Revenge of the Killer $1000
PCs
The Motley Fool - January 06, 1998 18:15
HWP Hewlett-Packard IBM CPQ Compaq AMD Advanced
Micro Devices INTC Intel DELL NSM National Semiconductor DEC Digital V%MFOOL P%TMF
The inexorable move toward cheaper and cheaper personal computers
continues apace, as Monday Hewlett-Packard (NYSE: HWP) announced the
introduction of a sub-$1,000 PC featuring lightning-fast
microprocessors, while today IBM (NYSE: IBM) introduced the first of its
Aptiva computers to be priced below that magic $1,000 mark and Compaq
(NYSE: CPQ) unveiled dramatic changes in its Presario line of PCs,
including a $799 computer that contains a sixth-generation chip made by
Advanced Micro Devices (NYSE: AMD). As a result, technology that less
than a year ago could only be found in computers that cost more than
$2,000 can now be found in machines going for half that price.
Sub-$1,000 machines have become the fastest-growing part of the PC
market, and recent estimates suggest that since their introduction last
February, they've garnered 41% of the consumer PC market.
While Compaq's move is but the latest in the company's relentless
cutting of consumer prices in the pursuit of market share, and while
IBM's move represents a belated admission that the company's premium
pricing of the Aptiva line was a tactical mistake, Hewlett-Packard's
announcement is something of a departure for a company that has taken
its time entering the cost-cutting fray. This is the first H-P computer
to be priced below a grand, and, perhaps more importantly, it is the
first $799 PC to contain a CPU built by Intel (Nasdaq: INTC). Over the
past year, H-P has remained a major player in the PC market, even as
second-tier competitors have begun to fall by the wayside. But it has
not enjoyed the kind of dramatic sales growth that Compaq and Dell
(Nasdaq: DELL) have produced. This new computer may be a sign that H-P
is ready to take off the gloves and get in the ring.
The more interesting question, though, is whether basing the new PC on
Intel architecture will make a difference to consumers. In that sense,
what Hewlett-Packard's new PC will do is give us a sense of whether
brand-name quality matters to customers who are buying sub-$1,000 PCs.
And that's a crucial question for the future of not just PC
manufacturers, but also of Advanced Micro Devices, Intel, and National
Semiconductor (NYSE: NSM), whose subsidiary Cyrix also makes
Intel-compatible chips.
Previously, Intel had conceded the sub-$1,000 market to its rivals, but
last month it abandoned that strategy and announced plans to move
strongly into that market. Its price cuts on both the older-generation
Pentium chips (like those used in the Hewlett-Packard PCs) and on its
top-of-the-line Pentium II chips have been sharper than usual. While
Intel traditionally has kept premium pricing on its newest chips for six
months or longer in order to reap the benefits of the huge margins these
chips offer (since once they're being manufactured, top-of-the-line
chips cost no more to make than older chips), the move toward cheaper
PCs has made price cuts impossible for even Intel to resist.
Intel has, of course, done a magnificent job of creating a brand
identity around a part of the computer that consumers never even see.
The "Intel Inside" ad campaign has been crucial to Intel's maintenance
of its 80%+ share of the PC microprocessor market, and the company's
stunning ability to build chips reliably and efficiently has made its
margins far superior to those of either AMD or Cyrix. Nonetheless, it's
far from clear how potent the Intel brand really is, and whether
consumers will be satisfied with AMD's K6 chip if its performance is as
impressive as has been advertised.
Compaq apparently believes that they will, since half of its new
Presario models feature the K6 chip, the speed and graphic capabilities
of which are comparable to those of the Pentium II. Investors saw the
announcement of this deal as good news for AMD, sending its shares up 5%
on Tuesday. Certainly AMD is the company with the most at stake in the
growth of the sub-$1,000 market, and it represents an interesting play
for investors willing to gamble against Intel's manufacturing and
technological prowess. AMD had a ferociously bad year in 1997, watching
its shares drop 31% on the year while missing earnings estimates in its
last quarter and reporting a loss for the year as a whole.
Although AMD spent millions of dollars on an ad campaign pushing the K6,
and although various computer magazines touted the chip as superior in
performance to Intel's best chips, the company had enormous trouble
ramping up production of the K6 and also found itself unable to produce
anywhere near as many chips per wafer as Intel. (The more usable chips
per wafer, the lower your production costs are.) At the same time, for
much of the year AMD was stuck selling its chips to customers like Acer,
Digital (NYSE: DEC), and Fujitsu, all of which were facing the problem
of shrinking market share. In addition, AMD's complete absence from the
corporate-PC playing field has kept its margins low, while the same is
true of its reliance on the sub-$1,000 market in consumer PCs.
On the other hand, the fact that AMD currently owns such a small section
of the market -- somewhere between five and seven percent -- for
microprocessors means that it has a lot of room to grow. It also means
that a relatively small increase in market share would have a major
impact on the company's bottom line. AMD was on track to sell somewhere
between 1.5-2 million K6 chips in its last quarter, and has estimated
that it will sell as many as 9 million of the chips in 1998. Obviously,
the Compaq deal represents a small, but nonetheless important step
toward achieving that goal, particularly given Compaq's aggressive sales
strategy.
AMD's shares have been driven down so far that the company does look
like an interesting play at this point, at least if one believes that
the PC market will continue to grow briskly in the year ahead. It would
be a mistake to invest in AMD in the hope that it will unseat Intel.
AMD's cash supplies are so relatively small and its production
performance remains so relatively mediocre that Andy Grove doesn't have
anything to worry about in the near future. But AMD's technology is
top-notch, and the market in which it's playing is big enough that
profits are there to be found. The real question now is whether, after
five years of unfulfilled promises, AMD will be able to take advantage
of this latest opportunity. |
