June 17, 1999 2:50 PM PDT

Digital still weighs heavily on Compaq

Nearly 16 months after it acquired Digital Equipment, and a year after the deal closed, Compaq has yet to fully digest the Massachusetts computing giant, and the results are hitting the bottom line hard.

As reported today, Compaq Computer stated it would report a loss of around 15 cents a share for the second quarter instead of an anticipated profit of around 20 cents a share, take substantial charges in the third quarter, and eliminate layers of management to pare back operating costs by around $2 billion.

Although pricing pressure and a competitive landscape are resulting in lower-than-expected revenues for the second quarter, company executives and industry observers are largely putting the blame on the bloated infrastructure that Compaq inherited when it picked up Digital in February 1998.

In a nutshell, Compaq is huge at a time when PC companies need to be lean.

"There is still a lot of fat from the Digital acquisition," said Kurt King, an analyst with NationsBanc Montgomery Securities. "They will lay off a huge portion of its employee base."

Turning the situation around, moreover, will be no easy task for whoever becomes the next chief executive.

"Steve Jobs's level of visionary-ness is beyond this," said Roger Kay, an analyst with International Data Corporation. "They are going to need someone with a vision, but also someone who can execute, someone with hard business skills, and someone who can inject a new morale into the company."

Sales continue to be a problem. Many estimated that Compaq would see a slight upturn in sales to around $9.7 billion to $10 billion this quarter. Instead, sales now are expected to be about $9.4 billion or less. The decline is attributed to lower retail prices and poaching from competitors.

"There continues to be a lack of leadership, and we believe Dell is taking share from Compaq," wrote Steve Milunovich, PC analyst for Merrill Lynch. Milunovich changed his rating from buy to accumulate and lowered his annual earnings estimates from $1.03 to 15 cents.

Others, however, point out that consumer losses are not significantly pronounced. Compaq may be losing orders, but customers aren't running for the exits.

Revenue is only slightly down from predictions, King noted. Compaq's stock, moreover, has gone up slightly, rather than down today, he added.

Compaq's earnings estimates are likely worst-case scenarios, King said, which means that the second-quarter numbers could be better than the predictions released today.

An executive at a major computer reseller said Compaq's desktop sales have been relatively flat in terms of revenue lately, but so has the revenue for most other manufacturers. What hurts is that Compaq is losing revenue at a time when no company can afford that.

"A small decrease in sales translates to an unsustainable bottom line situation," Kay said. "In this sort of environment, any stumble and you become vulture fodder."

Employee count still high
Compaq's troubles are reflected in the company's head count.

At the end of 1997, Compaq had 32,565 employees. A year later, the company had 70,665, or more than twice as many as the year before. In June 1998, Compaq stated it would reduce head count by around 17,400, according to documents filed with the Securities and Exchange Commission. Leading executives, including Andreas Barth, then head of Compaq's European operations, were quoted in news reports that the employee reduction would be complete by the end of 1998.

Head count, however, had only been reduced by 14,200 by the end of the first quarter of 1999, according to SEC documents, leaving Compaq with a 3,000-employee hangover. Today, executives said that further cuts were coming.

Some of Compaq's growth in employees and expenses comes from a string of Internet companies that the firm has acquired. Sources, in fact, have said that Compaq has been dumping money into AltaVista, its search engine unit, in an effort to take the company public in the second half of this year.

 

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