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Analysts: No clear point to Dell's price war

The computer maker keeps digging trenches in the PC price war, but Wall Street questions whether the battle is even worth fighting.

Dell Computer keeps digging trenches in the PC price war, but Wall Street questions whether the battle is even worth fighting.

Confident of victory, the PC maker has made it quite clear that it will continue the campaign and has given no signs of a letup.

For analysts, the biggest worry is that Dell has initiated a protracted war without any clear end game. If you're going to fight a war, there'd better be some spoils for the victor, analysts say. Investors don't mind that Dell is gaining market share in the PC sector, but they're not willing to trade profits for market share forever.

Dell didn't do a good job of soothing Wall Street in its first-quarter earnings conference call Thursday. The company met reduced estimates with earnings of 17 cents a share, but told analysts to cut estimates slightly for the second quarter. Dell said sales could fall 3 percent to 5 percent in the second quarter, sequentially.

The company is being "ruthless" about cutting costs and recently cut jobs, but it appears that Dell is hurting itself as much as the competition.

Dell executives said it's worth the fight. "The opportunity to consolidate share quickly has never been better," CEO Michael Dell said in the company's conference call. "The share gains are the engine for future growth."

But Dell wouldn't answer questions about what market-share number would satisfy him, an indication that the price wars could go on for a while.

"We do not believe we are at the bottom of this intense price competition but just played another move in a chess match that is far from over," said UBS Warburg analyst Don Young. "What is on the other side that makes the price war worthwhile?"

Analysts said Dell has set the pace for the PC sector, which could eventually look like the disk-drive or color-TV markets--commodity businesses where few companies can actually make money.

Dell figures it can lower prices, be more efficient and claim victory when its rivals consolidate and exit the PC game. Cost cutting will keep Dell profitable. When a truce is called, Dell theoretically will have the most market share and be able to grow its bottom and top lines.

Few analysts doubt that Dell is the most efficient of the bunch, but they still have concerns about profitability for the PC industry. "Sometimes being a great house in a bad neighborhood is not a good thing," said Morgan Stanley analyst Gillian Munson.

"We think that Dell has set itself on a course to continue to gain share. However, what isn't clear yet is where this takes the company over time," Munson said. "Dell's team talks a lot about gaining share and driving profitable growth. However, this misses one thing investors are really in need of: solid manageable bottom-line growth."

ABN AMRO analyst Robert Cihra said Dell's plan to trade profit margins to wage a price war is "somewhat irrational for a commodity-like market." Cihra points out that Dell increased its worldwide PC market share to about 13 percent in the first quarter this year from less than 10 percent in the first quarter of 1999, but over that same two-year period, Dell's operating income fell.

"Shipping an extra 1.6 million units per quarter, Dell's gross profit-per-unit was down an even greater 27 percent," said Cihra, who noted that profits have fallen even though Dell's share has grown in the higher-margin markets for notebooks, enterprise servers, storage and workstations.

Despite the big talk from Dell, Cihra said the PC maker could ease off its price war as soon as the PC market shows signs of growth and component costs stop falling. "The company wants to grow profits when the PC market rebounds," he said. "Dell has to show it can grow profits, not just be profitable as it grows."

But Cihra's theory is based on PC market growth rates picking up. Dell executives haven't said they will eventually refrain from trying to price the competition out of business.

Perhaps the biggest reason Wall Street doubts Dell is the lack of signs that the company's main rivals are going to concede the market. Second-tier PC vendors may crumble, but they aren't a threat to Dell anyway, analysts said. Simply put, Compaq Computer, IBM and Hewlett-Packard are not going to exit the PC business, and one of them would have to give up to significantly boost Dell's market share. That fact sets up a game of chicken where no one wins.

"We'd all like to tie this up neatly with a winner declared, but the idea that others are going to throw in the towel doesn't make sense," said SG Cowen analyst Richard Chu. "I expect to be on the beach doing something else by the time this story finally plays out."