October 23, 1997
Impact of Cheaper PCs Is Seen
As Boon for Some Tech Stocks
By SUSAN PULLIAM
Staff Reporter of THE WALL STREET JOURNAL
Main Street may be cheering this year's sudden surge in sales of personal
computers priced below $1,000. But Wall Street, so far, has only applauded
politely.
What gives? Any time prices start falling, investors get ready to run for the exits
because profit margins usually start falling as well. But in the case of personal
computers, some investors and analysts believe lower prices could actually be
good news for some technology shares.
The silver lining they see is that the lower prices will expand the market for PCs
enough to offset the lower profits on each machine. Until just recently, the
percentage of U.S. households that own a computer has been holding steady at
around 40%. Now some analysts say that figure could grow to 60% over the
next several years.
The impact of the $999 PC, known on Wall Street as "sub-zeros" after the
fancy refrigerators, seems likely to vary widely among the biggest high-tech
stocks.
Microsoft, for one, shapes up as a beneficiary because it receives a flat $45 for
each computer sold, no matter how low-priced, using its industry-standard
operating system. Ditto Compaq Computer, first on the scene with a powerful
$999 machine, which it began selling last February and which helped boost its
unit sales growth in the third quarter by 54%.
Intel, on the other hand, which has been trying to hold the line on
microprocessor prices, could lose big, at least temporarily. Instead of Intel's
well-known brand, most of the less expensive models contain cheaper chips
from its rivals Advanced Micro Devices and National Semiconductor's Cyrix
unit.
"In the long run, I believe this is good for everyone. I even think it's neutral for
Intel. But it's going to cause chaos in the market for technology shares, certainly
among investors who have to reassess the implications for the industry," says
Drew Peck, an Intel analyst with Cowen & Co.
The cheaper personal-computer models may have hit the shelves earlier this
year, but Wall Street began taking a harder look last week when their explosion
in popularity became obvious. On Tuesday, Intel reported third-quarter results
that fell short of Wall Street's estimates, as a result of price competition brought
on by the cheaper machines. Since then its shares have slid from around 91 to
Wednesday's close of $83.9375, down $1.8125.
Two days later, Compaq reported that its third-quarter unit sales jumped 54%,
in part because of soaring sales of its $999 Presario 4505. Its shares got hit
because of overall nervousness and a run-up in the stock before its earnings
were released. But since then, its shares have managed to hold steady.
If sales so far this year continue at the same pace, about five million of the new
cheaper models will be sold by year end, according to estimates by ABN Amro
analyst, David Wu. That would be about 40% of the U.S. retail computer
market units.
No technology company is set to take advantage of the new trend like Compaq.
"Of all the PC companies selling these machines, Compaq has the strongest
momentum. They have been aggressive on pricing and advertising and they
argue their margins are OK," says Hambrecht & Quist analyst Todd Bakar.
Another obvious beneficiary of all these new
low-priced PCs could be Internet stocks --
assuming more PCs equals more net surfing --
such as America Online, Yahoo! and Excite, says
one high-tech mutual fund manager. Modem
companies such as the U.S. Robotics unit of
3Com may also be helped.
But don't rush out to buy any high-tech stock
based on the $999 trend, alone, analysts caution.
Morgan Stanley's Mary Meeker said last week in a
note to clients that business couldn't get much
better for Compaq. But she concedes she is
"flinching" in her conviction about her
"outperform" rating on Compaq because its shares
are up 150% so far this year. What's more, she
says, Compaq had to turn up unit sales growth of
56% to turn out revenue growth of only 31%.
Some investors are waiting for the dust to settle
before they make any bets on the cheap PC
market. Lots of people think PC prices will have
to fall really low -- to $300 or so -- before
penetration into U.S. homes will really take off. At
those prices, analysts say, no computer maker
would win. And if the cheaper models spread to
the U.S. corporate market, some say the
industry's profits could really tumble.
Others, however, see at least short-term benefits. "Clearly, this is coming on
stronger than people expected," says Ed Petner of Lynch & Mayer. "I think it
will lead to a great Christmas for some tech companies," he says, including
Microsoft.
One surprising aspect of the $999 trend is that only Compaq seems to have
anticipated the demand. International Business Machines doesn't even have a
model, and last week said it will restructure its PC division to respond to the
trend.
"IBM, at least initially, missed this wave and they are rethinking their strategy,"
says Hambrecht & Quist's Mr. Bakar. Dell Computer and Gateway 2000 also
have yet to respond. Even Hewlett Packard, which has usually excelled in the
low end of the market, has been slow out of the gate, just recently launching its
sub-$1,000 product in recent weeks.
To be sure, personal computers below $1,000 existed before, in a price range
Packard Bell dominated. What has changed, however, is that Compaq's Presario
model is a better quality, more powerful machine than earlier cheap models. "At
$999 you can get a decent computer now. At $1,500 you get a really good box,"
says ABN Amro's Mr. Wu.
Sales have been strong for PC vendors such as Gateway 2000 in the
$1,000-to-$2,000 range for a while. But the emergence of the under-$1,000
market signals a changing trade-off between higher prices and extra processing
power.
Though most component prices have been falling for years, computer prices
had stayed relatively steady, partly because Intel has kept rolling out new
microprocessor generations whose extra power helped justify prices $2,000 and
above.
But that seems to have changed with Intel's Pentium II, says Cowen's Mr.
Peck. While Pentium II costs vendors $500 or more, Cyrix has a chip powerful
enough to make most users, such as net surfers, happy for $79. "The
performance for Pentium II isn't dramatically higher than for Pentium," Mr.
Peck says.
Other suppliers could feel the pinch of the $999 market as well, analysts say,
such as disk-drive makers such as Seagate Technology and Western Digital.
But few companies that look like big losers will sit still and let the $999 market
get away. "If Intel planned to sit on its hands, National Semiconductor and
AMD would make out great. But Intel has sent lots of signs that it won't sit on
its hands." In that event, he says, Intel will prevail.
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Barry |
