 90 percent of all
securities transactions. run through Compaq servers."
Even allowing for some annual report hyperbole, that's
pretty impressive. (Full disclosure: We use some
Compaq servers here at the Motley Fool.)
While impressive, such corporate PR is really only half
the story. Compaq, thanks to its recent acquisitions of
Digital Equipment Corp. and Tandem Computers, is now
the second largest computer company in the world. PCs
will be a smaller part of its business going forward, and
considering the challenges that the personal computing
industry will face in the coming years, that's a good
thing.
So, if you need PCs, servers, notebooks, networking
equipment, web-hosting capability, modems, printers,
hand-held personal digital assistants, 64-bit high-end workstations, and the support
services and consulting needed to hold it all together, Compaq can provide it -- and
more. The company's acquisition of Digital included Internet search engine Alta
Vista, which presumably explains the nice big link to Compaq's website in the
bottom right of Alta Vista's home page. Most companies would have to pay a pretty
penny for that.
Compaq aims to have $15 billion in services revenue and $60 billion in total revenue
by 2002, more than double 1997 sales. If the company returns to pre-1998 margins,
profits should also grow accordingly. Zacks' consensus estimates are for EPS of
$0.58 in 1998 and $1.63 in 1999. At recent share prices ($28 15/16 on June 26th), that's
only 17.75 times '99 earnings.
Of course, the big knock against Compaq is its recent inventory problems, which
reduced net income from a high of $667 million in the fourth quarter of '97 to an
anemic, one-cent EPS, or $16 million, in the first quarter of '98. Clearly, the company
miscalculated demand in the middle of an ongoing PC price war, and it suffered
accordingly. But Compaq has moved aggressively to solve the problem. It has
reduced inventories from over $2 billion in the third quarter of '97 to $1.26 billion in
the first quarter of this year.
In addition, Compaq is developing its "Optimized Distribution Model," which will
include direct sales over the Web and "build to order" kiosks that will be placed in
most major computer stores. The kiosks are presumably an attempt to placate
resellers, who will object to being undercut by direct web sales if Compaq goes too
far down that road. It's a tricky problem, and it's unclear at this point how it will work
out. Can Compaq move to a "just in time" direct sales model without alienating its
resellers? Should it try to? Is there a happy medium? After all, it's perfectly easy to
buy Compaqs both over the Web and at CompUSA now.
The happy medium may already have been found, however: Compaq CEO Eckhard
Pfeiffer recently noted that when reseller websites are included, Compaq sells more
over the Internet than Dell -- $6 million a day versus Dell's $5 million. Yes, yes, Dell
turns its inventory over much more quickly than Compaq, but so what? Compaq is
moving beyond simply trying to be the fastest PC distributor in the world.
Others question whether Compaq can swallow its $9.6 billion purchase of Digital
Equipment Corp., the largest merger in the computer world's history. Clearly, DEC
adds a lot to Compaq: 25,000 service technicians, including 2,000 certified Windows
NT engineers; access to thousands of business customers, which will put Compaq
ahead of IBM as the top PC supplier to large businesses; and the rights to Alpha,
Digital's 64-bit high-end microprocessor that's two years ahead of Intel's Merced
[Ed. Note: Intel recently bought the rights to Alpha technology.] This will be the
acid test for Compaq over the next couple of quarters, but as one analyst noted,
"Management is not underestimating the task." By looking at margins and revenue
streams, it should be possible for investors to track the company's success (or
failure) in this endeavor.
More importantly, these unresolved issues of sales models and acquisition
digestion are at least partly priced into the stock, which declined significantly when
Compaq's channel inventory problems became apparent. In fact, one could argue
that Compaq is a classic example of Wall Street overreaction to what will likely be a
temporary condition. In the long run, inventory management is simply not the
biggest issue that PC companies will face.
Instead, there are bigger challenges to be faced. Will other "Internet appliances,"
such as Web-TV devices, cut into PC sales? Probably -- so it's a good thing Compaq
is likely to beat Dell and other PC makers in bringing a PC-TV hybrid to market. Are
price wars going to continue? Undoubtedly, but that's why Compaq's broadening of
its business is a good thing. Dell, meanwhile, will also face challenges. Until
recently, its main supplier of customer services was. Digital Equipment
Corporation. Whoops!
Compaq is likely to significantly grow revenue and profits, it has a couple of clear,
easily monitored risks, and all at a fairly decent price. What more does anyone need
in a high-priced market like this?
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