Apple's warning notwithstanding, PC sales are still moving up
By Jay Palmer
Last week, it was Apple Computer, the week before, Intel. Though the
reasons were rather different -- Apple noted that back-to-school demand in
the U.S. had been weaker than expected, while Intel blamed European
weakness -- the messages were much the same: Third-quarter revenues and
profits were coming in significantly lower than expected.
With investors already skittish about the outlook for personal computer sales,
the latest news hit the sector hard. Apple Computer's shares were more than
halved on Friday, from 53.50 to a 12-month low of 25.38. Other PC makers
got caught in the backlash. Dell Computer also hit a 12-month low of 30.81,
down five points on the week, and Gateway slid 8.75 to 46.75. Compaq
Computer closed at 27.52, slightly down from 28.63 a week earlier, while
Intel, the prime supplier of chips to the PC makers, slid to 41.56 from 47.94.
Dell, Gateway and Intel are all nearly 50% off their 52-week highs.
But while investors seem to believe
the worst about the
end-of-the-year PC sales picture,
Apple's warning may not be a
harbinger of things to come. On
Friday, Gateway Chief Financial
Officer John Todd told Barron's
that he believed Apple's problems
were company-specific, not
industrywide. Though Todd is
prohibited from discussing
specifics ahead of the company's coming third-quarter numbers release,
sources close to the company say Gateway's back-to-school sales were
every bit as strong as expected. Certainly the company still stands by its
earlier forecast that third-quarter sales will be up 15% over last year.
That said, one has to wonder whether the once-powerful long-term PC
growth engine is stalling. And the best answer seems to be: not yet! "We still
consider this a growth market," says Mike Winkler, group general manager of
Compaq's Commercial Personal Computing Group. "Nearly everyone is still
looking for industry growth in the middle teens for the next three or four
years."
"People have been talking about the possibility of PC sales slowing ever since
the late 'Eighties, and they've always been wrong," adds Kevin Rollins,
vice-chairman at Dell Computer. "In terms of its long-term growth trend, we
believe the industry is very healthy. We think sales will grow in the same
15%-18% range for many years to come."
Gateway Chief Executive Jeff Weitzen
agrees. "I think an 18% sales growth is
sustainable for quite some time," he says,
though he goes on to raise a quiet
cautionary note. "Looking maybe five
years out, PC sales might then start to slow
to somewhere in the low teens."
Nor is Ashok Kumar, the respected PC
industry analyst at US Bancorp Piper
Jaffray who made prescient calls recently
on Intel and Dell, particularly bearish about
the prospects for PC sales. He says he
expects box sales will continue to rise at
close to their historic rate of 16% over the
past decade. "There's no reason for the
long-term trend to slow," he says.
But none in this group would dispute that
the good times can't last forever. Saturation of the U.S. market and an ever
declining number of new first-time PC buyers inevitably will mean a leveling
off in U.S. sales at some point. At the same time, PCs are becoming more
and more commodity items, with prices on the low-end machines dropping to
the point that already-thin margins are likely to become non-existent. All this
means that someday in the not-too-distant future, companies that have spent a
decade or more growing revenues and profits on the back of the PC boom
will have to look elsewhere for growth -- especially if they want their stocks
to enjoy the kind of historic multiples they've been used to.
Though they don't like to talk about it in those terms, the major PC makers
are already preparing for that day. And their strategies for this uncertain future
are in many ways quite different.
Consider Dell. Though well known as a direct
seller of PCs to individuals, a business model it
effectively pioneered, the Texas company has from its very beginnings in the
mid-1980s placed most of its emphasis on selling computers to corporations,
and today gets something over 85% of its revenues from the business sector
and only 15% from consumers. Now Dell is switching emphasis away from
slow-growing, thin-margin desktops and toward laptops, where sales are still
growing at a 60% pace and margins remain high. Corporate demand for a
combination of mobility and new wireless communications will help hold up
laptop sales, at least compared with desktops, maintains Dell's Rollins.
But laptops are still PCs and, since the mid-1990s, Dell has been looking
beyond this sector. One of its first moves was to open Dell Gigabuys, a
Website selling the full range of PC accessories and peripherals -- what
Rollins calls "an experiment to understand the marketplace."
But rather than follow that path down toward the consumer, Dell is betting on
an ambitious move up the computing foodchain, into the new business of
workstations and servers, the powerful up-market computers that are the
heart and soul of the Internet and e-commerce. Today these high-end
machines account for nearly 20% of the company's revenues. Competition
from the likes of Compaq, Hewlett-Packard and IBM is tough but, with
margins still a lot better than in PCs and a growth rate of between 40% and
50%, the outlook is upbeat. Says Rollins: "Our fastest growth is yet to come."
Like Dell, Compaq is often viewed as a pure PC play. In fact, the company
gets just half its revenues from this traditional source. Margins are tight and
sales may soon slow, but the company doesn't write these operations off.
"We are headed into a whole new phase of the market, one not based on the
death of the PC but rather on the augmentation of this traditional PC by a
whole new bunch of Internet devices and Internet appliances," says Winkler.
"I don't think we should be talking about PC sales slowing as much as about
the way this PC market is about to morph into a whole new business that
could be every bit as exciting as the PC industry ever was."
Perhaps, but Compaq, in part through the acquisitions of Tandem Computers
and Digital Equipment, has also gone out of its way to diversify up the ladder.
The company is now No. 1 in servers, in terms of units sold. "There are
essentially three parts of the 'Net where servers and workstations are being
used, and we are big in all of them," notes Winkler. "At the core of the
infrastructure are the large Unix-based mission-critical systems, the
high-performance servers than can never be allowed to go down. At the edge
of the network are Intel- and Microsoft-based servers that do a lot of content
rendering, such as e-mail or control of communications. The third piece are
the access devices and workstations."
Margins here are much better than for PCs and growth is far higher and far
more sustainable. "We believe the Internet infrastructure five years from now
is less than 5% built," says Winkler. "We feel the market is vastly
under-penetrated and that high-end server market will continue to grow at a
very fast clip."
Gateway, under the leadership of CEO Weitzen, has chosen a somewhat
different path to long-term salvation -- a path that's much more geared both to
the PC and the individual consumer. When surveys showed some 50% of
potential buyers -- especially first-timers -- wanted a hands-on experience
before shelling over cash, Gateway moved to open the first of what are now
over 300 Gateway "stores," small outlets where shoppers can play with PCs
and place their orders. Another 1,000 stores-within-stores will be opened in
OfficeMax outlets next year.
At the same time, with plunging PC prices driving the profit margins on the
basic box to wafer-thin levels, Gateway switched its emphasis to "beyond the
box," its code phrase for a strategy for ramping up faster-growing and
much-higher-margin sales of software and peripherals, services, training and
financing, as well as 'Net access and 'Net linkage through a partnership with
America Online. Indeed, Gateway has used its connections to the consumer
to ramp this business up to the point where beyond-the-box sales are
delivering 40% of net income on nearly 20% of revenues.
"Everything we do around the box is much more profitable than what we do
with the box," says Weitzen. "By the end of this year, out-of-box income will
be 45% of the company's total, and you can expect that number to rise still
further. There is a huge gap in the PC selling game. People, even sophisticated
PC users, are crying out for help on the how to use a digital camera, how to
print, how to use this or that software, how to fix an operating bug, how to
search the 'Net. We can help them do all this and make a ton of money doing
it."
If Apple's grim news is an aberration, then at some point in the future
investors will shed the concerns that have driven these companies' stock
prices so sharply lower. Given the industry leaders' confidence that growth
will resume and their ongoing strategies for continuing that growth, even if the
PC market does slow, then the current market weakness may be a good
buying opportunity. |
