PC Hardware: Preview November Monthly Monitor Report
08:03am EST 10-Nov-97 Lehman Brothers (Kimberly Alexy, CFA)
Today's Date : 11/10/97
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* In our November Monthly Monitor report, we highlight end demand trends in
both the corporate and consumer PC market, discuss average selling price (ASP)
and margin trends and focus on recent trends in the data storage industry.
* We will be resuming our Weekly PC Retail Sales survey, designed to assess
Christmas PC sales trends, next week. This month, we summarize ongoing impact
of sub-$1,000 and discuss consumer demand trends by vendor.
* Unit demand in both corporate and consumer PC market remained strong through
the month of October. We continue to believe sub-$1,000 are stimulating
incremental unit growth.
* While unit growth remains strong, however, we are seeing downward pressure
on ASPs from mix shift in the consumer market and increased price
aggressiveness in corporate markets.
* Unit growth remains strong for the drive stocks as well, but pricing
aggressiveness is pressuring earnings results.
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PC Demand Themes
PC demand through the month of October has remained strong at both corporate
and consumer markets. Concerns surrounding currency devaluation and weakness
in Asia Pacific economies caused a sell-off across the market and in
technology stocks, in particular. In general, unit PC sales into A/P remain
relatively small at approximately 12% of total unit volume. We estimate
minimal impact on total revenue growth as a result of such weakness. Our
larger concern is the continued decline in ASPs and reduced gross margin
contribution.
Throughout October, PC unit demand trends in both corporate and consumer
channels remained strong. However, while unit growth continues to be strong,
ASP declines continue to pressure revenue growth. For some companies, this
negative mix shift towards lower-margin consumer sales is causing margin
pressure. We believe ASP compression is occurring in both corporate and
consumer markets. Several factors are triggering ASP declines.
First, the strength of consumer PC demand coupled with the negative mix shift
associated with demand for sub-$1,000 systems is placing downward pressure on
ASPs. In addition, more aggressive price actions by indirect PC vendors in
the corporate market -- we believe, in an effort to compete more aggressively
against Dell -- have led to further pressure on desktop ASPs. Lastly, excess
notebook inventory are also contributing to weaker ASPs in this segment.
Positively, PC server growth remains strong and with ASPs two to four times
desktop ASPs, some offset is provided for those companies focusing on PC sever
sales.
PC Survey Summary
This month we continue our telephone survey checks of the consumer retail PC
market. With the holiday selling season fast approaching, we will soon be
reinstating our weekly surveys. The results of these surveys will be
published in weekly First Call notes, as well as summarized in future Monthly
Monitor reports.
In our survey this month, products from Compaq, Hewlett-Packard and Packard
Bell continued to be mentioned as the most popular. Each of these vendors has
delivered compelling price/performance packages into the consumer market.
While Packard-Bell remains the price leader, the strength of the Compaq and HP
brand names have provided competitive differentiation, especially on the low-
end frontier. With all three of these brands, plus Acer and some third-tier
players, having sub-$1,000 offerings, consumers now have available to them a
whole family of offerings in this price range. IBM has also announced a $999
product (the Aptiva E16) which, though supposedly shipping since October, has
not shown up in our surveys to date. Big Blue was late to market with a
product in this space and has suffered because of it.
We note the absence of the Japanese vendors from the popularity charts so far
in the second half of this year. While desktop systems from Sony and Toshiba
are still widely available, they have yet to repeat the strong showing in our
survey results that they turned in last year. Going forward, we will closely
monitor the success of these brands in the consumer retail desktop PC market,
as any continued weakness could signal a pullback by these companies from this
market segment (whether strategic or unintentional), and in any case would be
a further positive for the remaining players.
Compaq's three-tiered approach in its Presario desktop line aligns well with
the consumer market segments described above, and we believe that this has
helped the company in its exceptional consumer retail performance during the
last several months. Over the last month, Compaq has remained the dominant
consumer brand, as reported by our survey respondents. With their recent
Presario price cuts, we expect them to continue to be a category killer in the
consumer retail space.
Another market trend we are watching is the success of built-to-order PCs in
the retail channel. CompUSA entered this market in mid-September with its
"American" and "American Pro" PC lines. On their latest earnings conference
call, the company reported that demand for the machines dramatically exceeded
expectations. Even so, CompUSA management reported, there believe there is
little issue with vendor conflict, as they see the house-branded machines as
going primarily after markets where the major vendors are seeing little
penetration. This would imply the "screwdriver shop" systems builders, who
sell at low cost with little brand recognition. We still see vendor conflict
this as an area of risk for the program, as is the risk associated with so
directly staking the company's brand franchise on its internal product
business; if any major foul-ups do occur with the machines, CompUSA will have
to shoulder the burden of blame.
Addressing the profitability of the BTO business, margins on the machines were
described as being similar to the margins realized on sales of systems made by
other vendors. Tandy's Computer City chain is also said to be stepping up its
BTO efforts, reportedly negotiating with a third-party to partner in corporate
and consumer BTO programs, with goals of eventually making the systems
available through retail as well as on-line.
Promotional activity showed an uptick from last month's meager levels. A
number of package deals were available, with typical package prices in the
$1,200 to $1,400 range. Also, rebates continued on hard drives from Western
Digital and Maxtor, and one retailer offered additional break-point based
discounts on systems (starting on systems priced at $1,200) with additional
rebates on printers and monitors (monitor discount break points based on
screen size).
PC Channel Themes
Throughout our channel checks during the month of October, product demand
levels remained strong. In fact, as a general rule, growth prospects sounded
better than in recent memory. Most resellers indicated product growth levels
tracking between the high-teens and low-thirties.
Pricing aggressiveness by the indirect vendors has appeared to be limiting
Dell's share gains at several corporate accounts. Specifically, Hewlett-
Packard recently designated a pool of funds designed for use in competitive
bids against Dell. IBM is expected to announce a similar program. Resellers
may access this pool at their discretion in an effort to be more competitive
in a timely manner. In the past, even if the indirect vendors were willing to
match Dell's price, they had difficulty matching Dell's response time.
Resellers noted that Dell would frequently come in "at the eleventh hour" and
win the deal. Now, with the pool of funds concept, resellers are not bogged
down waiting for approval to match Dell's bid.
As a result, most resellers state that in large corporate accounts, the Dell
price delta has been successfully eliminated as a result of such pricing
actions.
When asked about Compaq's build-to-order program and any noted improvements in
meeting five-day turnaround objectives, most stated that while demand for the
product was very strong no material improvement I five-day delivery had yet
occurred. Channel assembly programs, however, will be ramping later this
month. Such programs have the potential, pending resellers' successful
execution, to significantly reduce inventory levels and drive fast and timely
order fulfillment.
Inventory levels generally remain unchanged at approximately five to six
weeks. We expect that as end demand levels remain strong and as channel
assembly begins to roll-out that inventory levels will gradually work down.
Indirect vendors continue to target two weeks as the stated inventory goal.
However, PC vendors will soon need to abandon their quarter-end channel
stuffing practices to make progress on such inventory reductions. To
accomplish this objective without risk to sales objectives, end sell-through
levels will need to be strong enough to pull through existing inventory levels
and sales of new BTO/channel configured products.
Data Storage Themes
With the enterprise drive environment not expected to improve for another two
to three quarters, we have been closely monitoring the desktop pricing
environment for signs of similar weakness. The lower capacity points -- below
2.0GB -- had been under pressure in the September quarter, negatively
impacting third quarter earnings results for both Seagate and Western Digital.
Quantum remained generally insulated from this weakness given its focus on
higher desktop capacity points.
Now, price aggressiveness has spread into the 2.0 and 2.5GB capacity points,
and we believe there is risk of further extension into 3GB and higher.
Western Digital's pre-announcement on Friday was triggered by a variety of
factors, but desktop pricing aggressiveness remained the primary culprit.
Fujitsu was targeted as the vendor displaying the greatest level of pricing
aggressiveness. In addition to negative pricing trends, Western Digital was
further impacted by cost difficulties associated with extending the life of
its older inductive product offerings and cited the company's late transition
to MR as now causing a competitive disadvantage.
In our recent meeting with Seagate, aggressive pricing at the 2.0 GB capacity
points was confirmed. Management noted surprise at the recent spread of
pricing degradation to this higher capacity point, but maintained that 2.5GB
desktop products and above remained on allocation.
Quantum has maintained that desktop pricing has generally remained within
normalized levels and cited its product focus on higher desktop capacity
points (3.2GB and above) as reason for reduced exposure to industry price
pressures. We are concerned that on its lower capacity points, Quantum is
experiencing desktop margin pressure. We are further concerned that such
pressures may extend upwards into higher capacity points which until now, have
been experiencing normalized levels of decline. Bleeding of further desktop
price aggressiveness into higher capacity points will be the critical variable
to watch.
Positively, all vendors are scaling back on production and end demand levels
remain strong. With limited capacity coming on board coupled with the
strength of end demand levels, the critical question is at what capacity point
will demand and supply re-align? We continue to monitor pricing trends in an
effort to understand this cross-over.
We would note that Western Digital and Seagate have the greatest exposure to
the HDD pricing weakness in the industry. And while we have already lowered
numbers on both vendors, we expect there may be further downside risk to our
earnings estimates. Quantum, however, is least exposed to such pressures for
two reasons. First, largely as a result of its leadership in the MR
transition, the company is focused on higher desktop capacity points which are
enjoying both strong demand and more normalized levels of price decline.
Second, the company's tape business represents approximately 60% of normalized
earnings. This business has been successfully cushioning HDD price weakness.
Quantum will be the name to watch most closely over the upcoming weeks. If
signs of price aggressiveness at higher capacity points surface, we would
question Quantum's ability to meet current earnings expectations. At this
time, the company continue to track to prior guidance. |
