FWIW (I don't agree with most of the following)
Updated: 22-Jan-02
The PC Market Matures: MSFT, INTC
[BRIEFING.COM - Robert V. Green] Intel and Microsoft, the great growth engines of the Personal Computer's (PC) takeover of the world, reported earnings last week. In the details of the reports lies a simple fact: the PC industry has matured. Recognition of this fact has not yet been reflected in the stocks of the two great PC companies: Microsoft and Intel.
Mature Markets
All markets mature, eventually. It is a fact of markets.
Growth markets have strong characteristics. Aside from high rates of growth, players can grow without taking market share from other players. In addition, in a growth market, products can be sold which are neither perfect nor complete. Demand is strong enough to allow partial-solutions to be sold, which creates demand for the full-solution product to be sold later. Small, innovative companies can often beat large, established companies in sectors of the market.
Mature markets have very different characteristics. Big increases in market share must come from taking business from some other player. The market demands a full solution product, not a stop-gap product. Innovation becomes less important in mature markets, because the incremental improvement on a product is often of only marginal value. Larger companies generally consolidate their positions in mature markets.
The PC market, on which both Microsoft (MSFT) and Intel (INTC) were built, has now matured.
Oddly enough, the stock valuations of both companies do not yet reflect this fact.
The Intel Report
There were three significant aspects to Intel's earnings report.
Year-over-year revenue was down 20%; Quarterly sequential revenue growth was only 7%
Capital expenditure costs will be cut by almost 25%
Full year revenue picture now roughly the same as 1997/1998, but with one-fifth the profits
These are not characteristics of a growth company.
The reduction in capital spending is an indication of hard times for the rest of the semiconductor industry, particularly the equipment suppliers like Applied Materials (AMAT). But the more important point has been overlooked by many. When a market matures, capital investment slows. It is a hallmark indicator of maturation.
Intel itself has already stopped growing.
The following table compares Intel in 1997 and 1998 to today. (We have left out 2000 and 1999 in this comparison.)
2001 1998 1997
Revenue, billions 26.539 26.273 25.070
Earnings per share 0.19 0.86 0.97
Market Capitalization, end of year $216 billion $208 billion $125 billion
Intel was roughly the same size three to four years ago, made five times as much money, and cost half what it does today. It is hard to construct an argument that Intel is a growth company, and even harder to justify today's valuation.
The Microsoft Report
Microsoft's report was also positioned as beating earnings and revenue estimates, but a close reading of the conference call made it clear. They have guided lower for the combined six months ahead.
Here are the important points from Microsoft's earnings report:
Saw PC shipments decline 5% in Q2, expects further declines, reset expectations from modest growth to declines going forward
Guided revenue and earnings lower for the combined upcoming six months
Looking at new markets for growth: X-Box, Wireless Home Network
When Microsoft talks about the future, the focus is increasingly on consumer products: X-Boxes and the Wireless Home Network. Even Windows XP is being positioned as the first operating system that truly supports video, presumably an appeal to consumers. Despite the fact that PCs are the dominant home computer, it isn't the territory with the growth engine. The enterprise desktop built the Microsoft empire.
The new product directions are stretches for the great Microsoft profit machine. They might turn out to be good businesses, but they are nothing like the engine that was DOS and Windows, and all of the associated software. The model isn't the same, and it isn't at all clear that people really want wireless home networks.
Microsoft has not shown sequential revenue decline, as Intel has, and it is significantly bigger than it was 2 years ago, unlike Intel. But Microsoft's great growth engine has been the PC, and the incredible business that the software license model created. Growth for Microsoft now is in completely different business models, such as the X-Box model. These models will erode the great operating model of the last 15 years. (We will have more on this in a future Stock Brief.)
The PC Industry - Declines in 2002
Microsoft and Intel are the proxies for the entire PC industry.
In the past, new product cycles have provided as much growth to the industry as the addition of new customers.
But today, new customer additions have slowed. And for most companies and consumers, there is no compelling reason to upgrade existing PCs.
The Meta Group, an industry research company, forecast lower enterprise IT spending for 2002 in October of -2% to -5% for 2002. They have recently revised this forecast to a -11% level. Since enterprise information technology spending is the primary driver of PC sales, the entire industry is likely to see lower total revenue numbers in 2002.
A smaller overall market means growth must come at the expense of some other player. For Microsoft, with its monopoly, a decline in PC sales means a direct decline in PC based revenue. It is a mature market.
The Valuations
Intel and Microsoft are great companies. They are going to continue to produce great products and probably continue to get bigger.
The problem is, they aren't growth companies anymore. At least, they aren't growth companies by virtue of the PC industry growth.
Unfortunately, the stocks are valued as if they are still growth companies. The table below lists current market multiples for both companies.
Microsoft Intel
Price $66.10 $33.50
Price/Sales Ratio 13.8 8.9
Price/Earnings Ratio 60.4 179
Market Cap $356 billion $225 billion
These are lofty valuations for any company, but for companies with revenues above $20 billion, they are extraordinary. Microsoft has deserved higher valuations because of its extremely high operating margins, but with growth in the future coming from businesses with other models, are these valuations deserved?
The Prognosis
The PC market has matured. It is not a growth industry anymore.
To become true growth stocks again, and worthy of growth stock valuations, something must change. Desktop PCs already do about everything that most people want from them. Either we need a new innovation in what PCs provide, forcing everyone to upgrade, or PCs need to be sold to those that haven't bought yet. Neither prospect is visible.
It is going to take a long, long time for this realization to set in for many technology investors. As it does, however, the valuations on the company will readjust to those of mature companies.
It is extremely likely that both Intel and Microsoft will basically go nowhere in stock price for at much as two years. Even as they grow slowly, and probably beat earnings estimates, the readjustment of valuations to those of mature companies will keep the stock prices from rising strongly.
Comments may be emailed to the author, Robert V. Green, at rvgreen@briefing.com |
