From Briefing.com this morning:
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Updated 24-Mar-99
IS PC Boom Over?
The PC group has come under assault over the past few days amid growing concern that revenues will fall short of expectations due largely to falling average selling prices (ASPs). Are the market's fears justified, or is this just another false alarm? Remember, we dealt with similar worries on a couple occasions last year only to watch the PC group post record revenues/profits.
Falling PC Prices
Much of the market's concern centers around the fact that PC prices continue to fall. And, so goes the logic, declining ASPs will ultimately result in deteriorating margins/profits. Not a bad argument except for the fact that prices represent only half of the equation. The other is costs. Before getting overly alarmed about IBM's newest group of sub-$1000 computers, investors need to remember that companies like Dell (DELL) and Gateway (GTW) have seen profits mushroom over the past few years, all the while PC prices have steadily declined. Why? One big reason is that costs fell as fast, if not faster, than prices.
So the question investors need to be asking themselves is whether prices are finally falling faster than costs. There is some evidence that this might be the case. Aside from the obvious drop in the costs of microprocessors, due largely to the growing acceptance of the K-6 by Advanced Micro Devices and Intel's Celeron, neither disk-drive nor memory chip prices appear as soft as they have been in quarter's past. One factor still difficult to calculate is the reduced distribution costs brought on by the success of direct, on-line sales. Leaders in this area are Dell (DELL) and Apple (AAPL). It is possible that the PC companies, which as a group were holding near record low inventories, are simply passing along the costs savings associated with lower processor prices and more efficient distribution. If so, margins won't fall and profits will hold up. If not, and prices are actually falling faster than costs in a reckless grab for market share, the bottom will fall out of the sector making current declines look small.
Demand Slowing
Falling ASPs are the main, but not only, concern of investors. Another is softening demand. So far this worry seems relatively small, as a number of analysts have recently come out and said that unit growth remains strong, about 12%-14%. Consumer demand really driving growth, as evidenced by yesterday's study which showed that for the first time ever half of American homes have PCs. Of course, the bad news here, and this goes to the first concern, is that more than 60% of the PCs being sold at retail stores are priced below $1000.
While we acknowledge that the growth of the Internet will continue to spur sales of low-priced consumer units, Briefing.com is worried that corporate demand - higher margins - will slow in the second half of FY99. The reason: replacement purchases related to resolving the Y2K problem will have run their course by then. On the flip side, IT spending related to Y2K issues (not tied to Pc replacement) will be available next year for network/computer upgrades. Nevertheless, we could witness at least a couple of quarters of sluggish corporate demand at a time when comparison periods are difficult. The end result being estimates for the out quarters are lowered as well.
Irrational Expectations
Another issue impacting the PC group is the fact that investors carried unrealistic expectations into the current quarter given the incredible strength posted late last year. The hope was that sequential growth would be no worse than flat. But increasingly it looks like the group will experience the typical seasonal slowdown in which Q1 growth falls below Q4 levels. Adjusting to this reality means living with a period of earnings/ratings reductions. And such periods are rarely pleasant.
Conclusion
Anxieties over falling ASPs aren't new. They seem to crop up a couple of times a year. Particularly during seasonally sluggish periods. But it is important to remember that the group has posted record profits over the past few years while PC prices have dropped dramatically. One reason is that unit growth remained very strong, particularly at the corporate level. Another is that costs were falling faster than prices. Given improved operating efficiencies, continued strong demand on the consumer front, the potential for increased overseas demand (particularly in the rebounding Asian/Pacific region) and sharply lower processor costs, Briefing.com contends that the current fears are exaggerating the threat to the PC sector. Consequently, once earnings season commences group is likely to experience a significant "relief" rally.
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