Dissecting the Entrails at Compaq

Seymour examines 12 issues surrounding the boxmaker's earnings warning.
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Let's take another look at the

Compaq

(CPQ)

debacle, in which Eckhard Pfeiffer & Co. on Friday warned that earnings for the first quarter would reach about 15 cents a share, far short of the 31-cent

First Call

consensus the company had gently encouraged (discouraged?) with its last earnings preannouncement, in late February.

Earlier I looked at the likely effect this week on Compaq's peers in the PC business -- the box-movers, like

Dell

(DELL) - Get Report

,

IBM

(IBM) - Get Report

,

Hewlett-Packard

(HWP)

and so on -- as well as its impact on its suppliers, distributors and retailers. And on those companies with no business relationship at all with the Houston giant, but which may still get whacked.

I've spent a lot of time working the phones this weekend. Compaq has a lot of unhappy employees who are eager to talk and possess their own theories about what's been going wrong at the company for the last few quarters. Some of what follows is from their anguish; some comes from other tea-leaf readers like me; and some is pure deduction and surmise on my part.

Twelve issues, point by point:

    Let's remember, first, that -- despite the ugliness of preannouncing a 15-cent profit two weeks after a quarter closes, when you've helped analysts along toward an earnings estimate twice that high -- Compaq did make a profit. And that profit is 15 times that of the same quarter a year ago. Compaq stock has struggled a lot lately -- since mid-1997, excepting only a brief spike earlier this year to nearly 50, Compaq has wallowed around in the 30 range -- and eking out a 15-cent quarterly profit when you did exactly 1 cent in the same tough post-Christmas quarter a year ago is an accomplishment. (On the other hand, let's not give Compaq too much credit: Since mid-1997, Dell's share price has more than quadrupled, and I expect a decent, if unimpressive, Dell profit for the same post-Christmas quarter when Dell reports this week.) Compaq's internal systems are, by all accounts, in disarray. That may be an unkind observation, but it's a heck of a lot nicer than to suggest mendacity in Compaq knowingly misleading analysts and investors, as many are this morning. I think this was incompetence, not conscious deception. Compaq has long had problems with bean-counting: Remember the inventory debacle two years ago? Eckerd Pfeiffer's brand of leadership may be what Compaq needed several years ago, when the board booted founder Rod Canion -- a gentle, intelligent, soft-spoken soul -- and replaced him with Das Boot (just one of Pfeiffer's unflattering nicknames among Compaq employees). That kind of management works, often, for a while. But eventually, you have to start running a company on a more stable basis. Compaq may be at the point where new leadership is required -- if only to rehab its image on Wall Street. Pfeiffer would, of course, disagree; and in fairness, I have to say that, at least to outsiders, he seems a decent, civilized person, better than his storm-trooper image suggests. Part of the problem here, I'm told, lies in that traditional swamp for Compaq: inventory management. While PC prices plummeted -- and initially, Compaq did well with its consumer-oriented Presario line -- the company failed to make the fundamental changes required to shift its business model. Too many beige boxes on the shelves is a catastrophic mistake for PC makers. An irony is that now Compaq says one of its big problems, at a time when corporations are cutting back sharply on PC purchasing, is that the mix of its sales is all wrong: too many low-priced/lower-margin machines, not enough high-priced ones. If, in fact, Compaq is also burdened with constipation in its Presario distribution (read: Its still-not-cheap-enough Presarios are piling up on dealers shelves and in warehouses), then the problem is even worse than we realize. If you don't sell enough at the high end, and you don't sell enough at the low end, and the middle of the market has simply evaporated ... what's left? Compaq's problems will have an outsize impact on the market, and especially on the share values of its direct competitors. Simply because Compaq is so large, its troubles are more visible, and more worrying, than those of smaller competitors who may in fact be in worse shape. Compaq has for the past few years punted on the innovation front. The company has always been by choice a follower not a leader -- Canion used to say that the company would innovate only within existing industry standards. But in a market with only two points of differentiation, price and technology, he who defaults on technological advances had damned well better cut prices to the bone. Compaq hasn't. Despite its struggles to match Dell and other low-cost producers, Compaq remains a relatively high-cost producer, still largely wedded to costly build-for-inventory manufacturing and a distribution system based primarily on resellers, with all the margin implications those suggest. Sure, Compaq's trying to develop an online-sales presence it hopes will challenge Dell -- but a big bottom-line impact from that is quarters away. Rehabilitation -- there is simply no other term -- is not going to be quick. No matter Compaq's operating results, announced changes, etc., the Street is not going to be forgiving when many of its best and brightest were so egregiously hung out to dry by Compaq. Sure, if Compaq shares fall low enough today and this week, some buyers will jump back in to establish or re-establish positions at unusually low prices -- the company has, or at least has had, some big True Believers -- but significant Compaq share-appreciation is unlikely to happen in the near- to midterm. Bite the Street, and the Street bites back. And it has big choppers ... and a long memory. Compaq could have mitigated some of the mid-to-long-term damage with a late conference call Friday. Rather than its terse statement, the company should have offered its senior execs as punching bags for outraged analysts. No fun, to be sure, and yes, there are risks in that, mainly that a beleaguered manager will in an especially difficult moment say something the company comes to regret. But taking a dive this way insults the investment community. One reason Pfeiffer, CFO Earl Mason and other senior managers at Compaq get the big bucks is that they're expected to stand and deliver ... or at least, stand and explain. Like big boys. Big strategic mistake. The lawyers are already sharpening their knives. Schiffrin & Barroway, a Philadelphia law firm that specializes in investors' class actions against companies based on securities-law issues, already has one filed against Compaq for the period from late January through the late-February warning. I think we can reasonably expect to see that expanded to include the company's announcements, including Friday's, over the entire first quarter. And others will emerge. Finally, shed a tear this morning for The Wall Street Journal. It must be hugely embarrassing to the nation's largest and finest financial dead-trees pub that on Friday morning it featured a big story at the top of page B2, with the headline "Improved Results Expected for Computer Firms." You can imagine how the rest of the story went from there: PC companies, especially Compaq, were about to report "mostly improved" first-quarter results. A respected analyst was quoted as forecasting 33-cent quarterly earnings. I take absolutely no glee in reporting this. The WSJ reporter was sandbagged by analysts' optimistic forecasts; those analysts were in turn sandbagged by Compaq. (There, but for the grace of God, etc.)

It's not a happy morning in Houston. I've had two calls already this morning from friends at Compaq who say this is the last straw: Do I know of any good jobs in other PC companies? And the market has already spoken, with Compaq shares taking a well-deserved drubbing, down more than 20% in the first hour.

Despite a 15-cent profit, that 15-times-better performance I mentioned above, Compaq is perceived this morning -- and will be perceived for some time to come -- as a loser, an out-of-control business, a dangerous cue ball bouncing off the bumpers, knocking other players around left and right.

It's not pretty. And Mr. Pfeiffer, it was not necessary.

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 the companies discussed in this column, although positions can change at any time. Seymour does not write about companies that are consulting clients of Seymour Group, or have been in recent years. While Seymour cannot provide investment advice or recommendations, he invites your feedback at

jseymour@thestreet.com.