Compaq needs to choose what gets cut next

A little more than a year after buying Digital Equipment, Compaq Computer is unloading major chunks of its trophy acquisition. And with good reason, analysts say.

4 min read
A little more than a year after buying Digital Equipment, Compaq Computer is unloading major chunks of its trophy acquisition.

And for good reason, say analysts and Compaq executives. Disparate corporate cultures, problems integrating operations, and dead-end technologies have contributed to Compaq's current problems.

Compaq also must clarify its strategy in three crucial areas: balancing adoption of Intel's Merced processor with its own Alpha architecture, finding ways to squeeze more profits out of the Unix technology it acquired with Digital, and ironing out its distribution and dealer issues.

Along with this may come more job layoffs. Last month, the PC maker announced a restructuring plan that included job cuts of up to 8,000.

Now it is up to new chief executive Michael Capellas and chief lieutenants Mike Winkler, Peter Blackmore, and Enrico Pesatori to set things right. But the biggest burden may be on Pesatori, senior vice president and group general manager of the Enterprise Solutions and Services Group. Most of the remaining Digital units are part of his organization and many of the "keep it or dump it" decisions will affect his group the most.

Compaq today concluded its sale of the AltaVista entity to CMGI. The Houston-based PC manufacturer spun off the Internet portal as a separate company earlier in the year and had announced a late-year IPO, which was later canceled.

Yesterday, Compaq sold its embedded chip business to Smart Modular Technologies for an undisclosed amount. The former Digital division makes computer circuit boards for about 100 large customers, including General Electric. The deal affects about 120 Compaq employees mostly in Massachusetts and Scotland with an expected completion date of late fourth quarter.

Deciding what, if any, division goes next depends on what direction Compaq takes, and that choice won't be easy. Several Digital units seem to have questionable or difficult long-term futures ahead of them, but they generate much-needed revenue now.

Tru64 Unix, the Unix technology Compaq inherited from Digital, and the Alpha chip platform, again from Digital, represent two of the larger dilemmas for Compaq.

"Tru64 Unix is making good money now," said Kimball Brown, analyst with Dataquest. "But do you want to dump money down that rat hole? It's high-margin stuff now, but what about the future?"

The future, say analysts, belongs to Monterey, the 64-bit Unix that IBM and SCO are developing.

One area that might make sense for cuts is Windows NT on the Alpha chip. Terry Shannon, editor of the Shannon Knows Compaq newsletter, said today he's heard unconfirmed reports that Compaq plans to cut some of its NT developers in Bellevue, Washington. The Alpha chip is the current basis for development of 64-bit versions of Windows.

Shannon said he "believes Compaq has seen the handwriting on the wall. The Windows NT operating system runs on a relatively small number of AlphaServers," he said. "Compaq's recent and increasing emphasis on Linux as an Alpha volume expansion solution represents a significant shift in the DEC/Compaq volume strategy."

Compaq also faces a similar problem with its Alpha processor on the eve of the IA-64 architecture from Intel, which will debut on the Merced chip. "There is not much future there [for Alpha] with Merced," said Roger Kay, analyst with International Data Corporation. "And it is an expensive research and development effort for Compaq to maintain."

Compaq is a supporter of Monterey and IA-64, and will likely dedicate more resources to both technologies over time, said analysts. That middle period will be the problem. The company has already said it will invest $100 million for development and marketing of Tru64 Unix and Alpha.

In addition to being expensive, the transition period will raise the classic business dilemma: Should the company try to build these technologies, or go for an end game?

Analysts suggest Compaq could still benefit from Alpha if it sold the bulk of its operations, including research and development, to a third party while maintaining a minority share. This is exactly what Compaq did with AltaVista, for which it got about a 17 percent stake in CMGI.

"Compaq has to figure out where the model fits and blow off the rest of it," said Brown.

Eggs in one basket
Compaq set the stage on Tuesday for unloading unprofitable Digital units by putting all the eggs in one basket. The company announced a new enterprise and services organization divided into three parts: storage, industry standard servers, and business-critical servers. Aside from Digital's StorageWorks brand, which has been very successful for Compaq, the bulk of remaining divisions and those acquired from Tandem Computer are in this group.

Publicly, Compaq vigorously supports the Digital units, their products, and customers. But analysts point out Compaq has made it easier to sell off weaker units by grouping them together. It also isolates some of the worst corporate culture problems inherited with Digital.

Pesatori is quick to admit the cultural problems exist, but points out Compaq is tackling them. "Compaq was always successful with a very leveraged model," he said. "We have a much more focused approach than Digital ever had and Compaq has had for the last few months."

Not all analysts are sure Compaq will act quickly or drastically. "What Compaq has to do is the give the units an opportunity to fight for themselves and demonstrate they can survive," said Tony Iams, analyst with D.H. Brown Associates. "I think it's still premature to speculate which parts are not long for this world."

Other analysts argue there is no better time to act than now. With its stock stuck in the low 20s, Compaq could afford to bite the bullet and take a revenue hit now for future growth.