Compaq drops a bomb on IT sector

News Analysis: As earnings tumble at the leading PC maker, is a price war looming?
  • @dusborne
IT WAS no wonder the world's equity and currency markets began the week with a bit of a wobble. After New York closed on Friday, Compaq Computer let slip news no one wanted to hear - its first-quarter earnings would be around 15 cents a share, half of analysts' forecasts. Compaq's shares tumbled in after-hours trading. The spectre a bloody personal computer price war loomed.

Ripples from the announcement were felt around the globe, beginning in Asia where Tokyo shares lost just over 2 per cent. Likewise the dollar was weaker against the yen and the euro. There was widespread fear that Compaq's warning would trigger a pummelling of stocks in New York, both on the Dow Jones industrial average and, more particularly, on the tech- heavy Nasdaq exchange.

The announcement was, by any measure, ugly. Compaq - the largest maker of PCs in the world - blamed its revenue shortfall on both price competition and an unexpected dip in demand. This poses several difficult questions; for example, the future of the company itself and the medium-term outlook for its own share price. A year ago, the company issued a similar sales- dip warning.

More important is this: what, if anything, do the woes of Compaq augur for the information technology industry at large? Does the springtime cold at Compaq translate into a flu epidemic, not just for other PC makers but also for other sector players, including processor manufacturers such as Intel and software suppliers, including Microsoft?

And what are the implications for the broader US economy? This industry, after all, has been vital in powering the boom of recent years, buoying up both the Nasdaq and Dow and helping to reinforce high consumer confidence. Everyone wishes its continued good health.

The timing of the Compaq shock was hardly helpful. There were loud mutterings in New York yesterday that Compaq sinned by not getting word of its problems to Wall Street earlier than Friday. Instead, it spoiled the IT party at the worst possible moment - at the start of the first-quarter results season. The full Compaq picture will emerge with its 21 April report.

Punishment for Compaq was swift yesterday. At midday in New York its shares were down 23 per cent. Several leading analysts were downgrading ratings as they offered varying diagnoses for what ails it. These include difficulties in melding Compaq with Digital Equipment Corporation, which it bought last year. Many analysts predicted that embattled chief executive Eckhard Pfeiffer would have to make more staff cuts in coming weeks.

Compaq's central challenge, however, may be how to maintain share in an environment of rapidly-falling PC prices without butchering its profit margins. Some analysts suggest that Compaq may have botched its attempts, launched last year, to begin selling direct to consumers - business and private - over the telephone and Internet, while still maintaining its network of retail distributors.

Snapping at Compaq's heels are Dell and Gateway, each credited with pioneering direct selling in the industry. The proportion of PCs sold directly is expected to reach 29 per cent this year, compared to 13.5 per cent in 1995.

Morgan Stanley analyst Gillian Munson was among those voicing frustration with Compaq's warning. "The shortfall is far worse than the ranges that were thought probable," she said, adding that it indicated "that Compaq's business model is not working in this market environment. It will take some time, in our view, for the stock to come back from this disappointment and the related loss of confidence".

The consensus among the analysts vanished, however, on the wider implications of Compaq's first-quarter debacle. One school said the slowdown in demand had to herald problems for the entire industry. They pointed to the so- called "millennium factor", where business customers may have been rushing to buy equipment well in advance of 2000, which could spell a freeze in demand for the rest of this year. Another school says the problems are mostly Compaq-specific; they highlight recent commentaries from Dell and Microsoft suggesting a still-healthy outlook.

For now, the jury is still out. All eyes will be on other IT first-quarter numbers, especially from Intel, due to report after the market closes today, and Microsoft and Dell. Intel, more than Compaq, is considered a bellwether for the industry.

For what it is worth, the slaughter that some feared in New York yesterday did not materialise. The early slide on the Dow was quickly reversed, and even the Nasdaq saw only a modest midday decline.

For its part, Compaq tried to soothe investor nerves. In a conference call with analysts, Mr Pfeiffer and his chief financial officer, Earl Mason, insisted that cost-cutting plans related to the $8.4bn (pounds 5.2bn) takeover of DEC were on track and denied that Compaq was discussing any new lay-offs or restructuring ideas.

"This should not be blown out of proportion," Mr Pfeiffer said of Friday's announcements in an interview with the Wall Street Journal. "Everyone is building expectations on certain market demand growth. If it comes at a somewhat lower level, the competitive reaction leads to price cuts that are deeper and more frequent. We had both these factors in the last quarter."