Bear Sterns Maintains Attractive
CPQ: Changing Channels: Making It Simpler; Maintain Attractive
08:05am EDT 11-May-99 Bear Stearns (Neff, Andy)
Bear, Stearns & Co. Inc.
Equity Research
Compaq Computer Corp. (CPQ-26) - Attractive
Changing Channels: Making It Simpler; Maintain Attractive
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*** Key Points. In an effort to simplify its model in order to
improve its execution, reduce its inventories and "contra-
revenues" and to rebuild channel support, Compaq yesterday
announced that it will cut the number of U.S. commercial
distribution partners it uses from 39 to only four major
distributors (Ingram Micro, TechData, Inacom, and Merisel).
Under this scheme, all resellers will buy from these four
companies, who will in turn have limited price protection. In
addition, Compaq's goal is to improve the efficiency of its
distribution systems by eliminating excess channel inventories
and emphasizing co-location to reduce product "touch." While
this move does not address all of Compaq's challenges -- other
large issues involve integrating DEC, simplifying its product
line, building its direct effort, consolidating its internet
efforts -- it is a step in the right direction as it focuses on
its turnaround. The issue will be how IMB and Hewlett-Packard
respond to this effort to force consolidation for distributors --
the early indication is that H-P is not planning to follow
Compaq's move. We maintain our Attractive rating and our
estimates, which could be optimistic near-term.
* Good Move. However, long-term, we believe the
restructuring is a good initial step in the turnaround process as
it can potentially simplify the company's complex relationship
with the channel, improve inventory turns, increase product
availability, speed order filling, and better the company's
forecasting capability.
* Focusing On The Turn. As we have noted, investors need to
look at Compaq not as a growth story but a company in the
midst of a turnaround. An important part of any turnaround is
management focus and execution and we think that streamlining its
channel is an incremental positive step designed to simplify
processes and thereby make it easier to focus and execute. We
would note that Apple reorganized its channel in front of a
return to growth and it would not surprise us if Compaq's next
step were to simplify its product line.
* No change In Estimates. While we have limited earnings
visibility and are particularly concerned about the potential for
shortfalls in the next few quarters, we are maintaining our EPS
estimates at $1.00 for 1999 and $1.75 for 2000, but our estimates
for the next few quarters could be optimistic. We continue to
rate the stock Attractive based on the prospect of a turnaround.
While we do not think the company is "there" yet, we believe that
the company is making incremental process.
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Shares outstanding: 1,750 million
Market cap: $45.9 billion
EARNINGS Q1 Q2 Q3 Q4
Mar Jun Sep Dec Year P/E
Current 1998 $0.01A $0.02A $0.08A $0.43A $0.56A 46.9x
Current 1999 $0.16A $0.18E $0.23E $0.43E $1.00E 26.3x
Current 2000 $0.33E $0.40E $0.43E $0.58E $1.75E 15.0x
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*** What's The Deal? The crux of the deal is that from August
the number of Compaq's US commercial product distributors will be
cut from 39 to only four "Distributor Alliance Partners" (DAP) --
Ingram Micro, TechData, Inacom, and Merisel -- thereby
consolidating the number of inventory carrying warehouses in the
US from 100 to only 30 and cutting commercial channel inventory
by an estimated 50%. While there is near-term risk as Compaq
tries to dispose of the flush the extraneous inventory out of the
channel, over the long-term we think the benefits are many:
* simplify the company's complex relationship with the
channel,
* improve inventory turns,
* increase product availability,
* speed order filling,
* better forecasting capability,
* and consolidate channel assembly programs.
In addition, only build-to-order (BTO) and channel assembly will
be handled by the DAPs, configure-to-order (CTO) will still be
handled by Compaq directly. Finally, Compaq is extending pass
through price protection for reseller -- three days for desktops
and seven days for servers.
*** Trying To Get Out In Front. Long-term, we believe this
restructuring is a solid initial step in a turnaround process as
it will start simplifying Compaq's complex relationship with the
channel. In its struggle to compete with Dell's direct model,
Compaq has tried to roll out a number of models that incorporated
the channel to various degrees but were all confusing to
customers, the channel, and investors. We think that Compaq has
realized that it cannot go all the way direct and is not trying
to amalgamate its various programs into a "hybrid" model
comprising direct and indirect components and focused on
"customer choice" and making indirect more efficient. Going
forward, Compaq believes that 25% to 30% of sales will be direct
and the remaining will go through the four DAPs. While we think
there may be short-term risks owing to confusion among resellers
and the 35 unwanted distributors who may shift business
elsewhere, over the long-term, we believe the greater
simplicity will pay off.
*** No Change in Estimates. While we still have little
visibility, we are maintaining our estimates of $1.00 for 1999
and $1.75 for 2000. We have little confidence in these estimates
given recent developments as these estimates are based on our
assessment as opposed to company guidance.
*** Continue To Rate Attractive. We are rating the stock as
Attractive because of the prospects for a turnaround -- the timing
of which is highly uncertain, but precedent is on our side given
history in the computer industry. From a valuation perspective,
the stock is selling at 130% of trailing twelve month sales,
which is at the low end of the computer industry, but if it hits
bumps, which are likely, it could sell down to 100% of sales,
which implies a downside of 24%. The other issue is that this is
not a near-term story, because the turnaround will take time and
will involve both pleasant and unpleasant surprises. On the
other hand, if and when things show improvement, the stock will
move well ahead of the fundamentals, which argues for holding on
to the stock at current levels. |
