FOOL ON THE HILL: An Investment Opinion
No doubt about it, Compaq is bouncing back from a terrible 1999. Leading the way are four new iPAQ Internet appliances, the most exciting products to hit the consumer computing world in years. However, even though the PC business is changing, some fundamental elements of the industry are not. Thanks to its customer information and inventory-related benefits, the PC industry's "direct" model is here to stay.
For starters, the company is expecting double-digit revenue growth in the second half compared to last year's flat performance. Meanwhile, the introduction of a quartet of new iPAQ-branded Internet gadgets a few weeks back has fueled chatter about an innovation renaissance at the company. And to top it all off, CEO Michael Capellas, on the verge of starting his sophomore year as Compaq's top executive, has shown up on the cover of the latest Business Week wearing a Springsteen-esque jean jacket (very retro, Mike) and sporting an electric guitar. What's going on here?
The inquiring minds of long-term shareholders who have stuck with the company despite its disastrous 1999 may want to know, but they aren't exactly asking many questions right now. So far in August, Compaq's shares are up about 22%, essentially matching the gains made by computing peers Gateway (NYSE: GTW) and Apple (Nasdaq: AAPL) over the same span. With sell-side analysts now fighting for space on the company's bandwagon -- 22 of the 29 Compaq analysts tracked by Bloomberg have the equivalent of a "buy" rating on the stock -- the general sentiment is that happy days are here again, as the old tune goes.
Moving away from PCs
While it should be pointed out that a combination of factors is behind Compaq's August run, the positive press generated by the new iPAQ devices surely hasn't hurt. Creating the buzz are four new products: a pager-sized digital audio player supporting the MP3, WMA, and AAC formats; a "plug and surf" home Internet access device running Microsoft's (Nasdaq: MSFT) MSN Companion Service; an iPAQ-branded version of the Research in Motion (Nasdaq: RIMM) BlackBerry wireless e-mail device; and something called the iPAQ Connection Point, which is ostensibly a product for secure wireless home networking but looks more like a small-scale droid from a George Lucas film.
The new offerings hope to build on the popularity of the iPAQ Pocket PC line of handhelds, which were released back in April but continue to regularly fetch above-retail prices in auctions on eBay (Nasdaq: EBAY) due to limited supply. Truth be told, there hasn't been this much general excitement in consumer computing since Apple wheeled out the first incarnation of its visually stimulating iMac two years ago. And, as is almost always the case anymore whenever there is even the slightest ripple on the consumer computing pond, the new devices have sparked renewed ruminations about "the end of the PC world as we know it."
Investors who have managed to keep even a casual eye on the PC companies over the past year or so are probably well-aware by now of the trend away from clunky desktop PCs and toward simpler and more svelte devices. For lack of a more user-friendly name, these emerging devices have collectively come to be known as Internet appliances, an unfortunate term that drums up images of a Web access device sitting alongside a toaster or a blender in the high-tech kitchen of tomorrow.
Compaq's not alone in Internet appliances; virtually all of the major PC makers are currently working on products similar to the new iPAQ devices, at least in spirit if not in exact form. As a result, the roll call of people supporting the view that it's time to put a fork in the PC business is growing, to the point where a Gateway spokesperson bluntly stated in a ZDNet News story recently, "We all realize that the PC is all over."
Wow. So much for subtleness.
The PC's day in the sun as the culture's sole digital information delivery device may be drawing to a close, but don't expect everything related to the modern-day PC industry to go gentle into that good night. Like bad habits, long-standing business economics tend to die hard.
Why the direct model still matters
The so-called direct marketing business model, which has produced an incredible amount of economic value for firms such as Gateway and Dell Computer (Nasdaq: DELL) over the years, stands to be one of the major legacies of the PC business to the new world of Internet appliances. Take notice, giddy Compaq investors: If anything, the direct model is poised to become an even more important determinant of value creation in the future than it has been in the past.
As the iPAQ product announcements show, tomorrow's Internet appliances are bound to come in many different shapes and sizes, serving all kinds of functions. Instead of dishing up scads of look-alike beige boxes, Compaq and its rival Internet appliance makers can be expected to bring very distinct product offerings to market. That's a big change from how the PC business has worked in the past.
Without a standard like the Wintel duopoly in place, the firms that are able to come up with the hot, innovative products will emerge as the Internet appliance winners, at least in the near-term. To do that, companies will need to be in tune with what the customer wants. In this area, the direct PC marketers have a potentially large upfront competitive advantage.
"Our business is centered around... direct relationships with our users," said Mr. Direct himself, Dell CEO Michael Dell, in a recent speech at the National Press Club. "And the fact that we deal directly with our customers means that we have perfect information about what they want to buy. We don't need to rely on inventory."
That part about perfect information might be a bit far-fetched, but Dell's thoughts on the correlation between customer input and inventory levels are worth noting. He continues, "It's indicative of a fundamental value shift that's occurring, where physical assets like inventory are being replaced for information assets. This data and knowledge that we have from our customers gives us a fundamental edge."
New market, new challenges
Buying into Dell's viewpoint, it's pretty clear how the direct PC marketing model could come home to roost in the age of multi-device Internet appliances. Without a standardized platform, there's a much greater risk of building up an inventory of the wrong product at the wrong time than during the halcyon days of the consumer PC. Forget about DRAM prices or Xeon chip shortages fouling up near-term execution. What happens to the company that stuffs the channel with the Internet appliance equivalent of the Salad Shooter?
Compaq is much more than PCs and Internet appliances, but the changing nature of consumer computing still poses a rather large challenge. With the company still more closely tied to the indirect selling channel than the direct channel, the potential fallout from a big, wrong-way bet on an individual Internet appliance could be ugly. Inventory problems are a sure-fire method of value destruction in this business. Compaq's former management team can attest to that.
None of this is to say that any of the new iPAQ devices are destined to go iPOOF anytime soon. Nor is it a blanket guarantee of the ultimate success of the direct PC companies in the Internet appliance market. Dell or Gateway could screw up and misgauge what their customers want just as easily as Compaq. However, the direct model, with its focus on greater customer information and less inventory risk, could end up playing a large role in determining the ultimate returns from the ongoing rollout of Internet appliances. In these days of the PC's "death" and Compaq's "rebirth," the lasting benefits of the direct business model should be given their proper due.