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The Weekly Contrarian Pick





52 week range: $9.25-$2.25

P/E Ratio



Institutional Holdings

Wholesale Computers

P/E to Industry
46.8 %

Price/Book to Industry
77.4 %

Profit Margin to Industry

Dallas based CompuCom Systems is a leader in the sales and service of distributed desktop computer products to large and medium sized U.S. businesses.  The company is a dealer of major manufacturers' desktop computers, networking equipment, computer peripherals, and software.  CompuCom's service business provides its customers with network integration services, consulting, asset tracking, system configuration, product procurement,  help desk services, and software management.  The company's ClientLink subsidiary provides information technology solutions and software application development services to large businesses.   CompuCom is majority owned by NYSE listed Safeguard Scientifics.

The company operates in a highly competitive business and must compete with other system integrators, direct marketers, and desktop computer companies themselves for business.    Increased competition in the industry led to a wave of consolidation as companies tried to increase their market share.  CompuCom completed two acquisitions in 1998 that added almost $400 million to its annual revenues.  Pricing is a key area of competition in the industry. CompuCom, a corporate reseller, must compete with direct marketers who are often able to provide their customers with more favorable rates.   Pricing pressure, and increased competitiveness, led to a decline in profit margins for CMPC and for the industry as a whole in 1998.

Earnings at CMPC fell 59% during the year's first 3 quarters.  The sharp fall in the average price of computers during 1998 hurt CompuCom as it had to struggle to increase units shipped to make up for the lower prices. The company attributed the lower prices to heightened competition and expects the downward pricing pressure to continue, although at a slower pace.  Excluding acquisitions, the company was able to increase product revenue by 16% during the 3rd quarter and by 3.9% for the 9 months.  Service revenues, excluding acquisitions, increased by 4.4% during the year's first 9 months to $188 million.  Gross margins in the service business tumbled to 31.9% from 36.5% the prior year  Lower billings per engineer in the systems engineering business was the primary contributor to the lower margins. Operating expenses increased as a result of the company hiring more sales personnel.

We believe that 1998 represented a low point in  CompuCom's operating history and that steps now being taken by the company will lead to an earnings turnaround in 1999.   The company and its major vendors (Compaq, IBM, and Hewlett Packard) have implemented channel assembly programs that will allow it to compete more effectively on a pricing basis with direct marketers. These programs will also give it a pricing advantage over those resellers who have not been able to obtain similar deals with major vendors.   The programs will allow the company to carry lower inventories of finished goods and meet lower price protection requirements (CompuCom's suppliers offer it price protection and return programs which help absorb product and inventory price reductions).

In early November CompuCom announced a restructuring plan (and a $25 million charge against 4th quarter earnings) that is designed to reduce the company's cost structure.   CompuCom will reduce its workforce by 10% and close branch offices as it shifts to a "virtual office model".   The company will close its branch facilities, but will retain a local presence in all of its markets as its sales representatives and engineers begin to use "remote communications" to communicate with customers and the main office.  According to CompuCom this move will lead to a "reduction in its product cost structure of approximately 1.25%-1.5% of sales".  The restructuring is part of a company wide reduction in expenses designed to improve profitability and change the current business models employed by the reseller industry.  This move to a virtual office model will allow CMPC to achieve higher margins and offer more attractive pricing than its reseller competitors who maintain costly branch offices.

The company is also implementing plans to boost the percentage of its revenues that are derived from its service business.  The service business will play an increasingly important role going forward as customers' technology needs increasingly become dependent on successfully implementing information technology into their business.

Earnings during 1999 are expected to improve from an estimated $0.24 in 1998 to $0.57 a share.  The benefits that will result from the company's new business model are not yet factored into the current share price.  CMPC shares are 53% off from their 52-week high and are trading at a forward Price/Earnings ratio of just 7.6. CompuCom is trading at a Price/Cash Flow ratio of 5.5, and at a Price/Sales ratio of just 0.09.   We believe that these shares are undervalued and will gain in price once the first results from the new business model are reported. We look for the P/E ratio accorded these shares to expand to the midpoint of  its 5 year range (26-6.7) as earnings begin to turnaround.  This would leave the shares trading at a forward P/E of 12-14, for a year end target of  $7-$8 a share.

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