BUSINESS WEEK ONLINE
October 20, 1999
STREET WISE by Sam Jaffe
A Blue Screen of Death for PC Stocks? Hardly
While most have followed Dell down after its warning, this is "not a tragedy, it's just a hiccup"
It was never supposed to happen. Ever since its infancy in the mid-1980s, Dell Computer (DELL) has almost always met analysts' earnings forecasts. Quarter after quarter, year after year, nothing has been more reliable than Dell's profit engine.
That's why the market was so shocked on Oct. 18, when Dell warned that it would not meet its earnings targets for the third quarter, which it will report on Nov. 11. The news was even harder to take considering that the week before Intel (INTC), another bedrock of earnings consistency, had also reported disappointing results. It was no surprise that most personal computer stocks dropped after Dell's revelation, out of fear that all PC makers would face similar problems.
The fact is, however that the market has overreacted. The problems PC makers are facing are short-term, and most analysts agree that the sector is now undervalued.
LITANY OF WOE. Of course, that's hard to believe in the wake of the other news that has come from PC makers recently. Consider: Apple Computer (AAPL) tried to raise prices on a new line of desktops on Oct. 18, only to withdraw the hike the next day. Micron Electronics (MUEI) announced a new, somewhat desperate-sounding plan to bundle its PCs with Internet service and charge a monthly fee. IBM (IBM), which began the PC revolution 20 years ago, announced that it will stop selling its PCs in retail stores and will sell them online instead.
The big picture here is that the PC, like any mature technology, is finally beginning to be priced rationally. Some refer to this process as the "commoditization" of the computer, but that's a misleading term. Computers are no more a commodity than a car. Manufacturers can still add plenty of value to increase profit margins.
What has changed, though, is that computer prices have dropped so low that the commodity parts that go into them now significantly affect the final price of the product. Dell's earnings hit reflected a sudden increase in the price of DRAMs, or memory chips, which is a result of higher-than-expected demand (and not the Taiwan quake, as has been endlessly and erroneously reported). In the past month, DRAM prices have risen by 25%. Since DRAMs account for 7% to 10% of the price of a computer, there's a noticeable impact.
PAINFUL SLICE. Dell, of course, can simply raise prices to make up for its higher DRAM costs. But that isn't true for orders that have been placed in the last three to four weeks. For those orders, the differential in DRAM prices will come right out of Dell's margins -- and knock its quarterly numbers down a notch. As a result, the company's stock dropped 6.8% on Oct. 19. "This is a short-term supply problem," says Paul Mansky, an analyst with US Bancorp Piper Jaffray. "It will be solved very quickly."
As often happens, other PC stocks fell in concert with Dell. Compaq (CPQ), Gateway (GTW), Apple, and Hewlett-Packard (HWP) all dropped about 6%. That's where the market went wrong, according to Gerard Klauer Mattison analyst Lou Mazzucchelli. "This kind of thing happens a lot, but the manufacturers are able to iron out price spikes in commodity components," he says. "But this time it happened at exactly the wrong time. It came in the last three weeks of Dell's fiscal year, so there's no way for them to use accounting magic to iron it out over the whole year."
So if Dell's problems are run of the mill, why did the market punish the company and the entire sector? "It's a mystery," says Credit Suisse First Boston analyst Michael Kwatinetz. "This is not a tragedy, it's just a hiccup."
Hiccups have been known to start avalanches, of course. But the good news is that once the snow has rumbled down the side of the mountain, the skiing can be great. What makes the drop in PC stocks especially interesting is that the industry is enjoying a far stronger burst in demand than anyone anticipated. And the fourth quarter, which is always the biggest one for PC sales, looks likely to be a bonanza. "This is a tremendous opportunity for anyone that has a long-term horizon," declares Mazzucchelli. "Anyone who buys these stocks now is going to be very happy by the year 2000."
Jaffe writes about the markets for Business Week Online |
