Looking for Answers at Compaq

A devastating first quarter has Compaq looking for answers.
Author:
Publish date:

For

Compaq

(CPQ)

, maybe it's time to go back to the drawing board. On Friday, Compaq management, blaming weak demand and pricing pressures, warned that its first-quarter earnings would be half what Wall Street expected. Today, investors dumped Compaq stock, pushing it down 6 11/16, or 22%, to 24 1/4 in heavy volume.

How can Houston-based Compaq, the world leader in PC sales last year, get back on track?

Merrill Lynch

analyst Steve Milunovich says Compaq may have to take "head count down a bit" -- analyst-speak for layoffs -- especially if the company moves toward selling PCs directly to customers. Milunovich, who was neutral on Compaq before the bad news struck Friday, said Monday he isn't lowering earnings estimates for the rest of Compaq's fiscal year until the company's earnings announcement April 21. Other analysts did not wait long. Consensus estimates for Compaq's earnings fell to $1.22 from $1.74 for 1999, according to

First Call

.

One theory floating around is that Compaq should focus its energies on that gold mine called the Internet. Investors and analysts got excited back in January when Compaq announced it was spinning off its

Altavista

portal later this year, but this time it may take more than another Shopping.com to woo back Wall Street. A possible acquisition of a larger e-commerce entity, or even free Internet access isn't out of the question, say company followers, who believe there is no other short-term solution to the company's problems -- which include severe pricing competition on the low end and the integration of

Digital Equipment

.

"In the longer term, it's really a question of will the Internet's tail continue to wag the PC dog," Milunovich says. "I guess I would like to see Compaq move further into this area." Milunovich, who has been calling for

IBM

(IBM) - Get Report

to pare its PC business for some time now, says he isn't sure what's the best path for Compaq to take in the Internet space. His firm has done no Compaq underwriting.

Offering free Internet access with a computer purchase is not exactly a new idea. Competitor

Gateway

(GTW)

offers customers who buy a PC costing $1,200 or more free Internet access for a year, according to a Gateway spokesman. Newcomer

Microworkz

goes one step further: It offers PC buyers who are paying only $299 per unit a year's worth of free access to

Earthlink

(ELNK)

.

Acquiring a major Internet service provider could make more sense in the near term, especially since it would enable Compaq to offer free Web access relatively cheaply. "An ISP? That sounds interesting," says Alex Mou, an analyst with

BancBoston Robertson Stephens

who covers PC stocks with lead analyst Dan Niles. Compaq already has bought a few low-profile e-commerce companies, such as

Shopping.com

, and is expected to buy more to complement its Altavista service. An ISP such as

Mindspring

(MSPG)

or

PSINet

(PSIX)

could fit nicely into the mix, according to a West Coast analyst who requested anonymity. No date has been set for the Altavista IPO and there are no plans to buy an ISP, according to a Compaq representative. Robbie Stephens has done no underwriting for Compaq.

'It's really a question of will the Internet's tail continue to wag the PC dog.' -- Merrill Lynch's Steven Milunovich

With little way of differentiating PCs, add-ons such as ISP service or free

Iomega

(IOM)

Zip drives are what will separate a very cluttered PC space as it reaches its "survival-of-the-fittest stage," according to John Puricelli, a technology analyst/trader for

A.G. Edwards

. For a maturing industry like personal computers, expect to see some consolidation as PC companies continue to suffer from extreme pricing competition, he says. "With eight to 12 PC vendors out there, you are going to need to have some consolidation like with what you're already seeing with software companies," Puricelli explains. Software titan

Computer Associates

(CA) - Get Report

, for example, just made a tender offer to acquire

Platinum Technology

(PLAT) - Get Report

.

Compaq investors are hoping that it is not too late for the company to make headway. "I've been a big fan of

CEO Eckhard Pfeiffer's team for quite a while, but I think they have been caught with their pants down here," says John Mannino, an individual investor and holder of Compaq and

Dell

(DELL) - Get Report

stocks.

Even for some professional money managers, Compaq's management has always been a question mark. "My expectations have been coming down ever since Mason came on board in 1996," says an institutional money manager, who requested anonymity and has no position in the PC group. The manager points to how the company is being sued in six lawsuits, alleging that top executives sold off stock because they knew bad news was coming. Compaq's Mason, for example, sold 265,000 shares, worth over $12 million, on Feb. 1, according to data tracker

Baseline

. Mason, who joined Compaq from

Inland Steel

in May 1996, did not return calls seeking comment. Richard Frutkin of the Philadelphia law firm

Savett Frutkin Podell & Ryan

says the suits will likely be consolidated and then move forward as one lawsuit this May. Often these lawsuits are quietly settled out of court for a nominal amount.

Regardless of the outcome of the suits, Compaq needs to understand that Wall Street doesn't like surprises.