THE DAY AHEAD: Should PC makers consolidate pronto?

Don't look now, but Bear Stearns PC analyst Andy Neff may have kicked off quite a debate on Wall Street. After the closing bell Tuesday, Neff released a "Manifesto for Change" for the PC industry. According to Neff, Dell should buy IBM's PC business, Apple should go Wintel and Gateway should sell out.

Neff's report zeros in on what's going to be a big problem. PC vendors are facing overcapacity and if they don't act now, shareholders will face years of disappointing results. Think about it -- do we really need all these Wintel box makers? Wouldn't just two do?

According to Neff, Wall Street will avoid PC stocks until there's consolidation. Here are the moves Neff proposes:

• Dell (Nasdaq: DELL) should buy market share, namely IBM's PC business or Gateway (NYSE: GTW). "It has cash and economics on its side," said Neff. "All it needs is some nerve to make its move to go after leadership -- which could be within its grasp." According to Neff, Dell should buy IBM's PC business to gain operations in Europe and Asia and beat Compaq for market share. And then Dell should buy Gateway to round out its consumer operations. However, Dell shouldn't go indirect -- too much baggage.

• IBM (NYSE: IBM) should exit the PC business, sell operations to Dell or Compaq, and ink a services deal. Neff's point is clear: IBM should ditch the legacy love affair with PCs. After all, Intel invented the DRAM business and then bailed when the economics went south. "We do not see a compelling rationale for IBM to be in the PC business," said Neff. "It does not seem to fit within its focus on services, software and technology."

• Hewlett-Packard (NYSE: HWP) should buy Compaq (NYSE: CPQ). "It's time for Hewlett to make offensive moves that will force its competitors to respond," said Neff. HP should get services and market share.

• Gateway should retrench and sell out to Dell or the Japanese PC players. Neff compares Gateway to those cool auto and beer companies that have a great niche, but eventually get gobbled up by larger players. Gateway's recent layoffs aren't enough and launching a price war is just plain dumb. "Gateway took a swing at the fences, expanded its distribution and went for share," said Neff. "Essentially, it's the same strategy that Napoleon adopted going after Europe -- but he ran into trouble in Russia."

• Apple (Nasdaq: AAPL) should drop PowerPC and go to Intel. Apple has already made one deal with the devil (Microsoft). So what's another? "Apple risks ending up like Silicon Graphics -- great technology but shrinking market and increasing competition," said Neff. Apple could also sell out to Sony.

Far fetched? Not really. A few of these ideas are no-brainers. IBM should definitely dump PCs and align with Dell. Apple, which has been hurt by Motorola's slow development of the G4 and the "megahertz" gap, should go with Intel. It won't happen, but it makes sense.

Neff shows some creative thinking that's often lacking in the analyst community. Other analysts are already calling Neff an alarmist. And they may be right in the short-term. However, I think Neff's long-term thesis -- the PC industry could look like the disk drive business in a few years -- holds up even if PC demand comes back. Anyone who has watched those lowly disk drive stocks knows all about the potential risks of overcapacity.

None of Neff's proposals will happen any time soon because PC makers are currently in denial. Oh sure, you'll see a few restructuring moves, but what's the point? "An attitude that we can outsmart, outwait, underprice, outthink, outstrategize the competition is prevalent -- but the competitors are thinking the same thing," said Neff in his note. There's plenty of denial to go around.

The cure is to eliminate overcapacity or develop new demand. PC vendors may have trouble boosting demand. PCs are cheap, but folks still aren't buying them. The companies that act first will get the best deals.

And one more cynical point to ponder: Bear Stearns has performed underwriting work for HP and IBM. If the PC makers mentioned above go for Neff's proposal, Bear Stearns may get a little more work headed its way.TDAIN

• Wall Street firm says PC makers must merge or die
• Day Ahead archive
• Get The Day Ahead>