Paul, and ALL, Article...analysis of computer market...
barrons.com
January 28, 1997
Tech Stocks May Soar on Wings of MMX, Pentium Pro
Howard R. Gold
Andy Neff's Picks
An interview with Andrew J. Neff. For some time, big technology stocks have led this bull market higher and higher. As 1997 dawns, investors are watching several key developments, especially the multimedia MMX Pentium chip, to gauge the health of this vital industry. Barron's Online turned to Andrew J. Neff, senior managing director and head of technology research at Bear Stearns & Co., Inc., for his views on how the sector will perform this year. A University of Rochester graduate with a Harvard MBA, Andy has been following technology for Bear Stearns since 1987.
Barron's Online: Since the sell-off last spring, there has been a nice recovery in the technology sector. In fact it has really been one of the market leaders. In some of your reports you cite some reasons why PC growth will continue to be strong in 1997 and beyond. Would you elaborate?
Neff: It is important that there be more than one factor driving demand. If you depend on one factor, that raises the risk to investors, because if that one thing doesn't happen, the growth might not be there. We have tried to enumerate ten factors driving demand.
They include the Windows NT upgrade cycle, MMX technology, replacement demand, the Internet, mobile computers, workstations, 56-KB modem technology. Also, growth outside the U.S. is greater than it is here, particularly in the Asia/Pacific region.
Q: So you're saying there are many factors coming together this year. We will get into Intel's MMX technology and Pentium Pro chip later. But I did want to ask you about the demand for greater bandwidth and more and more storage capacity on computers.
A: What is interesting about the Internet is that whenever you get to where you think you want to be, you're not there yet. A couple of years ago, you had 9600-baud modems. Now 14,400-baud is already obsolete, and 28,800-baud is almost obsolete.
As for storage capacity, in the consumer market, a one-gigabyte hard drive is entry level, 2 GB is becoming standard, 3.8 GB is high end. Next year we may have a standard 6-GB hard drive, 3 GB will be entry level. Declining price per MB is leading to more demand for bigger and bigger disk drives.
Q: Based on all these factors, you forecast global shipments of PCs this year will increase by around 20%. Is that a combination of consumer and corporate, domestic and international?
|A: Right. One of the things to keep in mind about the computer industry is that anywhere between 20% and 35% of the installed base upgrades every year. That is very different from other industries, and sort of flies in the face of arguments that we're near saturation. In fact, I think it is just the opposite: The larger the total base, the larger the increase in demand.
Q: So, do you think this is going to be a good year for technology and technology stocks?
A: I think this is going to be a good year, but investors have to be wary of some key issues that are coming up. For example, Intel is cutting prices coming Feb. 1. Everybody knows about it, and corporate buyers have begun to slow down their purchases. When the new prices come out, the trade press will say, oh, there is a price war going on. It is not a price war; it is a price cut. So, customers will settle in and then the buying will start up again.
Q: You are saying investors have to ignore these zigs and zags.
A: Right. The overriding point is, this is going to be a very good year. Advances in technology are going to be very significant, both for corporate and consumer users. We're seeing increases in growth outside the U.S., as well as domestically.
Q: Let's move right into some of these advances, which brings us to Intel's MMX chip, released early in January. Would you tell us about it?
A: MMX stands for Multimedia Extensions. Essentially what Intel did was add a certain number of instructions to the microprocessor, instructions that are geared specifically to accelerating multimedia functions, such as sound, graphics, video, imaging.
Q: The bottom line is that it significantly speeds up graphics, communications and video applications.
A: Yes. On a non-MMX-tuned application it would only be 20% faster, which certainly doesn't hurt. But running applications that incorporate the additional instructions can be up to two times faster on video, up to three times faster on sound, and four times faster on graphics. For certain applications, such as video conferencing or video games, that can be very significant.
Q: What effect do you think MMX will have on PC sales?
A: MMX is going to lead to a new wave of buying initially by consumers who have been holding off waiting for the latest and greatest Intel technology.
Q: Is MMX primarily a consumer-oriented product?
A: Well initially, but later on you will see business applications. It is a consumer product because consumers are usually the ones that first adopt multimedia. But the applications like voice and sound will eventually end up in business applications as well. In fact, we will see MMX in Pentium Pro machines, probably later this year.
Q: Because of the MMX launch, you said some of the normal computer buying patterns could change this year.
A: This Christmas, there was a lot of anticipation about MMX technology, so some people held off, waiting for it. On the other hand, January is usually a very strong month for retail PC sales. Then the consumer segment tends to die off come mid-February, and usually the worst time of year is right around April 15: people who are paying taxes don't really feel like spending money for computers.
This year I think it might be different in that as you start seeing the media and marketing build-up about MMX, January could be slower than anticipated, and you may see some more buying in the spring, which is typically slow.
I think the larger issue is that in 1997, Intel is going to have one of its biggest years ever in improvement of processor performance. That will have an impact on consumer buying, and the advancement in the Pentium Pro should boost the business market as well.
Q: People also have been waiting for the Pentium Pro, Intel's next generation of microprocessor. Why is that important?
A: It is significant because it is going to be faster, and once people see something is faster they are willing to pay a premium over the price of the previous generation.
Q: So, do you think corporate buyers have been holding out waiting for the conjunction of Microsoft's Windows NT 4.0 operating system and the Pentium Pro?
A: Somewhere around April 1996, you began to see the purchase by the corporate buyer of Windows 95 on the Pentium. And in 1997 we should see a move to Windows NT on the Pentium Pro. That is one of the things driving the market. Concurrent with that, the server market is moving to Pentium Pro even quicker.
Q: Obviously the prime beneficiary of all this is Intel.
A: Intel is really a core holding in this sector. Intel is going to be a beneficiary of a lot of key trends, including advances in processor performance and an emerging trend toward more than one Intel processor in a box. The key to multiprocessing on the desktop is you have to have a multiprocessing operating system, which is what Windows NT is. In fact, the microprocessor-to-machine ratio is around 1.05 today. It could be somewhere around 1.3 within three years.
Q: That's 1.3 microprocessors for every machine, meaning there are more machines out there with dual microprocessors.
A: Right. That won't necessarily become a low-end consumer product, but for the corporate desktop and the power user, it can become much more prevalent.
Q: You are calling for Intel to earn $8.50 a share this year?
A: We recently raised that to $8.75. We are looking for $10.75 in 1998.
Q: It is trading at about 14 times estimated 1998 earnings. You think it is still attractive at this stage to buy?
A: Yes.
Q: Let's talk about some of the storage companies. Seagate Technology, on which you have a Buy recommendation, bought Conner Peripherals last year. There are many indications the disk-drive industry has changed, that all these bloody price wars of the past are not going to happen anymore.
A: There have been a lot of changes in the industry. One of the most important things is that Seagate has become the largest and most profitable player with the lowest cost position. It created an industry environment where there is no incentive to have price wars. Seagate has a terrific high-end, high-margin product. So, if somebody starts a price war, Seagate will always win.
Q: Because they can always cut prices enough to stay competitive.
A: So it created some level of industry discipline. That happened along with the fact that the industry as a group became very different from, say, the dynamic random access memory chip (DRAM) business. The DRAM business today is really one business-16 megabits. That's it.
Look at the disk-drive business. There are many different segments--different disk sizes, different rotational speeds, different capacity. And what that means is that certain companies can be strong in one place and other companies can be strong in other places. The competition is a little more diffuse.
Q: So two other disk-drive companies, Quantum and Western Digital, which you rate Attractive, will also benefit from the consolidation in the industry.
A: Western Digital is a dominant player in the desktop market. In addition to that, they are expanding in two new segments: the high-performance area, where they have never been before, and the mobile segment, the three-inch size. Quantum is more of a turnaround story. They are doing well in the desktop segment, but have had many problems in the high end. If they can restructure that business and turn it around, it creates a lot of operating leverage.
Q: Let's move on to some of the PC companies. You have Compaq Computer and Dell Computer as Buys. Compaq is probably the premier independent producer and Dell is probably the leading direct marketer of computers. Why do you like them?
A: I think what is significant about Compaq and is probably overlooked is that they don't just sell boxes; they go into high-growth segments and tend to dominate them. They are number one in retail, number one in Europe, number one in the desktop market, number one in servers. They slipped in the notebook market, but they are regaining that share. But importantly, they are also focused on where the high margins are. That is important for Compaq.
Dell, because it is a direct marketer, is an extremely responsive organization. Their goals of liquidity and profitability balance each other. Last year what was driving growth was their entry into the portable area and Europe. For this year, they're focusing on the server area, on the high-growth Asia Pacific region and lastly on the consumer. Somewhere around 20% of first-time computer buyers buy direct. Somewhere around 35%-40% of second-time buyers do. So, in a sense the consumer is moving in Dell's direction.
Q: So basically you have your Buy recommendations on Compaq and Dell. You are neutral on Gateway 2000. And you rate Apple Computer as unattractive. A lot of people still love their Macs, and Apple was the pioneer in the PC business. But do you see any way they can solve their problems?
A: I think one of the big strengths they have is $1.8 billion in cash. That always is one of the most important things in any turnaround--having the balance sheet to do it. If you take a longer view it is very hard to kill a computer company. Every company that we mention--whether it is IBM, Digital Equipment, Compaq, Dell, Gateway--have gone through difficult periods, and turned around.
Q: But Apple has a tough road ahead. They probably will never be the force they once were in the business.
A: Clearly they are trying to figure out how to compete in a much more competitive environment.
Q: Anything else that you are looking at now?
A: We like IBM, which we rate Attractive. We view IBM as a technology conglomerate; it's not really a mainframe company anymore. It is well-positioned right now with its portfolio of businesses. Hewlett Packard's driver is revolutionary printing technology, which will be much more visible next year.
Q: Do you think there is a possibility of another sell-off in technology stocks in the months ahead?
A: The risk is how people react to these various seasonal trends, like these Intel price cuts. I think for the long-term investor, these are areas where there is not just relative but real growth.
Q: So, what you are suggesting is that there may be some short-term price weakness, and you would recommend that people buy on that weakness?
A: Yes. If we get overreaction to short-term news, it would be an opportunity to capitalize on the major cyclical trends.
Q: Thanks a lot, Andy.
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Now thier's a Guru who seems to know what he's talking about!!
Regards, Michael
p.s. I wonder if we can entice John Hull to address the pirating chip problem? |
