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Also, check out: "Compaq's Rockwell Modems May Rock Well, But That's About All They Do Well," "Was Compaq's Presario Pressed into Service Too Soon?", "ComDec to Boost Wintel?" 

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  Compaq to Acquire Digital Equipment Corp. for $9.6B

"ComDec" to Boost "Wintel"

Industry's Biggest-ever Merger to Pose New Challenges to IBM, Others...

Computer industry pundits have been talking for years about the blurring lines between the PC and minicomputer markets. Well, after today, the blur will once again become a solid line. Compaq Computer Corp. and Digital Equipment Corp. (DEC) announced today the computer industry's biggest-ever merger-acquisition. Compaq will acquire DEC for about $9.6 billion in a half-cash, half-stock deal which is expected to be completed in the second quarter.

DEC's shares soared by 10 points or about 22% in response to the news, while Compaq's stock took about a 9% dive (down 23/4 points). The shares of the main "ComDec" (our term) competitors - IBM, HP, Sun Microsystems, Dell - also declined, while the stock prices of Microsoft and Intel, the so-called "Wintel" combination, rose 2.4% and 0.6% respectively. And for once, we think that the stockmarket has got it generally right on the first try, i.e., on the first day of trading following the announcement. But the longer-term impact of the "ComDec" merger is likely to pose new challenges to IBM, while boosting the fortunes of "Wintel." That's because the "ComDec's" complementary strengths - DEC's in services and largest enterprise market; and Compaq's in the marketing and PC business - are a double whammy hitting IBM hard both at its strength and weakness at the same time.

Conversely, any success which the front-line IT warriors (companies which sell finished products and integrated services to end users - like "ComDec") enjoy in the marketplace, is bound to translate into additional market power of the technological foundries behind them - Intel, on the hardware side; Microsoft with respect to software, especially Windows NT.

So Jan. 26 - the Australia Day as it turns out - is likely to go down in the annals of the global IT industry as the day when loose confederations like "ComDec"-"Wintel," knitted together nothing more than self-interests, gained the upper hand over the integrated empires, like that of the Big Blue.

"ComDec" No. 4 in the World?

Some "ComDec" executives may have gotten a bit too carried away when they hailed their new brainchild as the "second largest" computer company. It is NOT! In the global market in which both Compaq and DEC compete, the "ComDec's" combined revenues of about $37.5 billion would put in it in a No. 4 position among the computer giants. IBM, of course, is still No. 1, with worldwide revenues of $78.5 billion. Since the Japanese companies' fiscal years end March 31, we still do not have the final results. But based on the partial year results, we estimate that NEC is No. 2 with revenues of about $42 billion; with Fujitsu coming in as close third at $41 billion. HP's computer products and services business is a close No. 5 in the world with about $35 billion in revenues.

So the new "ComDec" will be "only" the No. 4 computer company in the world. Once again, not too shabby, but no medal, either, by the Olympic scoring, anyway. It will be No. 1, however, among the top four in terms of growth. Which suggests that the time when "ComDec" will take its place at the IT Business Olympics winners' stand is not far off.

After all, Compaq's chairman, Eckhard Pfeiffer, had predicted even before the DEC acquisition that his company would reach a $50 billion revenue milestone by the year 2000. Now, it would appear, he'll have to revise his forecast - upward!

Services, Services... +  Apples and Oranges...

During this morning's news conference in Houston, Pfeiffer especially hailed the value which his company will get from DEC's services business. That's understandable. Because Compaq doesn't have any service revenue to speak of (since it deals mostly through business partners).

But service revenues is NOT where Compaq is likely to get the most value, though DEC's nearly $6 billion of services revenues with a 31% gross margin is not too shabby. The greatest value will accrue to Compaq from the large enterprise CUSTOMER RELATIONSHIPS which DEC's 25,000 service professionals have built up over the years. That's because they hit smack into the heart of one of IBM's strengths - the coveted Big Business IT departments.

But some "heads-up" comments may be in order here, in order to prevent you from doing some "apples-to-oranges" comparisons, as we have seen in the media.

For example, DEC's services gross margins were 31% as compared to the equivalent figure of less than 21% for the IBM global services in 1997.

So, it would appear that DEC has IBM over a barrel. It doesn't. At least not yet.

DEC does not break out in its financial statements the hardware maintenance as a separate item as IBM does. And of course, as do other IT services vendors, like EDS, Andersen Consulting, CSC, Cap Gemini, etc. which do not earn any hardware maintenance revenues or profits.

So DEC's $5.9 billion "services" revenue in the fiscal year 1997 corresponds with IBM's $25.7 billion figure (see Annex Bulletins 98-02, 1/15/98, and 98-04, 1/20/98), NOT the $19.3 billion "services" line item on the Big Blue's financial statements.

Once the combined IT services + maintenance gross profit is considered, DEC still comes out ahead of IBM - by a 31% to 27% gross margin in 1997 - but not by as much as the "face-value" comparisons might have yielded.

Such "technicalities" aside, the "big picture" view of the IT industry's biggest-ever deal can be summed up as follows:

The winners: DEC, Compaq, Microsoft, Intel;

The losers: IBM, Sun, HP... and counting.

Why Now?

"Why now?" is one of the frequent questions we've had to answer regarding the Compaq-DEC deal. The reason, of course, is that Compaq and DEC and had reportedly considered something like this at least twice before since 1995. Well, a part of the answer to the question probably lies in the fact that Compaq is in a lot stronger financial position now, after two outstanding years in 1996 and 1997. The company is flush with cash and has virtually no long-term debt.

But a positive turnaround at DEC may be another factor. A year ago, many people might have thought that Compaq would be buying a shrinking dinosaur. Now that DEC has settled its dispute with Intel over the Alpha technology and it has returned to profitability, it has become a more valuable acquisition target for Compaq.

Happy bargain hunting!

Bob Djurdjevic

Additional Charts

  • Compaq-DEC Acquisition - stock market reaction
  • Compaq's 1997 sales productivity
  • Compaq's 1997 international revenue shares
  • Compaq's business trends: Revenues, GP, SG&A (1990-1997)
  • Compaq's gross margins (1990-1997)


  • Compaq's worldwide operations: revenues, operating profit, employment, sales productivity by region (1995-1997)
  • Compaq's income statement analysis, including sales by business segment (1995-1997)

Also, check out: "Compaq's Rockwell Modems May Rock Well, But That's About All They Do Well," "Was Compaq's Presario Pressed into Service Too Soon?"

Give us a call at: 602/824-8111 or send us an e-mail: annex@djurdjevic.com

Volume XIV, No. 98-05
January 26, 1998

Editor: Bob Djurdjevic
Published by Annex Research;
e-mail: annex@djurdjevic.com

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