Another one...
PC HARDWARE AND DATA STORAGE: HITTING THE PANIC BUTTON
08:44am EST 10-Mar-99 Morgan Stanley\DW (Munson, Gillian)
KEY POINTS
- Judging from the crowd at the Morgan Stanley Dean Witter
Semiconductor and Systems Conference, PC investors are almost at a
full PC panic stage right now.
- Investors appear pretty well convinced that the data points of
slowing in the market are a signal that every PC-related company is in
trouble here.
- After listening to Ted Waitt, Gateway's Chairman and CEO, who was
upbeat about PC demand last night, and a variety of disk drive
companies (which said demand looks pretty solid for a seasonally
slower period) we are not convinced that things are all that bad.
- Though it is a bit early today, we think that once the panic we
hear plays out, it may start to create some opportunities on the
horizon.
- Today, we expect Dell's Vice-Chairman, Mort Topfer, to be
relatively upbeat in his presentation both about core PC demand and
Dell's opportunities.
- Granted, PC demand in C1Q is a little more seasonal Q/Q than many
PC related companies and investors anticipated and some expectations
may need to be reset. We suspect that overall PC unit demand may be
down a few percent Q/Q - which is pretty good relative to typical Q/Q
unit drops in C1Q of 8-10% Q/Q.
- However, we don't see a PC train-wreck on the horizon (a' la no
unit growth as some fear). We continue to believe that the PC market
will grow 14-16% Y/Y in units in C1999 and in single digits in revenue
(on a 10% Y/Y price decline).
- As a sanity check, we always try to count PC demand from the
inside out as gathering G2 from each one of the 100,000 PC
manufacturers worldwide is almost impossible. As a reminder, while
their share is growing, Compaq + Dell + Hewlett Packard + IBM +
Gateway, still only represent roughly 40% of worldwide PC unit
shipments.
- We think aggregating the unit trends of the disk drives vendors and
Intel and AMD are important proxies for PC unit demand and judging
from the data we have on these companies to date, things don't look
all that bad.
We have talked to Seagate, Quantum, Western Digital, Maxtor, and
Fujitsu at the conference (together this group represents roughly 75%
of the disk drive market). Generally, they expect their Q/Q unit
trends to be flattish. Moreover, they expect the year to track to
mid-teens PC unit growth for their industry, with some growing faster
and some slower.
One company, Western Digital, indicated that its unit demand could be
down slightly Q/Q.
Even if this group is gaining share (and/or is slightly over
optimistic), we can still only get to a scenario with a couple
percentage point Q/Q unit drop - which is pretty good in historical
terms and still supports our overall PC thesis.
- We aren't trying to come out as PC heroes as this panic phase
needs to play itself out and there is clearly risk for a number of
companies, most important, Compaq.
However, we have seen these panics before and they always tend to get
overdone. We simply do not believe that the core PC drivers we have
seen over the last six months and we see driving the market for the
next 6-12 months have changed all that much in the last five weeks.
We continue to believe that while the PC market is big its rate of Y/Y
unit growth is slowing and that slowing growth creates
dislocations. In this type of environment (which is not going to
change any time soon), investors are likely to get over enthusiastic
or overly panicky about PC demand and its implications.
Our investment philosophy is that investors should look for companies
that are: 1) gaining share, and/or 2) in market pockets that are
accelerating, and/or 3) driving bottom line leverage with new products
or cost cutting, and/or 4) implementing accretive acquisitions. In
thinking about companies to buy if/when sentiment shifts these are
important factors to consider.
COMPAQ - OUTPERFORM
- Compaq presented at our conference on Monday. We also spent some
time with their presenter, John Rose, EVP of the Enterprise Computing
Group.
- On demand, the company indicated that January and the first two
weeks of February were seasonally sluggish. The end of February
picked up and March needs to be strong (this will be a back end loaded
quarter). As the company has said over the last few weeks, the risk
profile has shifted into March. This will be a nail biter!
- Compaq did not have details on the full February financial outlook.
The company should get those figures later this week.
- Compaq does not believe that there has been a fundamental shift
down in core demand drivers given current information. Rose indicated
that so far, the demand trends he was describing were seasonal ex. a
few geographic issues (Brazil which is weak, and the U.K. where
government spending is somewhat weak).
- We are treading lightly with Compaq here. We still believe the
long-term opportunity is big and as a result are maintaining our
Outperform rating (but the risk level has gone up). We suspect that
quarterly fluctuations are probably getting a bit over exaggerated by
investors at the moment. Either way, the news flow for the moment is
Neutral to slightly negative which means that the stock is probably
not going anywhere fast.
GATEWAY - NOT RATED
- Gateway's (GTW, not rated) Chairman and CEO, Ted Waitt gave a
keynote last night at our semiconductor and systems conference.
- Waitt indicated that Gateway feels comfortable with PC demand
trends. Gateway continues to believe that the PC market is growing
nicely.
- The company said that it feels comfortable with C1Q and C1999E EPS
estimates.
- Pentium III has helped bring in more call volume - up 10-15% week-
over-week last week with the products' roll-out. 30% of sales at the
Gateway stores are now Pentium III and Pentium III is a smaller
portion of overall sales.
- Gateway stated that it hopes to extend its product reach, its
international sales, and the portion of sales it derives from non-PC
products (GTW hopes to get non-PC products to 30% of revenue by
C2002). Waitt also indicated that a big piece of GTW's push over the
next few years will be to create better solutions for customers vs.
point products.
QUANTUM - NEUTRAL
- Quantum presented at our conference on Monday.
- Quantum's presentation was in line with the commentary the company
has given throughout this quarter.
- The company focused most on what it believes is its biggest
opportunity - leveraging its storage systems business.
- Quantum indicated that it believes that margins in the PC disk
drive business are never going to be as good as they were in the "good
old days". The company is now planning for lower margins and is
working hard to drive asset utilization. Moreover, Quantum continues
to work to drive its new enterprise disk drive products further into
the market. All in, the disk drive business looks flattish Q/Q.
- On the tape side, Quantum said it feels good about its DLT
positioning. Moreover, the company believes that the DLT tape
installed base of near 1MM drives should help drive a more annuity-
like revenue stream of tape media.
- Quantum has a number of strategies for leveraging its systems
expertise including ATL and some disk subsystems solutions.
- Quantum indicated that it continues to work through the logistics
related to its "tracking stock" issue. SEC rules regarding marketing
during the period before the tracking stock is issued prohibited the
company from doing a Q&A session in conjunction with our conference.
WESTERN DIGITAL - NEUTRAL
- Western Digital presented at our conference yesterday.
- The content of Western Digital's presentation was generally in line
with Western Digital's previous commentary on its business directions
with one slightly negative twist (relative to expectations).
- The company did indicate that revenue and units could be down a tad
Q/Q versus estimates of slight increases (our revenue estimate
included a 3% Q/Q revenue increase). At the same time, the company
believes that its CQ1 EPS will be in line with expectations even on
the potentially lower revenue owing to cost savings - our estimate is
a loss of $0.67 per share.
- Overall, WDC indicated that C1Q PC demand (and disk drive demand)
is good relative to past C1Qs though slightly more seasonal than some
might have thought at the beginning of the quarter. Disk drive
pricing continues to be very aggressive as expected.
- WDC was positive about its relationship with IBM. The company
characterizes the relationship as just starting out. The company
believes that knowledge gained in the first product cycles with IBM
can be translated to additional new products down the road. WDC
believes the relationship can translate to product advantage on GMR
and Pico-technologies.
- WDC said it believes it gained share at OEMs Q/Q in C4Q. The
company indicated that it believes that its share will be flattish Q/Q
in C1Q and will rise in C2Q and C3Q owing to new products.
- WDC said that it will be ramping a 10K enterprise offering and a
6+GB per platter desktop product in the summer.
- Longer term, WDC's strategy is to balance the business model beyond
the HDD market with more profitable products (the acquisition of Crag
Technologies is a start).
- WDC indicated that disk drive industry inventory is the lowest it
has been in three to four quarters. WDC cited an overall disk drive
industry inventory level of near six weeks. WDC's goal is to end the
quarter at four weeks or less in inventory. WDC maintains that it
will not stuff the channel to make its quarter (it would rather take
lower revenue than stuff the channel).
The company is doing many of the right things for its business and is
appropriately focusing on product positioning and cost savings.
However, sentiment in the disk drive market remains negative and PC
uncertainty will continue to have negative pull on the shares.
Moreover, WDC probably needs to prove out its ability to execute a bit
more in order to get more support from investors.
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