Capellas May Not Be Up to the Compaq Task

He's clearly a nice guy, but Seymour wonders if the CEO has what it takes to turn the boxmaker around.
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Watching

Compaq

(CPQ)

CEO Mike Capellas on

CNBC's

"Power Lunch" from Houston today, I was struck once again by how tough his job is.

And how he's probably not the guy for it.

Capellas is one of the good guys in this business, and his good-guy nature is an especially welcome change from the autocratic operating style and personal demeanor of the man he succeeded Eckhard Pfeiffer. But sometimes companies in as much trouble as Compaq need a kick-ass leader more than they need a good and decent man as a manager.

Tech Savvy:

TSC message boards.

You can make a case that Capellas has done a fair job since he took over the reins in July 1999. Leaderless for three months after the Compaq board wisely

canned Herr Pfeiffer for his inaction in the face of growing crisis, Compaq moved from being run (sort of) by a guy revealingly known on the Compaq campus as "Das Boot," to being run (sort of) by a three-person committee of board members, to being run (supposedly) by one strong and fully empowered leader.

To underscore how fully the board was backing off and giving Capellas the room he needed to maneuver, Chairman Ben Rosen wandered the stage during the press conference announcing Capellas' appointment carrying a golf club. The message was clear.

Of course, the downside of Capellas having nearly absolute authority is his having nearly absolute responsibility for what happens on his watch. I'm not saying I want to see Capellas walk the plank -- yet -- but I think his very limited progress so far in fixing Compaq's deep, nearly systemic problems is not encouraging.

To give him his due, yes, Compaq's stock price is up a little from around 25 when he took over in July, to Wednesday's close of 28 (after an early-November bottom just under 19). CEOs are supposed to manage shareholders' assets in ways that increase shareholder value, so Capellas gets at least a C+, for about a 12% move during his six-month reign.

And yes, Compaq's earnings report on its fourth quarter, released after the market closed Tuesday, beat the

First Call/Thomson Financial

analysts' consensus estimate by three cents, earning 19 cents per share instead of the consensus number of 16 cents. But this is not good performance for a company with Compaq's size and presumed power. This was one hell of a quarter-over-quarter fall from 1998, when even a Pfeiffer-hobbled Compaq earned 43 cents on about the same total sales.

And yes, Compaq has slowly begun to refresh its product line, most visibly in the low-priced

iPaq

corporate desktop rolled out before Christmas.

But the big issues remain unaddressed -- or, at best, half-addressed:

  • Compaq still hasn't begun to solve its distribution problems. It gets 70% of its consumer sales, Capellas says, from retail, only 30% from direct sales. Yes, some retail buyers still want to touch the box before buying it, but many more would be happy buying direct -- saving Compaq a bundle in the process. Maintaining this two-tiered distribution system hobbles Compaq on pricing -- it can't undercut its retailers by offering the same goods directly at the more aggressive prices it needs to set. The current distribution system also leads to a lump of declining-value inventory sitting in the retail-distribution pipeline. Meanwhile, Michael Dell's troops continue to enjoy "negative-working-capital" advantages by nearly eliminating goods-in-progress inventory, and completely eliminating finished-goods inventories.
  • Compaq still hasn't shown that it has any idea what to do with the troops and product lines it inherited in its acquisitions of Tandem and Digital Equipment. Sure, Compaq can claim that 51% of its sales come from this enterprise solutions and services group (which also includes all direct corporate PC and server sales), but all those "feet on the street" that Compaq inherited -- and still occasionally brags about -- have become an albatross. The enterprise solutions and services group's sales were down by a worrying 3% in the most recent quarter.
  • As U.S. Bancorp Piper Jaffray analyst Ashok Kumar points out, Compaq still puts way too much emphasis on its very-high-end Himalaya and Alpha servers. (U.S. Bancorp Piper Jaffray has done no recent underwriting for Compaq and the firm rates Compaq stock a buy.) I think we're seeing a Great Divide appear in the server market, between ultra-powerful "industrial"-level servers, such as those from Sun (SUNW) - Get Report and Hewlett-Packard (HPW) , and a high-growth market for still-powerful but far cheaper Intel x86-based servers from Dell (DELL) - Get Report and others, the latter often running Linux. If that's so, Compaq's slippage in server-market share, which it once utterly dominated, is even worse than it appears. Add a focus on these high-end Compaq servers running Windows NT/Windows 2000, where there is much slower growth, and Compaq's direction looks even more perilous.
  • Capellas has apparently stalled out in a kind of reorg interruptus. Compaq has long been famously fragmented by overlapping, illogical and wasteful fiefdoms. As an insider at Compaq before taking the helm, Capellas certainly saw that -- and, at first, seem determined to break the old geographic focus in favor of a more rational products-and-markets focus. But the company has gone less than halfway toward fixing the problem, and finishing the job no longer seems at the top of Capellas' agenda.
  • Finally, Capellas spooked the market Tuesday with his Greg Maffei-like warnings that, while he thinks 2000 earnings could be up 15% over the disappointing 1999 results, we won't see that turn for some time -- and, at least implicitly, he sees a difficult year ahead. "The first quarter will start out a little bit slow," Capellas said Tuesday. "We expect revenue to decline quarter-to-quarter due to seasonality and be backloaded due to the release of Windows 2000."

Investors who bought into Compaq at its 52-week low have nearly doubled their money -- or at least they had before Tuesday's discouraging earnings report, and the subsequent slide in share price.

And some analysts have been inching Compaq up in their ratings, from "hold" to "buy."

Both are seen as good signs.

But I see worlds of hurt ahead for Compaq, despite this burst of enthusiasm. Maybe Capellas will pull Compaq out of this swan dive, but not soon, I think, and maybe not before being replaced by another leader.

Sad to say, shareholders' investments in Compaq look to me like largely dead money -- at least for the near term.

Jim Seymour is president of Seymour Group, an information-strategies consulting firm working with corporate clients in the U.S., Europe and Asia, and a longtime columnist for PC Magazine. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. At time of publication, neither Seymour nor Seymour Group held positions in any securities mentioned in this column, although holdings can change at any time. Seymour does not write about companies that are current or recent consulting clients of Seymour Group. While Seymour cannot provide investment advice or recommendations, he invites your feedback at

jseymour@thestreet.com.