Here's a pretty good analysis by Montgomery Securities on the whole e-machines thing:
10:19am EDT 3-May-99 Montgomery Securities (K. King 415 627-2820) AAPL CPQ DEL
eMachines: Revolutionary or the Next Packard Bell? (2of2)
NATIONSBANC MONTGOMERY***NATIONSBANC MONTGOMERY***NATIONSBANC MONTGOMERY
PC HARDWARE
(PART 2 OF 2)
Kurt King (415) 627-2820 Handout
Cindy Shaw (415) 913-3608 DJIA: 10789
Jason Wells, CFA (415) 627-2131 S&P 500: 1335
NMSGI: 168
EMachine Compaq Hewlett
Packard
Price (post rebate) $399 $599 $719
Price (with 15" $549 $704 $819
monitor, post rebate)
Processor 333MHz Cyrix 333MHz Cyrix 366MHz Intel
MII GX MII GX Celeron
Memory 32 MB 32 MB 64 MB
Hard Drive 2.1 GB 4.0 GB 6.4 GB
CD-ROM 24X 24X 32X
Speakers Low end Premium Premium
Warranty Service Mail-in / 90 day on-site1 year on-site
Replacement 1 year carry-
for 1 year in
Technical Support by 7x16 for 15 7x24 for 1 7x24 for 1
Phone days year year
from first
call
Software MS Works MS Works MS Works
MS Money MS Money
Quicken Basic Quicken Basic
MS Encarta MS Encarta
MS Word MS Word
misc. other misc. other
Evaluating the eMachines product -- not a bad deal if the dollars really
matter. We enlisted the expertise of our desktop engineering department to
disassemble and evaluate a $399 (after $75 rebate) eMachine PC and $100 eView
monitor. As expected, we found the eMachine to be quite satisfactory given its
price; the only truly critical thing missing from the system we purchased was
the $75 rebate coupon! Note that eMachines takes $50 out of the price of a
total system by offering a 14 monitor, versus Tier One vendors' minimum
offering of 15 monitors. Price notwithstanding, we found the eMachines system
to be something of a mixed bag, with such positives as cables color-coded to
ports and some high quality, name-brand components installed alongside somewhat
low quality CD-ROM and floppy drives and low-end external speakers. Overall, we
would gladly recommend an eMachine to the truly budget constrained buyer. The
trade-offs are straightforward, namely lower performance and quality and more
limited features, service and phone support than is currently available at the
higher Tier One price points.
Outlook -- Think Revenue, Not Units
Going forward we should measure PC companies by revenue growth, not unit
growth. The arrival of lower consumer price points reinforces this notion. The
onset of heavier industry ASP pressure in 1996/1997 has led vendors to tout
unit growth and downplay revenue growth in their public communications. This
can lead to some overly optimistic conclusions when vendors achieve unit growth
and corresponding market share gains primarily through penetration of
progressively lower consumer price points. The sale of, say, a $50,000 server
at 40% gross margin should obviously be valued by investors differently from a
$400 PC sold at 10% gross margin, even though unit growth numbers reported by
vendors miss this distinction. Note the difference below between Dell, whose
growth has been strongest in its enterprise segment, and Apple, whose recent
share gains have come mainly from the consumer market.
(most recently reported Dell
quarter) Apple Compaq* Gateway
Revenue Growth (y/y) 9% 38% 66% 22%
Unit Growth (y/y) 27% 55% 26% 31%
ASP Change (y/y) -13% -10% 11% -7%
% of Revenue from 36% 15% 15% 35%
Consumer
* As-reported data (e.g., excludes DEC from March
1998 figures).
The arrival of 'fat pipes' into the home is the best hope for ASP
stabilization, although we're probably a year or more away from the benefits
becoming material on an industry level. Broadband links allowing, among other
things, real-time video and easy access to large data files generally aren't
yet available to consumers lacking thick wallets and/or the correct home
location. The accelerated adoption of DSL and cable modems we're likely to see
in the U.S. over the next two years will lead to increased data flows, feeding
demand for more robust PCs than those currently purchased to cruise the web
through snail-like 56.6k modems. Bigger pipes will almost certainly accelerate
upgrades within today's consumer installed base, particularly those 486 and
Pentium-based boxes bought at $2000+ price points in the mid-90's.
Generating alternative revenue streams is the key to success within
consumer. Most attractive is attaching Internet access to the PC sale.
Depending on a vendor's hardware margin levels, gross profits from attaching a
year of Internet access are the equivalent to an extra $200 to $600 in PC
selling price. In addition, attaching add-on sales (peripherals, software,
financing contracts) can add hundreds dollars to a sales ticket, although
vendors will generally miss this opportunity if they're not selling direct.
Dell and Gateway each recently announced programs intended to drive add-on
sales to multiples of their previous portions of revenue mixes.
Despite a delayed pursuit of the lowest price points, the big brands will
win at the end of the day. There's little 'first mover advantage' to new
entrants differentiated by price. Given the biggest vendors' huge scale
advantages and ability to commandeer retail shelf space, we're confident we'll
see the same consolidation at the lowest consumer price points we've already
seen in every other price band. We recall Packard Bell just five years ago
holding about a 40% share of the retail market, prior to an onslaught by HWP
and CPQ. Although Packard Bell has never been consistently profitable, for the
last three years it has struggled to keep its doors open with the help of
funding from NEC, its corporate parent.
Implications for Vendors and Their Stocks
Implications vary by vendor. As usual, the direct model appears best
positioned. Packard Bell appears most vulnerable. More important than overall
market trends is the business model and target market of the individual vendor.
Our take:
o Packard Bell NEC (private) -- Most vulnerable, in the cross-hairs of the
new entrants. Packard Bell's traditional franchise is the first-time,
price-sensitive buyer, the top candidate for a new eMachine or anything
else with a low price tag. Packard Bell has been on shaky ground since
Compaq's and HP's consumer groups began pushing down-market in 1996.
o Dell -- Least vulnerable, most in control of its destiny. Consumer is
only about 15% of Dell's business. Within consumer, Dell has mastered the
art of using direct customer relationships to segment out the most
sophisticated, high-budgeted buyers and therefore has the most
profitable, highest ASP consumer business in the industry. Dell recently
disclosed plans to begin pursuing sub-$1,000 consumer sales, but
initially only at high triple-digit price points, and only at attractive
profitability levels. We think Dell's consistent 60%-80% unit growth rate
in consumer over the last two years is sufficient evidence there's little
defensive about Dell's current strategy. To the contrary, we view Dell as
methodical in moving gradually to lower price points as improved
efficiencies and product mixes allow stable operating margins.
o Gateway -- The savviest consumer marketer; absent from retail channels.
Gateway's position is not bulletproof given its heavy reliance on the
consumer market broadly defined. But the company still benefits from the
ability to segment customers and up-sell low-end customers to higher
price points. The company says only about 10% of its unit sales are below
$1000 currently, reflecting the fact that the most budget-constrained
consumers tend to shop other channels. The direct model allows Gateway to
aggressively pursue add-on sales (as evidenced by its YourWare program)
which should cushion ASP pressure going forward.
o Compaq, HP and IBM -- Forced to react to lower retail price points; this
is negative but exposure can be offset by other businesses. We believe
each vendor has accelerated its plans to hit lower consumer price points,
which should couple continued high unit growth with sustained ASP
pressure going forward. It's clear these vendors, particularly Compaq and
HP, will accept cannibalization of their higher price points over losing
share to new entrants. Consumer PCs are about 15% of CPQ's revenue and
closer to noise level for HWP's and IBM's overall businesses, meaning
more competition at the margin within consumer PCs is probably not
material to these companies' earnings outlooks.
o Apple -- Directly exposed to downward retail price trends, making
sustainable revenue growth even tougher; proprietary platform provides
some insulation. The Mac clearly doesn't exist in a vacuum, especially
given the importance of new consumers to Apple's long-term growth
strategy. Accordingly, it's not clear to us how Apple can escape the kind
of ASP pressure that last quarter led to 27% unit growth but only 9%
revenue growth against an easy comparison.
For complete report, please contact the associate analyst.
End of part two of two
First Call Corporation - all rights reserved. 617/345-2500
END OF NOTE
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