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Does Tech Sector's Woeful Week Portend Big Trouble For the Industry, or Is It Just a Case of Inventory Blues?
By Eric J. Savitz
Has demand for personal computers actually started to slow? That's the frightening question now gripping technology investors, thanks to a horrific week that featured discouraging forecasts on PC trends from Compaq, the biggest hardware vendor; Intel, the industry's most important parts supplier; and CompUSA, the leading computer retailer. Makes you think the whole sector is in big trouble. Or maybe not. Let's take a closer look.
The freshest evidence of trouble in PC-land came from Compaq after the
close of trading on Friday. Compaq warned that sales in the first quarter would be flat with the year-ago quarter, with roughly break-even earnings. The company blamed the weak results on highly competitive conditions in "the North American commercial market." In a statement, Compaq noted it has put in place price cuts and "aggressive promotions" for the first and second quarter to reduce channel inventories, and that its outlook for the second quarter is "cautious." In after-market trading Friday afternoon, Compaq shares were down more than two points, at 25 1/8 .
Compaq's disclosure comes just two days after Intel warned Wall Street
that first-quarter sales would be sharply below expectations. In January, Intel had projected that first-quarter revenues would be flat with the $6.5 billion reported in the fourth quarter. Now, Intel says revenues will actually be 10% below the fourth quarter's -- about $5.85 billion, if you do the math. Intel also warned that its gross margin for the quarter would be about 53%, down from 59% in the fourth quarter -- Intel had previously projected that gross margins would be down several points, but not six points. Finally, Intel warned that expenses in the first quarter would rise about 3% from the fourth quarter, owing in large part to a $165 million writeoff related to its recently completed acquisition of Chips & Technologies. Previously, Intel had forecast a 2%-5% drop in expenses.
While Intel didn't directly comment on earnings, the Street can take a
hint. Current-quarter estimates dropped to about 70 cents a share, from 93 cents. Likewise, projections for both this year and next were trimmed severely. Robertson Stephens, for instance, dropped its estimate for this year to $2.85 a share, from $3.80, while reducing its 1999 estimate to $3.45 a share, from $4.55. Soundview Financial, a smidgen more optimistic, went to $3.20 this year, from $3.77, and $4.00 next year, from $4.40. Tom Waldrop, an Intel spokesman, said the "simple" explanation for the shortfall boils down to weaker-than-expected demand for microprocessors from PC manufacturers.
Now, there are two possible explanations for why that's happening. PC
makers might be working down high inventories -- certainly, Compaq on Friday said it was doing just that. That explanation would be good news; work off the excess inventory, and things get back on track. And certainly, there has been concern for several weeks that some PC makers, Compaq in particular, have had too much inventory in the hands of third-party distributors. Alternatively, it's also possible end-market demand has simply softened, or at least shifted to the low-priced end of the market. That obviously would not be such good news.
Intel's Waldrop declined to offer a theory on what's really happening.
He did, however, note that most of the shortfall came from North America and Europe; Asia came in on plan. The weakness in Europe surprised some people, given a widespread perception that demand for technology goods there has been improving. Meanwhile, Waldrop contends, demand for Intel's high-end processor line, the Pentium II, remains on plan, "so the shortfall was elsewhere."
Mark Specker, the insightful PC analyst at Soundview Financial, believes the inventory correction theory, "with one caveat." The coming months, Specker warns, will see the introduction of new high-end server and desktop models from most of the major PC makers, to take advantage of higher-powered Intel processors. The server market, he notes, will shift away from machines based on Pentium Pro chips to boxes based on Intel's speedier Deschutes chips. Specker warns that some server buyers will simply hold off purchases pending arrival of the new gear. It seems to be already happening. "I've been hearing that IBM has a really large inventory of unsold servers sitting in the channel right now," he says, "and Compaq's inventory could be high on that front as well."
The bigger issue, Specker says, is what's happening with corporate PC
demand. Again, he notes that all the major PC makers will be rolling out new models in March and April. "It's not really in their interest to take a lot of older Intel processors right now in the face of the new chips and the new designs which are coming. They will want to push finished goods out ahead of the product rollouts." And that suggests continued pressure on prices, as Compaq demonstrated Friday.
Compaq, Specker adds, had no choice but to take steps to reduce inventory in the dealer channel, especially given Dell's continued success with a no-inventory strategy. "It's been fashionable to say Compaq will reduce inventories," he says. "Well, now they have to reduce channel inventories. PC makers essentially buy parts and convert them into systems. The value of the parts they buy drops on average 1% a week.
As for sub-$1,000 PCs, Specker contends Intel will have to face up to a fundamental change in the structure of its business. The $1,000 PC market has broadened downward, rather than upward, he says. "That's new. It's important. When the market was broadening upward, the market was waiting for the next new chip, to go faster. It gave Intel enormous power. They controlled the future. With a market broadening at the low end, people buy boxes with chips that have been available for a long time. So other manufacturers like AMD, Cyrix and others can come in and offer chips with lower performance. It's causing the biggest dislocation in Intel's business model. They have to be price-competitive if they want to participate. Long-term, we have to recognize that fundamental change. The competition has an opportunity, and it will get more adept as time goes on. These are enormous, wrenching changes."
Despite Specker's theory, Intel's Waldrop insists that the disappointing results aren't related to a lack of focus on the sub-$1,000 PC market. "We don't see any indication that this is coming from a loss of market share in the $1,000 arena," he says. "We continue to believe our market share in that segment is roughly comparable to the rest of our product line." Maybe so, but Intel nonetheless seems intent on strengthening its product offerings at the low end, as demonstrated by the introduction last week of its Celeron family of processors, targeting the low end of the market. Meanwhile, Intel's chief rival in the microprocessor business, Advanced Micro Devices, disclosed in an SEC filing last week that its first-quarter loss would increase significantly from the $12 million it lost in the fourth quarter. AMD also said revenues this quarter will drop "significantly" from the fourth quarter's $613 million.
Compaq's Friday earnings warning followed cautionary comments earlier in the week from its chief financial officer, Earl Mason, at a Merrill Lynch technology conference in San Jose. We can't tell you precisely what Mason said -- Merrill didn't let any journalists in, and Compaq can't seem to find a transcript of his remarks. But according to a report last week by Lucianne Painter, Merrill's PC analyst, Mason warned that the pricing environment in North America appears to be tougher than previously thought. Painter, in fact, dropped her short-term rating on Compaq to "accumulate" from "buy," and cut her first-quarter earnings estimate to 32 cents a share from 37 cents. Obviously, she underestimated the damage, because Compaq now says it will earn nothing in the quarter. Like Intel, Compaq had indicated that sales in Japan and Asia remain weak, but no more than expected. Unlike Intel, Compaq indicated that Europe is on target.
Compaq may have cleared the air on its inventory problems, but the company still has other issues to address. "The list of things we don't know about Compaq is long," says Specker. "Inventory levels, the structure of the Digital deal, how big the acquisition-related writeoff will be, how the businesses will come together, the investment strategy in the legacy Digital businesses, the management structure."
Give Intel credit for coming clean about its woes. CompUSA's disclosure of problems wasn't quite as pretty. After its shares plunged 6 1/2, or 20%, Thursday, a bigger percentage drop than Intel's, CompUSA finally issued a press release saying comparable-store sales in its fiscal third quarter (ending March 28) "may be lower than the company's planned midsingle-digit level." The release also conceded that while "it is pleased with its volume of unit sales, the average selling price of personal computer systems has
continued to decline." Apparently, CompUSA disclosed this information by dribbling it out to analysts before releasing it to the public. Naughty, naughty.
While Intel shares certainly have had a tough time, falling 10 7/8 Thursday, and 11 9/16, or 13%, to 78 1/8 for the week, in the broad scheme of things investors have treated Intel astonishingly gently. As recently as last summer, Merrill Lynch had projected earnings for this year of $5.60 a share -- nearly twice what some observers now expect.
James Townsend, chairman and portfolio strategist at Soundview Financial, observes that Intel has now missed the quarter or made a bearish forecast on future results for four quarters running. The stock has gone essentially nowhere since then -- which, when you think about it, is amazingly robust performance, given a nearly 50% drop in Street expectations. Quite a testament to the investment community's belief in the power of Intel's near-monopoly control of the microprocessor business. |
