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HolidayBuyer's Guide
Tech Industry

Wall Street gives up on PC stocks

Wall Street has given up on PC stocks. Gateway's fourth quarter profit warning discouraged analysts so much that many of them now liken PCs to TVs, a commodity business that investors should avoid.

Gateway's (NYSE: GTW) revelation that its revenue would fall half a billion dollars short of expectations and earnings would disappoint in the fourth quarter and 2001 whacked shares of all PC makers. Compaq (NYSE: CPQ), Apple (Nasdaq: AAPL) and Hewlett-Packard (NYSE: HWP) were just a few stocks to take a hit early Thursday. Gateway was off 35 percent to 19 in early trading.

Gateway's downgrades were too numerous to mention. Some analysts also downgraded other PC stocks because of Gateway's woes. Lehman Brothers analyst Dan Niles downgraded his whole "PC universe" and cut ratings of Intel (Nasdaq: INTC), AMD (NYSE: AMD), Dell (Nasdaq: DELL) and Micron Electronics (Nasdaq: MUEI) to name a few. Niles added that Intel's quarter "isn't in the bag" in light of the PC problems.

Whether the companies blame macroeconomics, inventory woes or pricing competition, the message is clear -- investors' fascination with PC stocks is about to fade.

"The one good outcome of the GTW news is that it should begin the process of semi-permanently removing PC demand as an element of continuing interest from the investor dialog (no one asks about color TV sales to dealers, once a hot topic) --- this is a secularly mature business," said Richard Chu, an analyst with SG Cowen.

Chu, like many analysts, has been warning about the PC business for awhile. What's different this time is the unanimous view from Wall Street and the resignation that PC sales are going to be flat at best for a long time.

Saturation vs. economics

Gateway's contention that macroeconomic issues were the biggest reasons why its sales and earnings fell flat sounded the warning bells for many analysts. "We believe the macro picture is getting worse," said Niles. "After the summer earnings debacle in the PC names driven by macro concerns around Europe, we have watched overseas demand issues come to our shores.

Sure, consumer spending, the Federal Reserve's six interest rate increases and even the election flap have curbed holiday outlays this year, but PCs are also nearing the saturation point.

"What do we make of the company's woe-is-me, it's the economy explanation for its troubles?," asked J.P. Morgan analyst Daniel Kunstler, in a research note. "Certainly the macro-economic climate is not as exuberant as last year, and the consumer seems to be whipping out the old credit card at a less frenzied pace than many would have hoped for. Neither Gateway, nor any other PC company wants to hear comments about specific sign of saturation in the desktop PC market, but some of the signs are there."

For Kunstler those signs include Apple's disappointing sales of its G4 Cube and Compaq's fourth quarter guidance, which had already factored in disappointing consumer PC sales.

Kunstler and other analysts hinted that Gateway botched its outlook and was caught offguard regarding the slowdown in consumer spending.

Why Gateway's profit warning hurts

So why would a profit warning from the consumer-oriented Gateway rattle so many analysts?

The biggest reason is Gateway's "beyond the box" focus. "While other PC vendors have missed revenue and earnings expectations or lowered guidance, Gateway was able to survive the slowdown in PC demand in the first three quarters of 2000, because of its focus on the US consumer market and strong sales of its non-system offerings," said David Bailey, an analyst with Gerard Klauer Mattison.

"With the company's pre-announcement, it appears that the weakness has worsened, and without a near-term catalyst, we do not expect consumer demand to increase substantially through the first half of 2001," said Bailey.

The consumer sales slowdown just aggravates weak corporate spending. When you add it all up, it isn't pretty.

With Gateway's Internet appliance effort and non-system profit growth, the company may eventually free itself from the fluctuations of PC sales, but it isn't there yet, analysts said.

Price wars and profit warnings

If demand is as bad as Gateway predicts, the company could alter its strategy in 2001. You can also expect more warnings from competitors.

"In checking with other PC companies, while everyone was unanimously surprised by the magnitude of Gateway's shortfall, we were offered no new guidance though we maintain that there could be similar announcements from Gateway's competitors -- Compaq, IBM, Apple and HP -- which puts their EPS estimates at further risk," said Bear Stearns analyst Andrew Neff.

On a conference call with analysts, Gateway CFO John Todd said a price war is likely as vendors try to clear out inventory.

Analysts said a price war is just another reason to stay away from PC stocks. Here's the scenario most analysts are painting: PC vendors try to clear out inventory with price cuts, but no one is buying because of macroeconomic woes. The pressure builds until profit margins erode even further.

Buying opportunity?

Despite all the gloom and doom, a few analysts floated the idea that the PC stock carnage was an overreaction. UBS Warburg analyst Don Young noted that Gateway at $20 is still undervalued even when you factor in the lower estimates.

Young, however, was in the minority.

"We would not view depressed share prices as a buying opportunity," said Bailey. "Although the sell-off in the PC group may be overdone, we do not think current levels are attractive entry points. Indeed, with a possible price war and a cluttered channel, we think the sector will experience weakness through possibly first-half 2001."


• The Day Ahead: High tech's hard landing
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