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ANALYST UPDATE: BULLISH IN THE EYE OF THE BEHOLDER
By Peter D. Henig
Red Herring Online
July 24, 1998
Were earnings really that good, or did analysts just have a soft spot for PC makers? We think it's the latter, but we'll give them the benefit of the doubt.
Compaq (CPQ) and IBM (IBM) each picked up analyst coverage after meeting (beating, some would say) Wall Street's expectations.
Computer Associates (CA) wasn't nearly so lucky. CA had its bell rung pretty soundly after the company gave guidance that Asia problems and Year 2000 issues were going to dampen earnings going forward.
Apples to apples?
Sometimes it's not what Wall Street hears, but what it wants to hear, that matters.
Take IBM's and Compaq's earnings, for example. Neither company blew estimates away -- IBM reported earnings of 1.50, a penny better than First Call's number, while Compaq came in 0.02 under -- yet the Street struck up the buy side for both, with four investment houses upgrading Big Blue.
BancAmerica Robertson Stephens, Merrill Lynch and Prudential all upgraded IBM to Buy, while Morgan Stanley Dean Witter rated it a Strong Buy. IBM posted strong earnings last Monday of $1.45 billion for the June quarter, showing strength in its business services side, but weakness in the personal computer area.
"Everybody is suffering from lower average selling prices. Gateway, Compaq, IBM, Hewlett-Packard, everyone," says Jimmy Johnson, associate analyst with A.G. Edwards and Co.
However, Mr. Johnson says that of all of them -- Compaq, Gateway (GTW), and Apple (AAPL), each of which he rates a Buy -- "the long-term potential is better with Compaq."
Really?
"Look, we don't want to get in the business of market timing this stock because there still exists an integration issue with the [Digital Equipment] acquisition. But to us the valuation picture looks good," says Mr. Johnson (no relation to the stiff-haired Miami Dolphins coach).
The analyst concedes that Compaq could miss third-quarter earnings this year, he predicts that "1999 should be looking pretty good."
If only Wall Street were as bullish on Gateway. The PC-maker famous for its Holstein-spotted boxes missed its earnings number for the quarter by 0.05, and then Wall Street -- or at least half of the Street -- decided to put it out to pasture.
Lehman Brothers and Prudential Securities immediately downgraded the stock, with Lehman taking it from Buy to Neutral, and Prudential reducing it to Hold from Buy. Curiously, Salomon Smith Barney raised its rating on Gateway from Accumulate to Buy, despite the company's guidance that lower average selling prices had begun to weigh heavily on margins, and even Credit Suisse First Boston -- the new home of Deutsche Bank's Frank Quattrone -- maintained its just-initiated Buy rating on the stock.
We can't handle the truth
Did Wall Street really want the true scoop out of Computer Associates after the company reported respectable earnings for the second quarter? We doubt it.
Yet that didn't stop CA from going ahead and digging their own grave. The company launched a shocker on analysts during the post-earnings conference call, giving guidance that Asia and the Year 2000 problem will have an impact on earnings going forward, with Y2K diverting IT spending and delaying mainframe hardware deployment.
Needless to say, Wall Street wasn't thrilled.
No fewer than six firms downgraded Computer Associates, including Goldman Sachs, Lehman Brothers, Merrill Lynch, Morgan Stanley Dean Witter, Donaldson Lufkin Jenrette, and NationsBanc Montgomery Securities.
"Six -- is that all? I thought it was more," said analyst Paul Dravis of Montgomery Securities. "Basically, management gave guidance that there would potentially be slower customer spending for their mainframe business, so it looks like it's going to be tough for the next two-three quarters."
Christopher Galvin of Hambrecht & Quist heard the same thing. "Management not only had a cautionary tone in regard to the mainframe business, they also said they might not have as much success as in the past in closing large-scale deals."
Mr. Dravis also pointed out, however, that this looks like a company-specific problem and that two other companies he follows in the same space, Compuware (CPWR) and BMC Software (BMCS), "remain excellent, excellent companies for investors." Montgomery has a Buy recommendation on each.
And in a related case of "I said it, but I didn't mean it" analysis, Charles Phillips of Morgan Stanley lowered his rating on Computer Associates from Strong Buy to Neutral, only to raise it again the next day from Neutral back to Outperform. But what do you really think, Mr. Phillips? Oh, never mind.
Let's not be hogs
Could we write an analyst update story and leave out an Internet stock? Never.
MindSpring Enterprises (MSPG) recently paid the price of success as Everen Securities downgraded the internet service provider after the stock had run an amazing 60 points, up 66 percent, over the last two weeks.
Still, victory had to be ever so sweet for the Atlanta-based company, known for uncompromising customer service, as it proved to the Street this was one Internet play which could deliver. MindSpring beat analyst estimates by 0.06, registering its third straight profitable quarter (earning 0.24 per share), just two days prior to the exercise of its board-approved three-for-one stock split.
Further rumors that it remains takeover bait doesn't hurt matters either. Did somebody say "cozy relationship with cable companies"?
Is IBM back for good?
Compaq delivered on its earnings promise.
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