Compaq Bull's Rebuttal
by Chris Rugaber ([email protected])

Louis, while I may have been a bit too sanguine about Compaq's inventory problems, you are too focused on them! You write: "…Compaq's core business has suffered from slowing sales, shrinking margins, and rotten execution. And the company is now looking to refocus its operations by acquiring a business that won't add to profits unless Compaq executes like crazy."

First, when arguing that Digital won't add to profits, it's not clear if you're taking into account that Digital sold off many of its money-losing divisions -- primarily its chip fab plants -- prior to Compaq's purchase. Secondly, you provide little proof that Compaq's "core business" is suffering from anything more than a temporary inventory miscalculation.

Yes, as I noted earlier, Compaq blew it during the most recent couple of quarters. But, to say this is proof that the company can't "execute" is to overstate the case. Let's look at the longer view. This is a company that has increased revenue in nine of the past ten years, with the CEO being booted the one year it didn't. Revenues have increased by a factor of five since the current CEO, Eckhard Pfeiffer, took over -- from $4.9 billion in 1991 to $24.6 billion last year. Net income has varied more, but has generally increased: from $172 million in 1992, to $893 million in 1995, to $1.86 billion last year.

Therefore, to act as if Compaq's recent inventory backlog is a new Achilles heel in a fast-growing but neophyte company is ridiculous. Compaq is no stranger to the tough PC market. Back in the early '90s when IBM clones were flooding the market, Pfeiffer cut margins in half and fought an intense price war. Profits declined from $577 million in 1990 to only $19 million in '93, but by '94 Compaq was the world leader in PC sales and produced $988 million in profits. And Compaq's position in PCs is still strong -- according to preliminary figures from Dataquest, Compaq grew worldwide PC shipments by 39% in the first quarter of '98 over the year-ago period. Dell increased its shipments by 66%, to go from less than half of Compaq's shipments up to approximately 3/5ths. When your much-vaunted competitor increases product shipments by 66% and is still that far behind, it's not a bad thing. Especially when you're still gaining market share, as Compaq is in the world market.

In short, Compaq is a giant in the computer hardware world and can recover from mistakes. For an example of Compaq's impact on the rest of the industry, read Jeff Fischer's June 9th Fool Portfolio Report on how Compaq raised the price of several Fool Port stocks almost single-handedly by announcing deals with Iomega, 3Dfx, and America Online. Weak companies don't have that kind of effect.

Louis also writes: "The question is, what business model will thrive in today's computer marketplace?" Well, everyone knows that Dell's is the best. We'll leave aside whether "everyone" is always right. For Compaq, the obvious way to respond is twofold: imitate Dell's model as much as possible, and move on to other things, rather than playing follow-the-leader with your competitor. Indeed, Compaq is moving on to other things with a vengeance, and it has recently announced that its goal is to deliver 95% of all products anywhere in the world within five days or less.

In short, Louis, we both agree that revenue for Compaq will probably skyrocket. The question is whether it can efficiently manage its new business model. Considering it has already managed several lines of business, rather than just clone-building like Dell, considering it had no problem digesting its $3 billion purchase of Tandem Computers, and considering it's way ahead of Dell in data storage, servers, and PC-TV appliances, I'd say you're going to have to wait quite a while before seeing Compaq's "butt kicked" by anyone. Of course, Compaq poses some risk right now, but if the company does pull it off, the stock has significant potential upside. Those who want to buy over-valued Dell stock can knock themselves out; those who want a diversified, moderately valued company with a history of executing might want to look at Compaq.

Next: The Bear Responds