Is the PC era really over?
In IBM's 1998 annual report, the words of IBM's chief executive Lou Gerstner are startlingly clear: "The PC reign...is over."
Self serving, yes--but in my view, correct. This doesn't mean certain segments of the PC market won't grow, however, considering that IBM recently reported significantly better results in its PC operations. It's just that the PC market, finally, is showing signs of maturity.
Does this mean that investors can't make money in PC stocks? Not really. It's just that the PC stocks will become more cyclical in the future--just as stocks are in other more mature industries. Many firms will attempt to expand as well into other markets to fuel growth. As Darwin would say, they must evolve--or perish.
This, I think, is what IBM is attempting to communicate--that the PC is no longer the center of the industry, and customers realize that it has become, so to speak, a commodity. The new focus is on the network, or more broadly speaking, the Internet.
Already, companies like Compaq and Hewlett-Packard that have both been less than consistent in their PC operations have focused their business on the Internet. This is why IBM has set its sights on services and software, while shying away from its hardware past. And even the PC players that use a direct-sales model--in my view the best business model in the segment--are shifting their focus and subtly expanding their offerings.
But to back up, has the market really matured? By all accounts, the roughly $200 billion PC business is the largest single product segment in the $1 trillion Information Technology market. And while unit growth continues to run at 13 percent to 15 percent by my estimates, this unit growth has appeared mostly at the low-end, driving application service providers (ASPs) for most vendors well below $1,000. Net result--the industry revenue growth is only forecast to be 3 percent to 5 percent this year. Certainly the technology innovation, and sheer power brought to the desktop by the component suppliers creates a dynamic environment, but as a whole, this is not generating greater revenues for the PC original equipment manufacturers (OEMs).
This environment has actually created signs of strain at the OEM level, especially as each of the top five players want to gain market share, often at a multiple of the market growth. This was significantly easier in 1996, when the top five firms claimed a 35 percent share of the market, but is much more difficult now that they control close to 60 percent.
Furthermore, the white-box business doesn't show any signs of disappearing anytime soon. Given the size and diverse reach of the overall PC market, I don't see any major dislocation that would affect all players, but slowing growth over time. Opportunities abound, with international PC penetration significantly lower than the U.S. market, especially in the consumer segment, and the new lower ASP products are opening up real potential in developing countries such as China.
From an investment perspective, I am increasingly focused on vendors that have sustainable cost advantages, or who are in the process of turning around operations--both characteristics of good stocks in more mature industries. The build-to-order, direct model in my view gives players such as Dell and Gateway sustainable cost advantages. Of the two, I prefer Gateway (As of April 23, 1999, trading at 69.5) as a near-term investment, as it also embodies elements of a turnaround, as significant new management has been brought on board to revive and accelerate growth in Europe as well as expand distribution options.
As far as the large indirect players are concerned (Hewlett-Packard, IBM, and Compaq), only IBM appears to be in the middle of a sustained turnaround, and has shown good progress enhancing its cost position. Each of these players will likely have times of strength, but I don't believe sustained leadership will be possible by any of the companies as the market slows. Watch for each of these vendors to emphasize segments outside of desktop PCs (such as servers or portables) to try and drive growth.
Of course this could all change if a new "killer" application appears, driving a significant upgrade cycle. Whether voice recognition, streaming video, or some other application will become a "must have" still remains to be seen, but don't count out PC industry innovation.
Philip Rueppel is a research analyst with BT Alex. Brown Incorporated. This column is not a publication of BT Alex. Brown Incorporated and may not represent Mr. Rueppel's complete or current opinion with respect to any company. Persons who want to make an investment decision with respect to any company mentioned by Mr. Rueppel should obtain a copy of Mr. Rueppel's current and complete opinion as contained in the most recent publication of BT Alex. Brown Incorporated. Mr. Rueppel's opinions are not intended as an offer or solicitation, nor as the basis for any contract for the purchase or sale of any security, loan or other instrument.