April 18, 1999 11:00 PM PDT

Compaq overhaul overdue, analysts say

As word of Compaq's top-level shakeup spreads, industry analysts say the No. 1 PC maker was due for a management overhaul because of baffling corporate behavior and too many earnings surprises.

Concerns came to a head with the most recent earnings bombshell, leading ultimately to Eckhard Pfeiffer's removal as chief executive this weekend, according to Kurt King, an analyst at Nationsbanc Montgomery Securities.

"What is galling is this sense of denial," he said. "They totally blindsided us with the earnings...They continue to insist that it's an industry demand problem. Investors hate that."

Investors have likely been in contact with chairman Benjamin Rosen recently, he said. The recent announcement that the company would not meet expectations was "the straw that broke the camel's back," he added.

Although Pfeiffer appears to have been asked to resign, chief financial officer Earl Mason is leaving to take over as chief executive of Alliance Foods, a large food corporation in Chicago, according to King.

He and other analysts point to a credibility gap that is starting to take its toll on the company among investors and Wall Street. "Given the gaping deficit between old management and the street, there was a structural issue that could not be addressed in a cosmetic fashion," said Ashok Kumar, computer analyst at US Bancorp Piper Jaffray. "The stock is now at an absolute low."

The company has also encountered difficulty in managing acquisitions, especially as it has strayed beyond its core consumer PC business. Compaq acquired Tandem and Digital--and, with the latter, Web portal AltaVista--but the revenue that comes from their corporate computers has not yet offset relentless price cuts at the lower end of the scale.

"If you sell more doughnuts then expect to sell more caviar, but they don't have the right mix yet," said Bruce Stephen, vice president at International Data Communications.

Kumar said he is uncertain whether Compaq will go outside for its new CEO, as IBM did a few years ago when it found Lou Gerstner, or stay within the company. One inside candidate could be John Rose, a senior vice president at Compaq responsible for servers and corporate hardware.

Stephen predicted that Compaq would try to land a savvy Internet executive who could coordinate the company's disparate properties into one coherent package. "For next wave of leadership, [Pfeiffer] was not the guy," he said. "They need somebody who can really pitch to Wall Street. They need dynamic leadership to wrap this all together.

One outside candidate could be Ross Cooley, the former No. 2 man at Compaq and now CEO of PcOrder.com, which develops online inventory and ecommerce systems for PC manufacturers and distributors, predicted Tom King, president of the Computalk Radio Network. Cooley was highly regarded during his ten-year-plus tenure at Compaq.

"At Compaq, faith in management clearly deteriorated over the last 12 months, especially after the company's surprisingly bad Q1 pre-release," wrote Gillian Munson, an analyst with Morgan Stanley Dean Witter. "While we don't think that two people alone drive the entire fortunes of a company, we do think that a tone of change and proactive management needs to be more prevalent at Compaq."

Compaq is slated to state its earnings for the first quarter on April 21 before the market opens. But the company's strategies, though good on paper, began to hit the wall long ago.

Although the company jump-started the low-cost PC market--forcing companies like IBM and Hewlett-Packard to follow suit--the Houston-based giant is becoming a victim of its own success. In short, sales of low-cost PCs are not being offset enough by shipments of lucrative computers such as workstations and servers.

Moreover, a new crop of PC makers are upping the low-cost ante on PCs, making it extremely difficult for Compaq, with a relatively large amount of overhead, to compete. "In the last couple months, Emachines stole share from Compaq...[it] was caught by surprise," said Danny Lam, a principal at Fisher-Holstein.

Upstarts like Gobi, DirectWeb, and Microworkz with fresh, new business models that make the PC a marginal expense as part of a larger Internet service package, are also beginning to chip away at Compaq in the consumer arena.

Nor has Compaq effectively responded to the aesthetic challenge posed by Apple Computer's iMac. Compaq's models are drab by comparison, at least in the eyes of an increasing number of consumers looking for systems that fit better with their tastes.

Compaq faces major obstacles in the business PC market as well. IBM is becoming hyper-aggressive in servers and workstations, as Dell Computer continues to do its well-documented damage with its direct model.

From comeback to earnings collapse
Pfeiffer has been credited in the past with turning the company around. He became CEO in October 1991 after the ouster of founder Rod Canion. At the time, Compaq was being battered by price competition. Compaq reached its zenith in late 1997 and 1998, growing at rates far faster than the market and had just launched a new program to build computers to order, similar to Dell.

Then, in early 1998, Compaq bought Digital, an acquisition that gave the company a huge services division and upscale hardware technology, both important for driving business in the lucrative high-performance computer segment. Overnight, it went from PC maker to a full-service computing company like IBM and HP. The acquisition made the company the second largest computing company in the world, Compaq claimed at the time.

The euphoria, however, was short-lived. Soon after the Digital acquisition, Compaq admitted that it would report virtually no profits in the first quarter of 1998 because of excess inventories. Compaq had approximately 12 weeks of inventory at the time, analysts stated. The bloat lead to widespread price cutting and a dismal first half.

Sales began to pick up in the second half, but the burden of selling both directly to consumers and indirectly through resellers have added costs to the company's bottom line at a time when PC prices have plummeted. In the second half, Compaq also launched its DirectPlus program, under which Compaq sells computers directly to customers.

"They have people on the street calling on small businesses, they have people calling on resellers. They are trying to be all things to all people," said Asif Hudani, president of NovaQuest, a Los Angeles-based computer reseller. "They definitely don't have a low-cost model."

In addition, Compaq got stuck with an excess amount of Pentium II systems in the first quarter and had to offer price protection funds--essentially rebates--to dealers, according to Richard Gardner at Salomon Smith Barney.

Despite his termination, analysts agree that Pfeiffer will bear a fairly strong legacy. "He was a huge success, but the issues they are facing today are different than the ones they are up against now. Dell is running circles around them," King said.

Compaq has been talking about direct sales and change for over a year "but not much has changed despite the rhetoric."

 

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