NEW YORK (CNNfn) - Following earnings warnings from Dell Computer, Apple Computer and Intel Corp., investors certainly have reason to be concerned about the future growth rate of the personal computer market.|
However, the outlook for computer makers is not as dark as it would appear, analysts say, partly because almost all of the players in the industry have diversified their operations beyond the desktop PC to servers, storage, notebooks and Internet service. In addition, the current valuations of the "box makers" already assume a significant slowdown in PC demand, leaving room for positive surprises, analysts said.
"Demand is off somewhat in the third quarter, but not nearly to the degree that it has been portrayed in the press," said Kevin Knox, research director at Gartner Group. "Europe has been a slow quarter for everybody, but I don't think there is a reason for panic that the industry is slowing down."
In fact, the warning that Dell (DELL: Research, Estimates) issued Wednesday evening was only a minor tweaking of its previous guidance on revenue and earnings. The company said that its fiscal year revenue growth would be about 27 percent rather than 30 percent, and that fourth quarter earnings per share likely would be "a penny or two" below its previous guidance. It was not a huge adjustment by any means, and most companies would be thrilled to have a 27 percent increase in revenue when they reach Dell's size.
In an interview with CNNfn, Dell's chief financial officer, James Schneider, said that demand remains strong across almost all of the company's product segments and geographies. [454KB WAV, 454KB AIF]
Ashok Kumar's warning
US Bancorp Piper Jaffray analyst Ashok Kumar can take credit for being one of the first analysts to warn about a slowdown in demand for microprocessors and PCs. On Sept. 5, he cut his stock rating of chip giant Intel (INTC: Research, Estimates) to "buy" from "aggressive buy," citing continued demand weakness, no seasonal recovery, oversupply and weakening fundamentals.
"We feel that unless business picks up substantially over the next three weeks, there is risk to our revenue estimate of $9 billion," Kumar said at the time. The Piper Jaffray analyst predicted that Intel stock would "pull back to its base in the 60s."
While Kumar was widely criticized for being too bearish a month ago, the subsequent series of earnings warnings from several technology bellwethers makes him look prescient. Intel stock, which stood around $69 when Kumar issued his now-famous research note, closed yesterday at $42, a 39 percent drop.
The revenue and earnings warning Dell issued after the close Wednesday sent the stock down $3 to $25.19, a two-year low. It was the third time this year that Dell had advised analysts to lower their revenue growth-rate estimates. Dell's comments also trashed the stocks of other PC makers, with Hewlett-Packard (HWP: Research, Estimates) dropping $7.38 to $88.25, Gateway (GTW: Research, Estimates) losing $2.77 to $49.13, and Compaq (CPQ: Research, Estimates) shedding $3.64 to $25.20 in late afternoon trading.
Dell cited weakness in sales in Europe and to worldwide small-business customers for its shortfall. However, in an interview on CNNfn's In the Money program Thursday, Kumar said that the small-business market actually is very robust, and that the weakness in PC demand stems from Fortune 1000 companies. [207KB WAV, 207KB AIF]
Bear Stearns analyst Andrew Neff cut his outlook for Dell's fiscal 2001 earnings per share to 92 cents from 94 cents and his fiscal 2002 estimate to $1.05 from $1.20.
"From a macro perspective, there is a demand problem in the PC industry in consumer (not that meaningful for Dell), U.S. small business (owing to dot.coms) and in Europe, because of economic factors," Neff wrote in a research note. "In our view, there is potential for further pressure on the estimates since we expect to see a more aggressive pricing environment over the next few months, which puts estimates for Dell and its competitors at risk."
On the other hand, SG Cowen's Richard Chu said that the bad news is already reflected in Dell's stock price. But that didn't stop him from downgrading Dell's stock Thursday.
"To a very large degree, the significant compression in Dell's valuation over the past 18 months already discounts this secular slowing, with price-to-trailing revenue now at 2.5X, down from upwards of 5-6X not too long ago," Chu said in a research note Thursday. "Accordingly, our upgrade of the shares in July and this downgrade cannot be more ill-timed."
A Compaq spokesman had no comment on Dell's warning Thursday, citing the "quiet period" that precedes the company's quarterly earnings releases.
"We don't give incremental guidance during our quarter," said Compaq spokesman Alan Hodel. "However, our senior vice president of sales and services, Peter Blackmore, said on Sept. 22 that our worldwide momentum is clearly continuing and European demand is currently tracking within our expectations."
Gateway spokesman John Spelich also declined to comment on Dell's announcement, citing a quiet period before Gateway's earnings release.
"In mid-September, before we entered the quiet period, we expressed comfort with the consensus estimate of 46 cents per share in earnings and $2.5 billion in revenue," Spelich said. "We have no plans to pre-announce financial results."
Spelich noted that in the second quarter, 40 percent of Gateway's net income came from non-PC sales, such as Internet service, financing and training. Gateway aims to get that number up to 45 percent by year end. In addition, only 6 percent of Gateway's revenue comes from Europe, which is where Dell and Intel have encountered a sluggish market.
Hewlett-Packard couldn't be reached for comment.
Beyond the box
Recognizing that the desktop-computer business is both cyclical and maturing, PC makers have moved aggressively into faster growing lines of business, such as servers, storage and support service. This makes them less vulnerable to a downturn and also less of a monolithic group that rises and falls together.
"The PC market is in a very mature stage in its evolution," said Eric Klein, senior analyst at the Yankee Group in Boston, Mass. "That is why vendors are expanding their strategies beyond the box, expanding into services and storage. You also see Intel moving into the rapidly growing area of communications chips."
Dell's rapidly growing sales of servers, storage products and notebooks account for almost 50 percent of its revenue, making it less of a PC company than most people perceive it to be. Gateway's beyond-the-box business strategy drove its gross margins to a record 23.3 percent in the second quarter, despite the fact that average unit prices for computer hardware are dropping. Gateway's Internet service has grown to more than 1.5 million users.
While PC makers have successfully diversified beyond the box, Microsoft's new Windows 2000 operating system for corporate use hasn't driven PC demand as much as analysts had anticipated.
"While Windows 2000 is important for the enterprise market, there is not a mad rush to adopt it," said Yankee Group's Klein. "The urgency isn't there because the platforms that exist today work."
"The adoption of Windows 2000 has been slower than we anticipated initially, but it will be one of the drivers that keeps PC demand going in the future," said Gartner's Knox.