Thomas Lepri
There's a reason things seemed too good to be true at Compaq (CPQ Quote - Cramer on CPQ - Stock Picks).
Compaq was finally forced to do Thursday what it so steadfastly refused to do two months earlier: admit that it can't help cutting prices to the point of putting serious pressure on its profit margins. The company lowered its earnings forecast for the first quarter to 12 cents to 14 cents a share, the midpoint of which comes in a massive 38% below prior guidance. Sales, meanwhile, should come in between $9 billion and $9.2 billion, the company said. That's as much as $600 million below the previous forecast, and roughly 4% below the year-ago period, which itself was hardly a blowout quarter. The problem is simple: demand stinks, and Compaq couldn't resist following its competitors -- think Gateway (GTW Quote - Cramer on GTW - Stock Picks) and Dell (DELL Quote - Cramer on DELL - Stock Picks) primarily -- down the price warpath. Forget the reassurances the company gave during its fourth-quarter earnings conference call in January. Then, Compaq had insisted that even though it would see no growth in first-quarter sales and that the PC business was notably weak, a shift in emphasis toward enterprise products and a refusal to chase PC market share at the expense of profits would help it bring first-quarter earnings in on target, at 21 cents a share. "You can avoid a price war if it lasts a quarter," said Gerard Klauer Mattison analyst David Bailey. "But if it lengthens into six months or more, it's very difficult to suffer those market-share losses. Essentially, Dell forced their hand." (GKM has done no underwriting for Compaq or Dell.) On the conference call Thursday, CEO Michael Capellas declined to give guidance for 2001 beyond the first quarter. But it's pretty much a given that the company won't be coming close to its goal of 20% to 25% earnings per-share growth. Of course, it wasn't just firm pricing and a focus on enterprise products like servers and storage that Compaq had been counting on to help it pull off the IBM (IBM Quote - Cramer on IBM - Stock Picks)-like trick of getting earnings per-share growth to outstrip sales growth by as much as 20 percentage points. Compaq had already signaled its intent to rein in costs, and the company sketched that plan in greater detail Thursday. It announced plans to combine its commercial and consumer PC businesses, scratch certain redundant product offerings and fire about 5,000 people. Compaq will take a restructuring charge of $125 million to $150 million in the first quarter. The company said the reorganization will save it $500 million to $600 million in operating expenses each year. The company's alacrity at chasing cost reductions should encourage some investors, though it's hard to say whether the savings Compaq gets from combining its PC units will put the problem of profitability behind it. "We're skeptical that the PC business will be able to drive solid profitability for the long term, period," said Bailey at Gerard Klauer. "Merging the two groups may allow them to lower expenses to a certain extent, but a more appropriate long-term move would be to lessen their focus on the consumer." It was hard to miss the sense of urgency betrayed by the management changes that Compaq unveiled. CFO Jesse Greene was replaced by Jeff Clarke, a 15-year veteran of Compaq and Digital Equipment whom Capellas introduced as "a great communicator." (The extent of Clarke's loquacity remains to be seen, as the company allowed only a few questions on the call.) Greene, meanwhile, will assume the position of senior vice president of strategic planning, a title created specifically for the occasion. "Draw your own conclusions," said Bailey.
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