John, here's a briefing.com interview with Dan Niles and Art Russell re PC stocks.
Updated: 08-Mar-99
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This week's topic: PC Makers
Panelist
Dan Niles, Senior Technology Analyst at BancBoston Robertson Stephens
Art Russell, Technology Analyst at Edward Jones
Q&A
Briefing: Has the recent sell-off in PC stocks been overdone? What are some of the contributing factors that have led you to your conclusion?
Dan Niles: I do think that the sell-off in PC stocks has been overdone and I will discuss some of the events that have contributed to the overreaction. Following Dell's (DELL ) recent disappointing results,Compaq (CPQ) announced during the last week of February that its sales of PCs had been soft for the first six weeks of Q1:99 with orders picking up in mid February. That, coupled with DRAM pricing weakness, has led to the question: "Is this the beginning of a cyclical downturn, or is it just seasonal?" We believe the PC industry is seeing normal seasonality versus cyclicality (with some market share shifts) and that true demand slowed in front of the PIII rollout with expectations being reset to more achievable levels. Expectations have gone from unduly pessimistic (June 98) to unduly positive (January 99) and are now headed back to the overly negative camp. There were many theories exiting Q4 that Q1 could see flat sequential PC unit demand. Our belief is that the PIII, like every other major product transition before it, is having the same effect - demand is slowing down in front of the transition. The good news is that demand should start to pickup over the following month. Also in Q1:98 and Q1:97, we exited the prior year with excess channel inventory. We entered Q1:99 with inventory levels the best in two years.
Though Asia as a whole is somewhat improving, the issues in Brazil are somewhat dampening the overall recovery expected abroad. Latin America is definitely an area of concern. As a result, we view the foreign markets as not providing much upside from a seasonal Q1 versus original expectations.
In addition, in the PC market we believe that the major players are closer competitively than they have been over the past year. As a result we believe market share shifts between the major players can obscure what is truly happening in the PC market. For example, in the first half of Q1, we believe that unexpected weakness at Dell and Compaq is being offset by unexpected strength at IBM (IBM ) and Gateway (GTW ).
Art Russell: Yes, we do think the sell-off has been overdone as PC sales in the first quarter are normally weaker than the fourth quarter. Nonetheless, this is a market that alternates between fear and greed, and when the former takes root, stocks can fall in a hurry. Weaker than expected sales to small- and medium-sized customers and a general delay in purchasing ahead of the release of Pentium III were the precipitating factors behind the sell-off. Driving investor fear, however, is uncertainty over whether this is just a bump in the road or the start of a sustained downturn. In our view, it is most likely a bump in the road as it is mainly a product transition issue. February sales are looking better and the fact that Intel hasn't brought down guidance is an encouraging development.
Briefing: PC makers are broadening their Web-retailing presence by selling accessories in addition to computers. What does this shift portend not only for the PC industry, but for the technology sector in general?
Dan Niles: We think that the fact that the PC makers are broadening their Web-retailing into accessories is a logical extension. It makes sense, for instance, that Dell would begin selling printers, digital cameras, etc in terms of growing top line reach. It will change the economics of the PC makers business models and it will also change the competitive landscape, making brand name reputation increasingly important as competition increases.
Art Russell: The success of AOL and Yahoo! has awakened the PC makers who are beginning to realize that a lot of eyeballs hit portal spaces; and given the decline in average selling prices for PCs, the move into becoming portal players will allow them new ways to generate revenue and gross profit margins. Gateway has been a pioneer in this approach, but Dell and Compaq (CPQ) are quickly getting on board with this strategy. The main benefits are that they will develop a recurring revenue stream, they will maximize the revenue they generate per customer as they will be able to provide more upgrade options at the time of sale, and they will be able to steer customers toward their private-branded web-sites, thereby generating ad revenue and e-commerce fees. This shift into Web-retailing will eliminate the smaller players as economies of scale will favor bigger players. Therefore, we are likely to see increased consolidation activity in the technology sector.
Briefing: What is your view of the Y2K issue and the residual effect it has had - and will have - on the PC makers?
Dan Niles: Y2K has been positive for the PC makers. Spending has increased so that consumers are certain that they are compliant. But human nature is to put off today what can be done tomorrow. I haven't talked to any IT managers that feel they are where they want to be with regard to Y2K. I think that the positive effects of Y2K will continue throughout this year and that spending will not fall off in Q2 as some have suggested. The US is ahead of Europe on this issue, so we will probably see increased spending out of Europe.
Art Russell: The Y2K issue has been somewhat confusing as executives at Intel, Dell, Compaq, and the like have all said that Y2K will be a net positive through the first half of the year, and right out of the gate, PC makers are showing slower sales. Overall, though, the Y2K issue has had a positive effect on the PC makers as corporate customers have been upgrading their systems. What's important to remember is that the corporate market buys roughly 80% of new PCs, and that they're not going to make all of their purchases in one weekend. That said, many companies are still not where they want to be with respect to Y2K so PC makers are likely to continue to benefit from Y2K spending as the year progresses.
Briefing: Which stocks are you recommending and/or avoiding?
Dan Niles: I have a STRONG BUY on Intel (INTC), Micron (MU), Texas Instruments (TXN), LSI Logic (LSI), and Compaq (CPQ).
Art Russell: Our two favorites are Compaq (CPQ) and Gateway (GTW). We have a STRONG BUY rating on the former and a BUY rating on the latter. The selling in Compaq has been dramatically overdone, and if you're a long-term investor, now is the time to step up to purchase an attractively-valued stock. We also have BUY ratings on Dell (DELL) and Hewlett-Packard (HWP). Dell is a long-term core holding, but its lofty valuation presents a near-term risk in light of concerns over slowing revenue growth. If you own the stock, and are a long-term investor, we would suggest a dollar-cost-average approach.
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