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Market Volatility Threatens Compaq's Investment Strategy

With its Internet portfolio slammed, observers say the boxmaker's taking its eye off the ball.

Like every other PC maker,



is under pressure to reduce its reliance on the sagging desktop PC market and get into higher-growth businesses. It has lots of efforts under way, including nifty new handheld devices, but it has been in its investment portfolio that the company has found the fastest payoff -- by investing in fast-growing tech stocks.

The recent gyrations in the Internet sector, however, have made that strategy look a lot dicier than it did just a couple of months ago. That in turn may complicate the company's plans to raise the profile of, and revenue from, its investment operations.

Compaq first sketched those plans in January, in the thick of the


first-quarter frenzy. CEO Michael Capellas told reporters at a New York luncheon that the company planned to turn its investment operations into a separate division with its own profit-and-loss statement.

Later, in a meeting with analysts, Capellas said that Compaq expects to raise $50 million to $100 million a quarter this year from the sale of securities. Those proceeds would add income of as much as 6 cents a share in quarterly earnings, double what the company added to net income in its fourth quarter on investment gains of $50 million.

The shellacking in the Internet sector has made it unclear whether Compaq will continue to be able to bank on such gains, however. Nearly all of the company's significant positions are well underwater on the year. Sample the carnage:

Ask Jeeves


is off 75.2%;



, down 65.4%;

Ticketmaster Online CitySearch


, down 57.7%; and



, of which Compaq holds a whopping 41.6 million shares, down 52.4%.

Those declines have lopped about $3.4 billion off the value of Compaq's investment portfolio, which the company said was worth $6.6 billion at year-end. Compaq did not return calls seeking comment on the matter.

Other major tech companies have big investment portfolios, too. But Compaq is "a little late to the old party," says Fred Hickey, editor of the

High-Tech Strategist

. "It's OK if you're


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and you've been in that for years now and were buying these things for 25 cents. But if you've announced that you've become a venture capitalist in the last month or two, and if you made those investments, then you're going to be in for some trouble." Hickey is short Intel and has no positions in Compaq or Microsoft.

Compaq has been playing venture capitalist though its

CPQ Holdings

unit, which has invested in several private companies that have already filed to go public, including

divine interVentures


CrossWorlds Software






But with the outlook for the new-issues market looking very uncertain, it's hard to say when those investments will pay off. CMGI's move Friday to shelve the IPO of its


unit has already deprived Compaq, which still holds 18.5% of the Web portal, of around $512 million in potential fair market value, based on the low end of the anticipated price range.

To be fair, unlike true investment companies such as

Chase Manhattan


, Compaq doesn't include its investment income in operating earnings. So a shortfall in Compaq's portfolio won't produce a corresponding crunch on the company's bottom line. And Compaq isn't the only PC maker with extensive Internet exposure. Dell's portfolio includes recent skydivers like




Internet Capital Group


(the latter of which Compaq also holds).

Still, the pasting Compaq's holdings have taken this year could raise new questions regarding the troubled boxmaker's credibility and focus.

"I don't see a lot of upside," says David Bailey,

Gerard Klauer Mattison's

new hardware analyst, of the company's Internet forays. "If you're investing in a portfolio of Internet stocks that don't necessarily pertain to the core business, I don't see where that's a long-term benefit. It seems a little off strategy." GKM has done no underwriting for Compaq and rates the stock a hold.

"Execution is the key for them," Bailey notes. "They need to sell to corporations using the direct model. We've seen them narrowing their focus, but if they're broadening their investment portfolio, that gives me cause for concern."

Compaq has said that it expects direct sales of corporate PCs to make up 40% of total revenue by the fourth quarter of 2000, after accounting for only 15% of revenue last year. As far as Compaq is concerned, most observers agree that successfully completing that shift is a bigger priority than constructing an Internet portfolio.

And that takes concentration.

"The issue is, is the company taking its eye off the ball in a market where revenues are not growing and you're competing head-to-head with the likes of


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?" asks Hickey, who is long Dell and has no position in Hewlett-Packard. "If you're taking your eye off the ball and saying, 'I'm going to make money as a venture capitalist,' and you don't, then you're in deep doodoo."

The market may get a sense of just how deep when Compaq reports first-quarter earnings on April 25.