"Not the Compaq We Used to Know"


By Gene Marcial With the nasty slowdown in PC sales, are the computer "box makers" in a, well, box? Not necessarily -- especially in the case of Compaq Computer (CPQ), the world's largest PC manufacturer and second-largest computer company. In fact, some investors are starting to take an upbeat view of Compaq, mainly because of its fresh focus on certain high-margin markets. The stock, currently trading at 22 a share, is well off its all-time high of 51 in 1999 and down from its 52-week high of 35 on August 28, 2000.

Compaq's improved outlook comes from its new strategy: The company is trying to shed its PC-centric business plan to focus more on boosting profit margins -- even at the expense of sacrificing market share.

Given this, "we expect a shift in Compaq's financial model more in favor of the enterprise [computer] systems, which should favorably impact profit margins," says Walter J. Winnitzki, senior analyst at J.P. Morgan H&Q. In other words, Compaq now would rather go after the business of supplying and servicing corporate computer systems.

THE MISSING PCs. Part of the strategy is to target the high-end, high-margin markets dominated by such giants as IBM (IBM), Sun Microsystems (SUNW), and EMC (EMC). These are entrenched competitors, admits Winnitzki, which won't make for easy sledding. But he notes that Compaq has had some success already in winning big customers in the enterprise infrastructure market, including Walt Disney (DIS) and Yahoo! (YHOO). But substantial progress won't happen overnight.

Noticeably absent from Compaq's new plans is the area of PCs. The clear message is that Compaq "doesn't want low-margin sales here and is willing to let competitors like Dell (DELL) have these sales, and, we believe, take even the No. 1 market share position in the overall PC industry," says Winnitzki. "Clearly, this is not the Compaq we used to know," he adds.

But many analysts are still down on the company: Andrew Neff of Bear Stearns has lowered his 2001 numbers from $1.15 to 75 cents a share based on his new model that reflects a 5% decline in Compaq's revenues in 2001, vs. his previous expectaton of 8% growth. Compaq earned 98 cents in 2000. Neff expects demand for servers, storage, and PCs will continue to weaken. And Megan Graham Hackett of Standard & Poor's Corp. has downgaded Compaq from accumulate to a hold due to "evidence of a dramatic slowdown in PC sales."

BROADER FOCUS. But the bulls are looking beyond the weakened demand for PCs. "A sum-of-the-parts analysis for its major products divisions shows a potential valuation of 30 to 35, or more," argues Winnitzki. The analyst has raised his rating on Compaq to a buy from long-term buy not only because of its "compelling valuation" but because of the progress it has achieved in focusing more on the broader enterprise computer-systems market. According to Winnitzki, Compaq plans to aggressively push its industry-standard PC servers at the upper end of the market using Windows 2000 and some unique server technology to go after the low-end of the UNIX server market now dominated by Sun.

And it plans to leverage its close relationship with such partners as Oracle (ORCL), the world's largest supplier of information-management software, to scale up to the high-end market and bring along more services in competition with IBM, says Winnitzki. In the storage area, Compaq plans to target EMC's domain by offering value-based competitive pricing and performance.

Success in the enterprise computer-systems market -- the fastest growing area of the industry -- would provide Compaq with the greatest growth opportunity and insulate it from PC concerns, says Winnitzki. Sales from the enterprise systems market accelerated in the fourth quarter by 20%, to $4.1 billion, and now make up about 36% of Compaq's total revenues.

Still being valued by investors as a commodity-PC vendor, Compaq is trading, as Winnitzki notes, at a steep discount to the market value of comparable companies. In 12 months, he thinks Compaq will hit 30 to 35. Marcial is BusinessWeek's Inside Wall Street columnist


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