Compaq earnings mask deeper
woes
By Michael Kanellos and Jim Davis
Staff Writers, CNET NEWS.COM
July 15, 1998, 1:15 p.m. PT
news analysis Although Compaq surpassed analysts'
predictions today in reporting an operating profit of
two cents a share, the numbers don't resolve
underlying market conflicts facing the Houston-based
vendor and PC makers in general.
Demand for PCs appears to
be slowing down; at the
same time, consumers and
business customers are
demanding lower-priced
machines. While Compaq
maintains that its
sub-$1,000 machines are
just as profitable as
higher-end machines in terms of gross margin
percentage, the aggregate margin dollars generated
by each machine is less, according to analysts and
even Compaq executives.
Some of the price reductions come as a result of
component cost reductions, but some come straight
out of margins, according to most observers. As a
result, PC makers have to make up the difference by
selling more units, again, in a market that appears to
be slowing down.
"We should get a seasonal uptick. All the indications
are that there is really no reason to think that it won't
happen," said Gene Glazer, vice president of Fortis
Advisers, an international financial services company.
"But there has been a slowing of demand generally in
the world."
Vendors are going to have to emerge from this cycle
either by taking market share from each other, cutting
costs, or moving into new areas such as service.
Compaq's problems are compounded by the fact that
it has only just begun to integrate recently acquired
Digital Equipment.
The company's experience this quarter typifies the
struggle between unit and revenue growth. In the
past three months, Compaq cut inventories and
boosted unit sales in all markets, including an 86
percent jump in the consumer arena.
Sales, however, stayed relatively flat at $5.8 billion
when compared with the same period for the year
before, and generated approximately one-fifth of the
operating profit.
In fact, when revenues and earnings from the
acquisition are removed, Compaq posted lower
revenues than the same period the year before,
showed relatively flat unit growth, and could have
suffered a loss. Nineteen days of Digital revenue were
added to Compaq's numbers for the quarter.
Without Digital, Compaq's revenues declined to $4.9
billion for the quarter and resulted in a ten cents a
share loss, said Ashok Kumar, an analyst with Piper
Jaffray. "If you look at it without Digital, Compaq has
a 14 percent sequential decline and an 11 percent
decline year by year. "
Kumar added that the average selling price of the
company's PCs dropped to $1,750, down 30 percent
compared with year-ago numbers. By contrast, Dell
currently has an average selling price of $2,500, while
Hewlett-Packard is at $2,200.
"I suspect that it [the Digital acquisition] actually
helped them because this is seasonally Digital's
strongest quarter," added Glazer.
"The underlying revenue appears to be off more than
is apparent in the financial statement," agreed Roger
Kay, an analyst with International Data
Communications. "There is an apparent revenue drop
that can be accounted for by average selling price
decrease."
The decrease, he added, can be attributed to both
component drops and Compaq's reaction from
customers for even lower prices.
Glazer and others have pointed out that Compaq will
partially skirt the revenue-unit conflict by cutting costs
and reducing revenues. Compaq is in the midst of its
job-cutting program and continues to move forward
on its build-to-order initiative.
Beyond PC pricing, Compaq still has the lion's share of
work ahead of it in digesting Digital, pointed out
Daniel Kunstler, computing analyst at J.P. Morgan
Securities.
"In the near term, there is the nuts and bolts of
restructuring. You have to look at the number of
employees that will be reduced, the expense ratio,"
he said. "In the long term you have to see some
tangible evidence that the marketing of DEC's
products has some teeth."
To successfully sell DEC products, Compaq will have
to bridge a credibility gap with Digital's customer
base. Compaq has been an active proponent of
Windows NT; however, a substantial portion of
Digital's product and service revenue comes from its
Unix base. "Digital's legacy business has the highest
margins," he said.
To his credit, CEO Eckhard Pfeiffer seems to
recognize the need to develop this revenue stream,
Kunstler said |
