Boring Portfolio

Compaq Pre-Announces
Big Surprise!

By Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (April 12, 1999) -- A couple of notes on Boring Port holdings today.

Berkshire Hathaway (NYSE: BRK.A) chairman Warren Buffett was in London today and will also be speaking in Paris and Frankfurt about Executive Jet and its NetJets program. Speaking of the company, the Fool's Yi-Hsin Chang will be going to the Berkshire annual meeting and reporting back. I can't make it this year, as I've scheduled something on the same weekend, but some good transcripts make it out onto the Internet fairly quickly. We also have some good friends who come back with their analysis of what Buffett and Charlie Munger had to say. Finally, Morningstar usually comes up with a good rough transcript following the event (though I know no recording devices are allowed in). So we won't be hurting for raw details after the annual meeting.

Gateway (NYSE: GTW) took a haircut today on news from Compaq that it will miss estimates for the first quarter. Zero surprise there. As I wrote at the beginning of March, I thought Compaq was already dealing with problems. I think one thing that hurt them is their price protection schemes, which was what hurt them last year. Older machines with Pentium II CPUs have fallen very fast in price as Intel rolled out PIII and Celeron processors. The direct PC companies like Micron Electronics (Nasdaq: MUEI), Dell Computer (Nasdaq: DELL), or Gateway might take a bit of a revenue hit if that happens at the wrong time in the quarter, but Compaq takes a balance sheet risk, as well.

This is because Compaq sucks up the price protection they offer distributors through a contra-revenue item, which flows as a debit straight down to net income and retained earnings. In the process of adjusting the balance sheet, a credit is taken to accounts receivables. You can look at it as an adjustment to past earnings if you want, too. Which means that Compaq's discussions of its business aren't meaningful, as far as I'm concerned and as far as I think they pertain to individuals.

I've talked about this before when I've said they're somewhat dysfunctional. One quarter they talk about sell in and revenue growth, another quarter it's sell out and inventory levels, and some other quarter it's going to be hits on and their unit.

I find it truly bizarre that you have a company with over $36 billion in gross product sales and over $6.5 billion in service revenues, UNIX and VMS hardware and software products, RAIDS, intranet and internet ITS services, networking, AlphaServers, and mission critical (Tandem) servers and everything boils down to PC pricing this quarter? I don't understand that. There are no glitches anywhere else in Compaq's business and it's all an industry problem in PCs? Personally, I don't believe it at all. Sure, the PC industry is challenging, but the business model at Compaq is still not the shock absorber business model that is inherently built into Gateway and Dell from the ground up.

By the way, Herb Greenberg's column at today mentioned that Gateway must be "making up" weak commercial PC sales with consumer sales, or else they would otherwise have pre-announced. I don't know where that comes from. Large commercial sales is not the make-or-break category at Gateway. With CPU price declines and more favorable component pricing across the board (I am assuming this, looking at weak stock price movements for component suppliers), I think price elasticity of demand and the ability of the direct suppliers to capitalize on declines in cost of goods sold will be working in our favor this quarter. Just because prices are dropping doesn't mean you can't hold margins and increase absolute operating income. Of all the media accounts I've seen on the subject of the PC industry, about 9 3/4 out of 10 make that assumption or imply that. That's just not the way things work.

On to other things... Soon, we will very likely announce our intent to acquire shares of American Power Conversion (Nasdaq: APCC). Alex Schay and I will be meeting tonight on the issue.

By the way, on the Lucent Technologies (NYSE: LU) short idea, Bob Olstein of Olstein Financial Alert had some thoughts on the company's valuation, as reported by Gretchen Morgenson in Sunday's New York Times (you need to register for the Times, which is free, to see the article). Again, we're never in a hurry to buy or short something, but here are some thoughts on it from a guy that has a sharp eye.

Have a good Monday night and we hope to see you on the boards.

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    04/12/99 Close
    Stock  Change    Bid
    BRKb  +16      2364.00
    CSL   -  1/16  42.69
    CSCO  -  3/8   117.75
    GTW   -4 13/16 69.88
                       Day    Month   Year  History
            BORING   -0.65%   1.88%   2.16%  37.18%
            S&P:     +0.76%   5.62%  10.85% 125.91%
            NASDAQ:  +0.22%   5.57%  18.52% 149.66%
        Rec'd   #  Security     In At       Now    Change
      6/26/96  225 Cisco Syst    23.96    117.75   391.54%
      8/13/96  200 Carlisle C    26.32     42.69    62.16%
     12/31/98    8 Berkshire   2244.00   2364.00     5.35%
       2/9/99  100 Gateway 20    72.38     69.88    -3.45%
        Rec'd   #  Security     In At     Value    Change
      6/26/96  225 Cisco Syst  5389.99  26493.75 $21103.76
      8/13/96  200 Carlisle C  5264.99   8537.50  $3272.51
     12/31/98    8 Berkshire  17952.00  18912.00   $960.00
       2/9/99  100 Gateway 20  7237.50   6987.50  -$250.00
                                 CASH   $7658.52
                                TOTAL  $68589.27