Why Times Could Get Tough for PC Distributors

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Monday Morning Madness:

From Compaq (CPQ) capers to the Compaq calamity:

When manufacturers in any industry get indigestion, their distributors and resellers often get downright sick. With Compaq now admitting in its roundabout way that its distribution channel is stuffed, the chatter in some investment circles is that the real aches and pains may be felt by companies that rely heavily on selling PCs to corporations -- namely, companies like

Inacom

(ICO)

,

Microage

(MICA)

,

Vanstar

(VST) - Get Report

and

Compucom

(CMPC)

. Even diversified distribution kingpins

Ingram Micro

(IM)

,

Tech-Data

(TECD) - Get Report

and

Merisel

(MSEL)

could catch cold.

The trouble, according to Compaq CEO Eckard Pfeiffer, is that Compaq's sales "out of the channel" didn't materialize. Ditto, presumably, for other large PC makers. In plain English it means the distributors, for whatever reason, couldn't unload what they already have. When that happens, the channel starts to back up (yeah, just like your sewage system), which means distributors and resellers get stuck holding more inventory than they had anticipated. As a result, they can't bring in new inventory. Distributors and resellers "live on inventory turns," says Seymour Merrin of

Merrin Information Services

in Palo Alto, Calif. If they can't bring in new inventory, he says, their sales volume falls. If sales volume falls, all heck breaks loose because suddenly they can't take advantage of special deals many PC makers offer the distributors to get them to take additional product, especially rebates that are paid if certain sales quotas are met. These rebates help the distributors pad margins that are usually in the low single digits.

Without the rebates, margins -- and profits -- could very well fall.

While perhaps not as dire, the current situation reminds some industry observers of the PC industry's last upheaval in the late 1980s, when the big names in distribution and reselling were the likes of

Computerland

,

Businessland

,

Computer Factory

and

Entre Computer

.

Where are they today? They're not.

Biting the hand that feeds you:

That's what graphics chip maker

3D Labs

(TDDDF)

did in January when it sued its main fab,

Texas Instruments

(TXN) - Get Report

, and switched to

SGS-Thomson

, after missing its December quarter earnings because of problems on TI's end.

Trouble is that 3D Labs' biggest customer is

Diamond Multimedia

(DIMD)

, which recently got a big graphics board design win from

Dell

(DELL) - Get Report

. The contract was based on a 3D Labs chip that was produced at TI. Diamond, as the story goes, didn't want to switch to a chip made by another manufacturer because its board would have to get requalified. So it struck a deal with TI whereby Diamond would buy the chip directly from TI starting in April. In turn, 3D Labs will get a small royalty that works out to a gross margin along the lines of 12% per chip as compared with the more than 40% analysts were expecting.

That shift could translate to a much smaller bottom line than analysts had expected in an industry that is only expected to get more competitive. Funny, though, you wouldn't know it from analyst estimates, which have pretty much remained unchanged.

3D Labs officials couldn't be reached.

I don't make it a practice to reprint what has already elsewhere, and for all I know this is widely known, but:

Didja see Carl Hall's story in Saturday's San Francisco

Chronicle

about how health insurers may not cover the full cost of

Viagra

,

Pfizer's

(PFE) - Get Report

h-h-hot new impotence pill? Hall reported that Oakland-based

Kaiser Permanente

, the country's largest HMO, has decided to reimburse only h-h-half the cost of the pill, which is expected to retail and $10 to $20 per hit. Wanna bet how that influences what health insurers will pay? ("Sorry, dear, not tonight; I'm broke.")

Contrary to what this column's newbies may think:

Herb on TheStreet is not a tech-stocks column. It just appears that way, based on events of the past week. Look for more diversity as we move forward.

Policy statement, cont'd:

David Murphy, like many

TSC

readers, is perplexed by the policy that doesn't allow

TSC

staffers to own individual stocks. "You guys obviously know your stuff, and must really like the investing arena to cover it as well as you do. That being a given, isn't the urge to buy stocks overwhelming? I always wonder whether you either A) have enough socked away that you're content to let it continue to accumulate in mutual funds, or B) don't have a spare nickel to invest?"

TSC's

policy allows writers to own mutual funds, bonds and the like. That has been this column's policy since its creation 10 years ago. When you write a daily column about publicly traded companies (or work as a reporter at a place like

TSC

), you never know which company you'll write about next. From personal experience, many readers assume guys like me are always either on the take from sources (especially short-sellers) or trying to pad our own pockets by promoting positions we already own. The only way around that is to avoid owning any individual stocks, period. That policy, in my family, extends to my wife and kids. There's been plenty of debate inside my house about the kids, because I believe individual stocks, rather than mutual funds, give kids more bang for their buck as a learning tool about investing. But the last thing I want is

them

to get dragged into the middle of some controversy based on something I've written. (Nothing would surprise me based on how hostile some folks get when their stocks get knocked.)

Why not simply disclose that I own a stock (in an IRA or elsewhere) if I write about it much the way Cramer does? Because that would be tantamount to a recommendation. It's tough enough to convince readers that what they read here isn't

my

recommendation, but the recommendation of my sources. (Hey, folks, I'm just the messenger.) My role is to present the info and let you make the decision. Sure, sometimes it has an angle; other times it has a solid point of view. But it's not

my

recommendation.

Moreover, unlike Cramer and other outside contributors, I will be in the newsroom, privy to conversation and news meetings where stock stories are discussed before they are published. It's vital that readers understand that the reporting staff is not pushing anyone's agenda.

Guys like Cramer often put their mouths where there money already is. Cramer himself is careful to write about big, liquid stocks and sees his job as offering an inside glimpse at trading, not at stock-picking. If you decide to go down the risky road of riding the coattails of people who recommend stocks that they've purchased, you had better realize that while you may know when they're getting in, you may never know when they're getting out, leaving you with what turns out to be a very empty bag.

Making investment decisions based exclusively on what you read in this column or elsewhere, or hear or see on TV or radio, is just as risky. My sources are some of the brightest folks on Planet Wall Street. But sometimes even

they're

wrong -- or in the very least way too early.

Finally, about my bio:

If you check it out on

TSC's

masthead, you'll note that it mentions I used to work for a publication called

Amusement Business

. Indeed I did, and for one year I covered circuses and carnivals. No wisecracks. Margaritaville's

Jimmy Buffett

had the same job a number of years earlier. He hated it. I liked it. Prepared me to cover Wall Street.

Herb Greenberg writes daily for TheStreet.com. In keeping with the editorial policy of TSC, he does not own or short individual stocks. He also does not invest in hedge funds or any other private investment partnership. He welcomes your feedback at herb@thestreet.com. Herb Greenberg also writes the monthly "Against the Grain" column for Fortune.