Compaq's third-quarter earnings gave its investors hope but one has to wonder where the company and its stock would be today had it not shelled out close to $10 billion for Digital Equipment back in 1998.
Before I start playing Monday-morning quarterback on the DEC fiasco, let's take a minute to appreciate what Compaq (NYSE: CPQ) did this quarter.
In the quarter, Compaq raked in $550 million, or 31 cents a share, on sales of $11.2 billion.
First Call Corp. consensus expected the PC maker to earn 29 cents a share.
Excluding a $25 million gain from the sales of some of its Internet investments, Compaq earned 30 cents a share in the quarter.
The $11.2 billion in sales marked a 22 percent jump from the year-ago quarter and was well above even the most optimistic analyst estimates.
Wall Street shrugs off 4Q warning
Investors were so impressed with Compaq's third-quarter results that the stock actually gained ground after it warned that a soft euro would trim about $100 million off its fourth-quarter earnings, roughly 4 cents a share.
And that modest gain came on a day that saw the Nasdaq composite plunge more than 190 points, its 10th-largest, single-day decline in history.
Its server sales surged to $1.6 billion, up 41 percent from the year-ago quarter. Meanwhile, storage sales improved 9 percent to $1.4 billion with most of that growth coming from its burgeoning enterprise unit.
Meanwhile, while other companies and analysts are predicting dire times ahead in the PC market, Compaq recorded commercial PC sales of $3.5 billion, up 28 percent from the year-ago quarter, and consumer PC sales of $2.1 billion, up 45 percent year-over-year.
But services sales, the supposed strength of the DEC acquisition, fell 2 percent to $1.7 billion.
Back in 1996 and 1997, Compaq shares were on an unprecedented roll. Shortly after the DEC deal was announced, Compaq shares hit the wall and haven't recovered since.
Dell (Nasdaq: DELL), Gateway (NYSE: GTW) and even Apple Computer (Nasdaq: AAPL) went on to enjoy huge run-ups while Compaq was left spinning its wheels.
Everyone expected a bit of a hangover from the deal. Putting aside the obvious dilution from spending $10 billion, integrating such a huge company with such a divergent culture wasn't as easy as Compaq or its investors had hoped.
Meanwhile, the company brought in CEO Michael Capellas to restore some measure of credibility on Wall Street.
Capellas deserves some praise for being more forthright with the analyst community and focusing the company's attention on that which it does best, namely Intel-based servers and notebook computers.
But clearly the expected boost in service sales hasn't materialized. In the interim, Compaq's stock has taken the abuse that shareholders would gladly accept for the big payoff at the end.
They're still waiting.
Service sales still lagging
"The crown jewel of the DEC acquisition, services, continues to flounder," said USB Piper Jaffray's Ashok Kumar in a research note. "At 15 percent of revenues, growth has been nonexistent."
Kumar maintains a "buy" rating on the stock and a $40 a share price target.
Other analysts were more forgiving.
J.P. Morgan's Daniel Kunstler upgraded the stock to a "buy" recommendation and set a price target of $40 a share.
"We had been a little fearful of other businesses being a drag on the aggregate growth, but Compaq did a good job of making sure that didn’t happen," he said in a research note. "The only area where the company is still coming up short is in services. All told, there were plenty of bright spots in the quarter…"
Kurt King, an analyst at Banc of America Securities, reiterated his "strong buy" recommendation and said Compaq is still a "top pick." And Richard Gardner Salomon Smith Barney raised his price target to $32 a share from $25 and reiterated a "neutral" rating.
Looking ahead, Capellas said the company expects earnings growth in excess of 40 percent in 2001, "consistent with consensus estimates."
First Call Corp. consensus expects it to earn $1.48 a share in fiscal 2001.
If Capellas can somehow find a way to transform the white elephant that DEC has become into even half of what it was expected to be, Compaq might actually become a growth stock again.