What do you get when you buy a sub-$1000 PC? I knew that the sub $1000 PCs were the fastest growing segment, but my impression was that they were also extremely limited machines. But take a look at what CPQ is selling for less than $1000.
Would you believe
200 MHz chip
6.4 GB Hard Drive
32 MB RAM
56k modem
DVD-ROM drive
And the article's writer thinks CPQ is making good (not great) money on these machines.
investor.msn.com
Posted 1/9/98
Archived 1/16/97
Compaq and the Profits of
Doom
A few winners are bound to emerge from
Asia's turmoil. The No. 1 computer maker is
a prime candidate.
By Jim Jubak
Most stocks don't thrive during economic
meltdowns, bloody revolutions or financial
collapses. For example, you'd have lost
your shirt -- and perhaps more -- investing
in the frock-coat industry during the
French Revolution. Cake makers? Who
could make a buck with Marie Antoinette
as your celebrity spokeswoman? But bad
times always produce some winners --
often surprising ones.
In the early stages of most revolutions, for
example, owners of distilleries and
winemakers reap huge profits as alcohol
becomes the preferred method for getting
local carbohydrates from farm to
consumer. (A warning to market timers:
Take profits early, since the collapse of
agriculture will make raw materials hard to
find. And do remember to smuggle your
profits and yourself out of the country.)
I know from my mail that a lot of you have
been looking for companies that would
actually prosper as a result of the turmoil
in Asia. Well, so have I, and based on my
efforts so far, I'm convinced there are such
businesses -- they're companies that buy
parts, subassemblies, or finished goods
from hard-pressed Asian suppliers who are
more than willing to cut prices, and these
companies then sell finished products into
predominantly non-Asian markets. Names
like Home Depot (HD), Wal-Mart (WMT)
and The Gap (GPS) spring readily to mind
-- and investors have started to snap up
shares in companies like these.
But retailers aren't the only kind of
company that fits this bill. Manufacturers
of all kinds, including a strikingly large
number of high-tech manufacturers, are
set to benefit from the same deflation of
prices. It's harder to find one of these
companies -- you have to work through the
company's manufacturing system to
understand what parts of the finished
product are made where. But for that very
reason, I think stocks in manufacturing
companies that source in Asia may be the
most profitable way to play the current
economic turmoil. And the stock of a
high-technology company that will profit
from the upheaval would be especially
attractive, since everyone knows that the
slowdown in Asia will hurt technology
companies.
>>>>>>>>>>>>>>>>
>>>>>>>>>>>>>>>>>>>>>>
These new $800 machines aren't merely $200 cheaper
than the $1,000 models of last winter -- they're better too.
Compaq's original Presario 2100, for example, used a
Cyrix MediaGX 133-megahertz chip -- no "Intel Inside"
here -- that handled the audio, graphics, and controller
functions normally performed by additional chips. That
resulted in slower graphics performance, but the
compromise shaved $100 off the cost of the box. To save
a few dollars more, the Performa came with a relatively
slow hard drive and without any expansion slots. And it
was available only in black. Still, Compaq's engineers had
picked their compromises well, and customers found the
machine's ratio of price to power attractive.
Less than a year later, a customer is making far fewer
sacrifices for $200 less. The new Presario 2240, for
example, uses a faster 200-megahertz Advanced Micro
Devices K6Mmx chip. The system comes with 32
megabytes of memory instead of 24, a bigger hard drive
(6.5 gigabytes instead of 2), a 56k modem (instead of
33.6), and a cutting-edge DVD-ROM drive instead of a
plain vanilla CD-ROM.
Can Compaq possibly be making any money at all on this
machine? Every analyst on Wall Street knows that the
company makes its biggest profits selling high-power
desktop computers and servers to the corporate market.
The company could be willing to cut margins to the bone
at the low end of the market to prevent some competitor
from building the volume that results in manufacturing
efficiencies. Compaq, which owns more than 30% of the
personal-computer server market, could afford that tactic.
But I don't think Compaq has to use high-end sales to
subsidize its sub-$1,000 business. You've probably read a
lot about how the company -- already the most efficient
manufacturer in the personal-computer industry by many
measures -- has cut costs out of its distribution system in
its hot pursuit of Dell Computer (DELL). Those increasing
efficiencies certainly don't hurt Compaq's bottom line -- but
the real key to its ability to make money on an $800
machine lies with the companies that actually make most
of what Compaq puts in its boxes.
The industrial giants of the 19th and early 20th centuries --
U.S. Steel, General Motors, U.S. Leather -- made almost
everything that went into their product. U.S. Steel mined
the coal that fired its furnaces. U.S. Leather owned the
oak forests that produced the bark tannin that it used to
cure its leather. General Motors made the batteries that
went into a Chevy or Caddy.
In comparison -- and I don't mean this as a slight in any
way -- Compaq is more a packager than a manufacturer.
The company takes microprocessors from Intel (INTC) or
Advanced Micro Devices (AMD), graphic chips from S3
(SIII), disk drives from Quantum (QNTM) and turns them
into computer systems. When the prices of those very
sophisticated raw materials drop, so do Compaq's costs.
And right now the prices of those items are sinking like
stones.
Some of this has nothing to do with the Asian crisis. For
example, the hot competition between Intel, Advanced
Micro, and Cyrix/National Semiconductor (NSM) is almost
entirely the function of technology cycles in the
microprocessor industry compounded by slowing demand
for personal computers. (See my last column, "The Two
Faces of Intel," for more on that battle.) The falling price of
microprocessors accounts for most of the $200 price cut
in Compaq's offerings all by itself. In the first quarter of
1997, an Intel Pentium MMX 166 chip -- one faster than
the Cyrix chip Compaq used in the Presario 2100 -- sold
for $356. Right now the same chip goes for $112,
according to Lehman Brothers. The faster 233-megahertz
chip sells currently for $213. Figuring that Intel's
competitors have cut prices at about the same speed as
the industry leader, plummeting microprocessor prices
alone have cut $143 out of the cost of Compaq's product
even as the company improved what it sells.
But the Asian crisis is pitching in to cut Compaq's costs
too. Compaq itself does very little manufacturing in the
countries hit hardest by the currency crisis. Its factories
are located in Houston, Scotland, Brazil, Singapore, and
China. The latter two nations have managed to escape the
worst of the Asian currency devaluation so far, so I don't
expect that Compaq will get big cost savings from its own
manufacturing.
To measure the real effect of Asia, you've got to look at
Compaq's suppliers. Western Digital (WDC), a major
supplier of disk drives, makes its products in California,
Singapore, and Malaysia. (Malaysia's ringgit is down more
than 40% against the dollar in the past 12 months.)
Competitor Quantum Corp., headquartered in Milpitas,
Calif., actually has farmed out all of its manufacturing to
Japan's Matsushita-Kotobuki Electronics. That's produced
a double price cut from a falling yen -- down 10% against
the dollar in the past 12 months -- and from the
plummeting baht and ringgit, since Matsushita-Kotobuki,
like many Japanese companies, has moved substantial
parts of its manufacturing to Southeast Asia. Seagate
(SEG) makes all of its drives in Southeast Asia.
The disk-drive companies were swimming in over-capacity
even before the Asian slowdown. That produced major
price cuts, especially at the low end of the market (1.2-
and 1.6-gigabyte hard drives) as these companies tried to
move inventory quickly to make room for more profitable
6.4- and 9.3-gigabyte components.
But the cash crunch that has hit Korean manufacturers is
likely to drive prices even lower as companies such as
Samsung and Hyundai look for sales at any price as long
as they'll bring in dollars.
The savings from dropping prices in hard drives -- about
$30 a machine, I calculate -- aren't the end of the story
either. Memory prices have collapsed. The new Presario
uses a graphics accelerator from S3 with major Asian
content. And on and on.
I don't think Compaq is making a killing on each $800
machine that it sells, but thanks to these price trends I
believe the company isn't selling the product at a loss
either. In fact, I think Compaq may be in the enviable
position of being able to grab market share from less
efficient manufacturers by aggressive pricing of a
feature-loaded machine and still be making more money
on its cheapest system than it was a year ago.
That's the fundamental case for buying Compaq now. The
technical case argues for a bit of patience. Currently,
Compaq's stock takes a pounding whenever any
technology company announces bad news. Shares are
stuck in a relatively narrow trading range of $56 to $62. I
don't think that Compaq will make much of a move higher
until we're through the steady dose of bad news that
January earnings announcements are likely to bring. Since
14% of its sales go to Asia, we could even see bad news
from Compaq in this period, before the mathematics of
lower costs kicks in. I'm going to watch the stock carefully
for a while before adding it to Jubak's Picks.
Given the red ink I'm expecting to see running in the
streets in the next few weeks, I think I'll sit on the
sidelines like Madame LeFarge and stick to my knitting. |
